Geckko's World

Sovereign annuities

2011-03-28T14:05:00.008+01:00

Comment on the launch of "sovereign annuities" [note: they aren't annuities] over at Irisheconomy.ie. I can't seem to comment over there. Not sure if I've been banned or something, but this worth noting. While the sarcastic tone is well deserved for the accompanying launch commentary - "there is no risk of default" (I wonder how the Financial Regulator feels about statements like that??), it might be worth noting that there could be some traction for the index linked issues if they pay Irish inflation, something to which Irish pension schemes are currently exposed to and against which they only have a rough hedge in the form of Euro inflation. Pension schemes would of course be sensible to combine such assets with appropriate Credit Default Swap cover.

Ireland's nuclear button

2011-03-11T13:20:00.004Z

There is a popular theory going around that Ireland has some form of nuclear button at hand in the event of negotiations with EU partners on our debt problems and their assistance don't go as we had planned.

The hypothesis is that if they don't give us what we want we will default and German banks, or the German economy will be at threat.

Just a quick reality check here. While the sums involved are indeed extremely large and will be fatal to the Irish economy, they are a fatal threat to neither the German banks involved nor the German economy. What they would be is a severe financial irritant.

What those debts are, under potential default, is a massive political concern for Angela Merkel and the German electorate. Irish default would be enough to be extremely annoying politically the very people we are trying to get something out of.

So the more we talk about such a possibility, the more trenchant the German government is likely to become as they attempt to send the message to their voters that they (Germans) won't be picking up the tab. That strikes me as completely counterproductive from an Irish perspective.

Markets sense a Euro end game

2011-03-10T09:45:00.002Z

If you want to see the best indicator of market expectations for the likelihood of widespread fiscal failure in Europe, you need look no further than the shorter end of the Irish yield curve.

Ireland is supposed to be backed by a line of credit that will float our finances for maybe 2-3 years. You shoud (should) feel relatively comfortable about lending to the Irish government over such a term given that they the EU/IMF credit line will provide funding for close to that period. And up until only a few months ago markets appeared to feel that way. Not so now. 3 year Irish bonds are yielding 9% to maturity.

Markets have a high expectation of a default event. The only way you could be fearful of such a scenarion would be if you believe the much trumpeted EU support fund, the EFSF, will burn through its €750 billion leaving nothing additional for Ireland to call on. The only place such demand will be coming from is Spain pretty much.

And this fear doesn't really appear to have hit the media headlines yet. This is the markets say that the Eurozone is going to default.

Talking tough with Europe - the markets watch

2011-02-28T10:58:00.004Z

As predicted and expected, it looks like a Fine Gael/Labour coalition government is in prospect for Ireland. While the two parties need to talk turkey before consummating their marriage, their is at least one policy area where we can already surmise the certain direction of the new government.

Debt restructure/negotiation. That means, reconsidering the position of creditors of those limited liability entities formerly known as Irish Banks. as well as some form of renegotiation of funding terms from the EU.

As has been commented on already be knowledgeable commentators, the only outcome of use to Ireland will be one that significantly reduces or curtails the prospective national debt burden, which is already at a level that arguably is not manageable.

So, is there likely to be any success on this score from FG/Lab? Monday morning gave us an early glimpse of the view of financial markets who are looking at nothing else:

So the early running on that question appears to be "no".

New year's predictions

2011-01-13T16:13:00.004Z

Well, only one really.

What, one may ask reasonably, could be a potential political patch that would leave the German and French governments free and willing to expand their support of the European Financial support mechanism? (stump up promises to back lots more borrowing).

Here is a tip. Keep an eye on the corporate tax rate.

Let's say I wouldn't be too surprised to see somebody float the idea that a Eurozone (maybe, at the risk of enraging the UK, EU wide) corporation tax levy.

Most likely something drafted in such a way that it prescribes a centrally remitted tax of, say, 10% (initially) on corporation profits, subject to a total corporation tax burden in any country of something like 30%.

Surprise surprise, German (and French) domiciled companies would not be subject to any additional tax. Ireland? well....

Go ahead, punk. Make my day.

2010-12-14T08:30:00.007Z

Dirty Harry understood that for a threat to have any effect it had to be credible. He didn't stick a banana in the face of some criminal low life, but a 44 Magnum (the most powerful handgun in the world, that would blow your head clean off).

In all the trivial inanity surrounding the AIB bonus fiasco I have seen all manner of stupid nonsense aired, but the latest "threat" by the minister that AIB will have its future capital funding withheld if the €40 million in bonus from 2008 are paid is up there with the best.

I can only imagine that the Chairman of AIB, or whomever took the call from Brian Lenihan had to restrain himself from the most obvious response - "or what?". Brian Lenihan isn't a fan of the movies. He has confused his Dirty Harry with his Indiana Jones, by bringing a knife to a gun fight.

But on a serious note, Brian (he's not the messiah, he's just very naughty boy), is most certainly penny wise and pound foolish. Hooray!!!! he has saved the taxpayers €40 million. Shame he is and will be (jointly) personally responsible for costing us up to €100 billion. And he stillr efuses to turn off the tap.

But the sad indictment on the country is that electorate cheered!

Quantitative easing in a monetary union - not as easy as it sounds

2010-12-02T09:00:00.009Z

The Eurozone is heading gradually off on a path that might require the authorities to consider a large scale QE policy.

If government debt becomes too large to manage, then one way out of the pickle is to create lots of inflation that will erode the stock of debt over time. It is smoke an mirrors or course, as it does not create any wealth, but simply creates a transfer from bond holders to governments. The losers tend to be pensioners, since they are the bond holders in society in the main and receivers of fixed income directly or indirectly from long term government bonds. But that is a distributional issue tangential to the purpose of this post.

This post is to ask a more practical technical queston. How exactly would QE work in the Eurozone? Normally, say in the US or UK, the Central Bank would buy government debt for new money. This increases the amount of money in circulation, which if enough, will create more than enough liquidity which will then, in effect, be given away by banks who in the end won't be able to find any counterparties to deposit it with - because all the banks will have more liquidity than they want or need.

More money in the economy per unit of output produced will mean the ratio of Euros to output (GDP) will increase. The value of money will erode, which is inflation. In a previous post I have described how inflation then leads to a reduced burden on those in debt who have borrowed over a long term. Basically this means governments.

Now what is interesting here from a Eurozone perspective is that there are usually two distinct things going on here. There is the liquidity and eventual inflation that the QE produces. However, just as importantly, the act of buying government bonds for money retires some government debt. The Central Bank is owned by the government, so those bonds purchased can effectively be written off. In other words, what has happened is that the government, via the Central Bank, has called in its bonds and swapped them for an extremely cheap form of liability, or debt, that it will never have to repay - money; Dollars, Pounds etc. which are merely another form of government liability (although sitting on the balance sheet of the central bank).

Do you start to see the question here?

In the US the Fed would buy Federal bonds. These are debts owned by all Americans. They can be retired (swapped) for fresh dollars in the manner I described. The US government debt is both reduced and deflated.

However, what of the Eurozone? Whose government bonds will be purchased? And after that, can we employ the same logic and retire those debts, letting some countries off the hook?

The answer to the first question is that we can and probably would buy the debt of those countries that are prospectively insolvent , that have too much debt. Step forward Ireland. The answer to the second question is that we can, but with the full realisation that the rest of Europe would be bailing our Ireland, Portugal, Greece, etc. by swapping the debt incurred by those nations for liabilities (Euros) owned by all of Europe. The inflation that would ensue would adversely effect all the normal losers in this process (those pensioners in particular that I mentioned), but those losers in Ireland will have benefitted by the reduction in Irish debt that will allow.

Who will like this solution?

The Irish, Greek, Portuguese, Spanish governments
Irish, Greek, etc. state and civil service pensioners
Irish, Greek, etc. taxpayers

Who will not like this solution?

German pensioners
German taxpayers

Those who might or might not like this solution?

Irish, Greek etc. private pensioners (they will have their pensions eroded by inflation, but governments will be better able to afford to maintain higher level of public services - especially health)

It sure makes QE in Europe one hell of a political minefield, something I have not yet seen mentioned in the media.

Just as an aside. Where might a QE program start? Where better than a purchase of the €80bn plus in Irish government debt held by the ECB in Repo. agreements?

How much wriggle room do we really have with the banks?

2010-12-01T15:17:00.003Z

Quite a bit actually.

I just had a perusal of Bank of Ireland data and as at June 2010 they had around €31bn in various bonds on issues. That includes many things like floating rate notes, but technically all ripe for "restructuring".

€31billion would have placed a nice buffer between the banks and us poor taxpayers. It should be used.

Waiting for an explanation

2010-11-30T11:22:00.002Z

What baffles me most about the Irish banking debacle is that I have not yet seen anyone offer an explicit explanation of why banks (plus buidling societies etc.) alone should be exempt from the insolvency laws that govern all other corporate entities?

It seems now to have been enshrined into the law of the land. Talk about moral hazard.

Breaking the piggy bank

2010-11-29T11:08:00.003Z

So we will be spending another €12.5 billion of our National Pension Reserve Fund as part of the EU/IMF "Bail Out".

This seems to have raised some hackles, but I don't know why. Generally, in your personal finances as well as national one you would always tend to use the cheapest source of funds first.

How much does our NPRF stash cost us? Well, we could retire €18 billion of Irish 6 year government debt for more than 8% per annum. That alternative use makes this expensive money.

We are at the point where we need to do everything possible to stem the growth in our debt. Ideally, we should have been cutting our exposure to bank liabilities. But if we aren't then we have to accept our rainy day has arrived. Time to break the piggy banks.

Scary numbers - debt dynamics in Ireland

2010-11-26T11:09:00.009Z

I thought I would review some of the debt dynamics for Ireland. It turns out that within a common currency area there is a twist on the normal dynamics that would apply.

Let's start with a little algebra. General government debt as a percentage of GNP will grow as interest accrues (r) and a the government run a deficit before interest (primary deficit) and it will be deflated by the rate of nominal growth in our income (GNP)

Using some mathematical manipulation we can see that the debt to GNP ratio will only stabilise or fall if the government runs a primary balance which is larger than the sum of the difference between Irish real growth and Euro real interest rate, plus the difference between Irish inflation and Euro inflation, all scaled by the ratio of debt to GNP.

When this is normally done for an economy the inflation terms simply cancel one another out - the inflation rate at which the economy grows is the same as the ex post inflation premium paid through interest. For Ireland and indeed any Eurozone country, this is no longer the case. What this is saying is that we are borrowing on terms that reward lenders with an inflation risk premium that relates to the currency of issue, the Euro. However, Ireland will need to service the nominal repayments out of a tax base that will rise only with domestic inflation. A nasty twist for Ireland at this juncture, when one might anticipate a significant ongoing real exchange rate depreciation - in common English; falling Irish prices relative to Euro prices.

So from this relationship we can play with scenarios.

I plug in numbers that would represent a pessimistic scenario relative to official plans.

Very weak medium term growth of 1%
Real Euro interest rates of 3% (5% minus 2% Euro inflation)
Deflation in Ireland relative to the Eurozone (zero inflation here, 2% in Eurozone)
All multiplied up by 150% which represent our debt to GNP

Under such assumptions Ireland would need to run a primary balance of 6% of GNP or greater. Our tarting point is a deficit of about 10% of GNP. We would need a fiscal adjustment 16% of GNP or more to stabilise our debt. And the kick is that if we allow the debt to GNP ratio to rise further the surplus we need to run on our primary balance becomes larger - i.e with debt at 200% of GNP that 6% required primary surplus becomes an 8% primary surplus. Ouch.

I think the worry is that the more we deflate (Irish inflation lower than Euro inflation) the bigger the fiscal adjustment needed. And the bigger the fiscal adjustment the more deflation we bring. A viscious cycle that leads to national bankruptcy.

Let's not underestimate what the stakes are with the decisions we will be making over the next weeks.

Why did AIB retain its stock exchange listing?

2010-11-24T13:50:00.007Z

It is a curiosity that AIB will retain its stock exchange listing for stock issued which accounts for one tenth of one percentage of the company's ownership. The obvious question is why??

Initially I thought it was to allow restructure and eventual sale of the company, without going through the hassle of nationalisation and a completely new IPO.

Then I read this:

http://ntma.ie/Publications/2010/SubDebtBurdenSharing.pdf

Thursday, 7 October 2010: Following the Statement on Banking made by the Minister for Finance on 30 September 2010 there has been some uncertainty among market observers and participants about the intended treatment of subordinated debt in issue from Irish banks.
In order to clarify the position the Minister has advised that prospective resolution and reorganisation legislation, insofar as it affects subordinated debt in issue, will apply only to such debt in issue from institutions which are not listed on a recognised stock exchange, are in 100 per cent State control and cannot survive in the absence of total State support.

My bold.

Note that AIB isn't going to be delisted from a recognised stock exchange, nor pass into 100% state ownership.

Comfort for AIB subordinated bond holders then. Thanks for that Brian.

Yours sincerely,

Taxpayer Bled-Dry Esq.

Oh, forgot to add. Can anybody name a bank that is not listed on a recognised stock exchange, is 100% owned by the Irish government and cannot survive without State support?

Anyone?

Closed to new borrowing!!!!!

2010-11-24T11:58:00.005Z

More tripe being spouted from government circles about why we need to stay committed to pouring more and more of taxpayers' money into Irish banks in order to prevent them going into insolvency and default on their liabilities.

The cry goes out "if there is a default on bank bondholders now, nobody will lend to us in the future".

OK, let's put aside the obvious point that nobody has been willing to lend to either Irish banks and now the Irish government at an affordable rate of interest for some time now and think about that alarmist statement. It is nonsense of course.

The fact is that default on bondholders today will not in itself mean lenders or potential buyers of bonds will be scared off in the future. In fact, the result could be expected to be quite the opposite if we finally manage to do the right thing policy wise.

Why would that be?

It is pretty obvious. Nobody will lend now at anything less than completely unacceptable (unaffordable) interest rates because they believe that the massive financial burden of the current and prospective size of Ireland's debt (government + bank losses assumed by government) will make it increasingly unlikely that they will get repaid.

However, if we quickly and it needs to be quickly stop the rot now we might have one last chance to write down a mass of bank assets and liabilities (which will mean bond holders), restructure them, likely with debt to equity swaps, and emerge with smaller banks with little concern over potential additional assets and liability write downs and a cap on the additional government borrowing that would be needed to fund the banks.

In effect draw a line right now under any potential future capital demands on taxpayers from the banks by putting them into nationalised administration (which I have mentioned before) and forcing the risk capital lenders to those banks to take the losses.

If we do that we then only (only!!) need to address the smaller (smaller!!) issue of general government finances in order to put a lid on government debt at a high, but not disastrous level - something around 130-140% of GNP.

And do you know what? People will lend to us again. They won't be looking back and thinking "well, they burned those bondholders last year", they will be looking forward and thinking "the losses have clearly been taken now and Irish banks and the Irish government are much better risks now". That is how markets work. Yesterday's loss is gone and irrecoverable. Markets look forward.

It still isn't too late, but it nearly is for Ireland.

Our banks need to be put under nationalised administration using special emergency legislation and restructured by defaulting on enough of the tier 1 and tier 2 capital (that includes senior bondholders) as required to make them unambiguously well capitalised with impairment free balance sheets.

End game approaching for Ireland - what to do?

2010-11-24T11:54:00.003Z

Does anyone have a plan to get Ireland out of this financial quicksand that is sucking the country under as we try and stop anybody (except taxpayers) losing money on our failed banks?

Well, yes. Here is one I made earlier - over one year earlier:

http://geckkosworld.blogspot.com/2009/08/more-nama-debate.html

But it doesn't have to be that way. The guarantee expires next year. The government can effectively renege by threatening to string out affairs until its expiry. This can be used as leverage to force the reconstitution of the banks balance sheets by wiping out current shareholders and doing debt-equity swaps on some bond holders to reestablish the banks.
If the shortfalls are too large the government could then force the banks to be declared insolvent and nationalise them on the basis that they tale only those liabilities they are required to - effectively deposits and secured creditors/bondholders. Then use taxpayers' funds if necessary to restore tier 1 capital. Only that way could you ensure that the burden on the taxpayer is kept to a minimum.

Keynes has a lot to answer for

2010-11-23T13:53:00.015Z

Well, that might be a bit unfair. John Maynard Keynes was an exceptionally clever person. It is hardly his fault that people get all confused by what he was saying.

It is an almost undeniable fact that probably more than 90% of the population (maybe more) believe that macroeconomics can be understood by reference to what is nothing more than a basic accounting identity - a banal statement of equivalence:

Y = C + G + I + X - M

Economics begins and ends there for an alarming proportion of the populous and an even more alarming proportion of opinion formers and decision makers (especially my bugbear, "successful businessmen").

Let's get one thing straight. All that little identity tells us is that everything we produce must by definition be bought and/or added to inventories. That is it. There is nothing else in there of use to understand economics, or formulate economic policy.

For example, it does not:

mean that not buying foreign (imported) goods will increase our output or incomes
mean that increasing government expenditure will increase our output or incomes
mean exporting a lot will increase our output or incomes

I could go on, but I think you get the picture. This national accounting identity is just a simplified algebraic description of how we deploy our income. Economics is really (really) about how we create that income in the first place.

So what made me blog this rant today? Believe it or not it was our new IMF overlords in a tangental way. A news report this morning that an IMF paper has floated the idea of a lower income tax rate for women on the basis that they "tend to put more back into the economy than men". And we had a couple of accountants (christ!) and other economic ignoramuses proclaiming what a clever idea. If I had to appraise this argument for its intellectual efficacy I would tend to the technical. Ughhh!! What a load of tosh.

The premise, as presented by the media, is that women will spend more of their income - increasing the "C" in our accounting identity above - hence leading to more output and hence incomes. Output and hence income, we were told, would increase. Huzzah!! We've found the magic formula!!!

Now, it is entirely possible that the IMF report does not make such an argument but that is exactly what was presented and commented upon.

So why is this stupid? It is stupid because if (if) such claims about propensity to consume by the female gender were true, giving them lower taxes than men would reduce growth in our output and incomes. Yes, reduce it not just in one year, but by a small amount every year forever.

To understand why this is so you have to forsake your beloved accounting identity and accept the power of the supply side (mwwaahaahhaaahaahaa).

We create output and hence income by combining labour with capital to create stuff that is greater than the sum of its raw material parts. There are three parts to this process; capital (income we don't consume), labour (blood sweat and tears), productivity (the ingenuity possessed to make stuff out of other stuff).

In market based economies we become wealthier each year because we experience increases in two of those three areas (the amount of labour we have is limited at 24-sleep-eat-etc.). Productivity rises because humans, despite our clear collective stupidity are strangely collectively clever. We become more ingenious as time goes by and can make more stuff and more useful stuff out of less stuff every year.

Then there is capital. This tends to rise over time because we will save some of our income, preferring to defer some of our consumption to later years rather than simply live hand to mouth. That means we have an increasing pot of capital (per head) available to use to produce output and income.

And that is where these spendthrift women come in. If we tip the incidence of taxation towards men and away from women and they do indeed consume more of their income each year, we will reduce the rate at which we accumulate capital. Lower growth in our capital stock means slower growth in our output and hence incomes.

Sure, there will be a lot more bling bling about and we might feel richer, but we will be poorer and the opportunity cost will rise over time as we forsake investment for lipstick.

Do you doubt it? Ireland has just completed a nation wide experiment of this very theory. We consumed and consumed until we made ourselves the poorest country in Europe. We have no capital, that is why the IMF is filling up our hotel rooms.

Today's fun number fact - 125%

2010-11-23T13:36:00.004Z

125%

The total net foreign debt of Ireland expressed as a percentage of our annual income.

To give a point of reference, Australia is considered one of the most heavily indebted economies in the developed world due to running a substantial current account deficit for decades and has a total net foreign debt of 67% of annual national income.

The UK is 22%

Another fun number fact

2010-11-22T10:39:00.011Z

Time for another fun number fact.

100%

The value of Irish domestic banking assets (equivalently liabilities) accounted for by lending to one another, expressed as a percentage of annual national income.

For point of reference, the number for the UK - another over-banked country is 30%.

Rearrange for the following words to make a coherent sentence:

as, cards, as, of, house, strong, a

....

Fun with numbers - today's fun fact

2010-11-18T15:53:00.003Z

Want a fun number fact?

64%

The current amount of "Repo" lending to Irish credit instutions as a percentage of our annual GNP. For those who don't understand jargon, that is probably a bit like going down to the pawn shop to borrow over half your annual income in order to buy this week's groceries down at Dunnes.

Stay tuned for another fun number fact tomorrow.

Mortgage forgiveness - an alternative

2010-11-12T15:38:00.009Z

The "mortgage forgiveness" proposal is a bad idea. Firstly it does threaten to introduce as well as exacerbate moral hazard problems (these have been quite transparently glossed over by some of the scheme's proponents), but worst of all is that it will not have any material macroeconomic benefit. To suggest it will is absurd, to borrow a phrase.

The reason is because this scheme will only transfer wealth between parts of Irish society, when the problem is our complete lack of wealth in total, or more accurately our now massive net indebtedness as a country.

The proponents say it will address the "mortgage default overhang", which is essentially to say that it will allow further required contraction in the balance sheets of the Irish banking system by writing down those banks' assets. However, it will do so in exactly the same way that the hair brained NAMA scheme has and will. It will create a capital hole in the Irish financial system which will be filled by government borrowing. It didn't work for NAMA I and that was when Ireland was far less grossly indebted than it is now. This mortgage forgiveness will be NAMA II, where taxpayers are forced to pile even more of their money into those same banks from a far far more indebted starting point. It is a really really bad idea, especially because we have only just tried this stupid idea, it didn't work.

So what should we do? This is what we should do:

Modernise Ireland's bankruptcy laws. There are many models in the UK, US etc., but they have similar features in that the force a crystallisation of loss on the debtor and creditor, the debtor is required to make as realistic reparation and there is a clear finite term (say 5-10 years).
Repeal the bank guarantees - yes I have said it countless times since I declared it hair brained upon its introduction. Of course that leads to bank collapse, so you take them into nationalised administration under some properly drafted legislation (what they should have done in the first place) and begin capital restructuring talks with creditors while allowing them to continue business.
End the political coercion that is stopping forclosure on mortgage holders who are defaulting on their loans.
Let markets get at it.

What would this do? Well it would do the following that the "Times 12" proposal will never do:

It will have a beneficial macroeconomic effect. As banks begin to write down bad mortgages as they deal with them on a case by case basis, capital losses will be taken by the banks risk capital investors - mostly foreign - and not Irish residents. There will be a positive net wealth outcome for the Irish economy.
It will be much more efficient. The lenders themselves are best positioned to determined what mortgages will or will not ever provide an economic return and they can foreclose and take the write down under the modernised bankruptcy laws. Simply having "negative equity" won't be enough - nor should it.
Banks balance sheets will contract in a relatively orderly and proper way, with liabilities falling as well. Smaller balance sheet less encumbered by non performing loans.
This will be far more equitable. This won't represent the arbitrary transfer of wealth being proposed by the Times 12. Those who lose will be those who lent the risk capital to the banks, not Irish taxpayers who managed their financial affairs sensibly.
Reduced likelihood that we promote moral hazard. Although modernised bankruptcy procedures would allow a clear exit path for borrowers beyond the point of no return, it would still be onerous and clearly punishing. Effectively, having to work for your creditors and your creditors alone for 5 years or more isn't an attractive option.
It won't treat the existance of "negative equity" as a problem. It isn't People in negative equity have exactly the same fixed cash flow burden they anticipated when they borrowed the money. They still have their property and as long as they continue to pay off their mortgage there is no problem to try and "solve".

Mortgage forgiveness and moral hazard

2010-11-10T09:50:00.013Z

Stephen Kinsella of Limerick University popped up on Newstalk this morning to tell the country that concerns that the floated mortgage debt forgiveness might cause increased problems of moral hazard as absurd, or somesuch dismissive noun. His argument is put here.

It wasn't a complete or particularly coherent argument, which is forgiveable given the live radio context, but I feel a need to point out that Stephen's performance leaves me feeling that his is the absurd position on this issue. And he can't be given the same forbearance for his blog posting.
It is worth parsing his argument to see how poor it is, riddled with omission, straw men and simple appeal to emotion.

Stephen makes three supposed points referring to moral hazard, conveniently labelled one, two and three in his post. Let's look at them:

"First...the Irish economy has already been  pumped full of moral hazard because of the bailout of Ireland’s banks and bankers"

Well, I don't disagree with this, but point out that the bank bailout was stupid and most likely has increased moral hazard, but for lenders of risk capital. What is at issue here is whether to compound one immeasurable level of stupidity (the bank guarantee/bailout) with another (mortgage debt forgiveness) which would extend the exacerbation of moral hazard from risk capital lenders to the borrowers as well - a type of "why stop now?" type of argument. Strange indeed. Stephen's argument might also seem to imply that we should all be allowed our share of moral hazard, that it simply isn't fair or that households should not miss out on this fun. I would characterise that as a rather strange type of analysis of welfare economics.

"Second, the moral hazard existed at the point of sale–the bank  selling the mortgage had more information about the likely evolution  of the market...
...Recent research has shown that rising house prices were driven predominantly by increases in the size of mortgages that banks were willing to give, meaning the banks were the engine of the housing bubble, not interest rates or population. The average person just wanted a house to live in."

I don't know how to interpret this. He makes a claim and doesn't support it. To state that "the moral hazard existed at the point of sale" and was manifested through the lender, suggests that the lender had strong belief when they made the loan that they would not be made to bear the cost of any default, over and above their contracted security. Does Stephen have any proof of that? I am not aware of anything that suggests that banks believed they could rely on anything more than the ability of the borrower to repay and the strength of the backing collateral (the house). So this claim is just absurd.

But Stephen then confuses this non-argument by going on to claim that house prices were being driven by the size of mortgages (well, d'uh Stephen, it was a monetary and credit bubble), but doesn't make it clear how that matters for his argument. It is simply a well accepted fact; people wanted/needed larger mortgages to buy property and took increasing personal risk (gearing) to do so, banks wanted/needed to make larger mortgages available and took increasing risk (gearing) to do so. If Stephen has evidence that either side had some information that led them to believe they had some "get out of jail free" card in the event that something went wrong he should actually state it. Otherwise he has not pointed out any moral hazard.

And Stephen then descends into something which is pretty deplorable for an academic economist. He resorts to argument from emotion: "The average person just wanted a house to live in". But I don't give Stephen full credit here. This is even worse than an argument from emotion, it is just plain stupid. There was and is plenty of housing available. People could have rented a house or apartment. Would that have sated this desire of the "average person"??? Moreover, this average person could have found "a house to live in" at a rental yield so low that it made the very idea of buying over renting totally irrational - in fact it was.

So to number three:

"Third, the worry is that these bailed out homeowners would start  taking out more debt, thinking they’d be bailed out again. Think about  this for a second from your own point of view. Say a bailout happens  for you and your wife with a 600,000 euro mortgage on your home. Say through some mechanism the bank forgives 200,000 euros of the mortgage, you keep your home, and you continue to pay a reduced amount to the banks. You and your wife have spent probably two years getting letters and phone calls from banks and solicitors, you’ve gone through the stress of nearly losing your home. A note about the debt forgiveness exists on your credit record. You are not going to start running up debt again, and
even if you’d like to, you’ll be stopped. The moral hazard argument is flawed and useless. We should discard it."

This is flawed by not properly identifying where the issue of moral hazard is really concentrated. Increasing problems with moral hazard will come from all those people who will try to manage their financial affairs in order to qualify for a bailout. For example, we are probably talking large sums here, potentially multiples of gross annual earnings for individuals. People will be incentivised to make their financial position appear worse than it is, or heaven forbid actually deliberately make their financial position worse than it is (why bother with this saving lark, lets blow some cash on holidays etc.) as they reorder their priorities away from paying off their mortgage. Just like a lot of people tried to distort their financial position during the bubble in order to qualify for a larger mortgage, a lot of people will certainly try to distort their financial position in order to qualify for debt forgiveness.

And there is more. The moral hazard will in fact be most likely to affect the children of those people who get the bailouts, or those people who won't get the benefit of this bailout. They will be the ones watching risk being absolved and factor that explicitly or implicitly into their future decisions.

After that series of non-points Stephen then makes some intellectual doodles before signing off. They are all pretty specious, but I find this one probably the most unforgiveable for a supposed Economics professor:

"Fully cleansed, functioning banks, homeowners taken out of substantial negative equity and consuming and investing again, and a clear signal to the markets that Ireland has put its house–no pun intended–in order, may be worth it"

There is a serious ommission of fact that mortgage debt forgiveness will spark increased solvency problems for the banks - they are writing off yet more assets, OK - and not help to "cleanse" them, but require us to put more taxpayers capital into them under the current polices.

With that in mind I hope readers of this blog will immediately understand why I find this statement completely unconscionable. We are talking about a redistribution of wealth here. Ireland's economic problem is a hangover from a massive savings/investment imbalance. A mortgage debt forgiveness program will simply take capital from members of society and give it to some others - completely arbitrarily. Note that the capital might be "taken" via even more borrowing by government, which of course has to be repaid by taxpayers.

Back to Econ 101 for you Stephen. How does such a redistribution of capital either:

increase the total amount of capital available, or
increase gross saving in Ireland

It doesn't, unless the capital is coming from foreigners, say in the form of default on (foreign)bank bondlholders - but Stephen doesn't say that, nor does he show any indication that he understands that only with such an inward foreign transfer of wealth, would his argument hold water. That is a shocking, shocking piece of supposed analysis from an Economics lecturer.

No, our big mistake was the bank guarantee and subsequent bailout, as I have stated many times over. We should have taken AIB and Bank of Ireland under national administration at the earliest possible sign that they might fail (for "liquidity" or solvency reasons) and then recapitalised at minimum possible cost to the taxpayer, leaving shareholders and then bondholders progressively down the capital structure to take the losses. Thinking we can make debt somehow evaporate (when as I stated it is merely an act of transferring wealth) is seductive, but flawed and dangerous in equal measure. We risk merely compounding our problems and mistakes.

Let them eat cheese

2010-11-08T09:58:00.003Z

If proof was needed that we have truly descended into the rabbit's hole, the Irish Government has helpfully announced their program to give away cheese to the masses. Of course, when I say masses I mean that elusive body of the population variously labelled as "the most vulnerable", "the poor", "those in need". In other words, that politically useful rhetorical devise; "the third person".

Once we all stop laughing and crying in equal measure, let's just turn to some economics to make some interesting observations and some random predictions.

The cost of this scheme in terms of packaging and distribution, verifying that the recipients as indeed "the most vulnerable" etc. most likely rivals the costs of handing everyone who qualifies a €20 bonus in the welfare payment.

If the reports are to be believed, vis:

The cheese is available in 12 x 1kg boxes from stores in Clondalkin, Portlaoise, Kilmacthomas Waterford, Cobh and Togher Co Cork from November 15th with a “minimum of one box per collection”.

(a minimum of 12kg of cheese each!!) we will have a nice little arbitrage opportunity opening up. Prepare to see markets do their stuff. So:

This could mean cheap cheese for everyone, as enough clever clogs see the opportunity to take a few boxes of their free cheese and sell it on. There may be attempts to restrict the sale of this cheese, but that is likely to futile as either nothing will be illegal about it, or a black market will simply develop.

And when this secondary, or black market for cheese develops, the demand for cheese via regular outlets, like supermarkets will fall. In order to prevent wastage, the price is likely to be discounted, potentially below cost in order to clear purchased stock.

Or, an alternative scenario:

Clever supermarkets recognising this potential cheese glut curtail significantly their cheese purchases over the next month. That might lead to a shortage of cheese in supermarkets. Riots in the dairy aisle shopping mums and toddlers battle it out for the last 500 gram block of red cheddar.

And of course the medium term consequences:

Cholesterol levels sour and heart disease takes off. The strain on the national health budget increases and our cheese binge starts to look like a big mistake.

Oh, how much fun it is to live in Ireland today. The comedy rolls on every day.

The Frankfurt dilemna - Ireland, hold on to your hat

2010-10-26T11:43:00.010+01:00

So you think Ireland has some significant economic difficulties? Trying to manage our way off an explosive debt and deficit path for both the public sector specifically and the entire country generally is a painful adjustment.

Well, don't look now because things might get worse in the not too distant future. The reason is because short term interest rates might be on the way up before too long if recent trends continue, which if it comes to pass will make our adjustment even more painful and more difficult because the interest charge on the country's massive debt stock will rise too. Note that most of Ireland's total debt is subject to a variable, or short-term interest rate largely due to the concentration in variable rate mortgages of some description or another.

But why would interest rates increase? Surely it doesn't make sense. Well, tell that to those humourless suits at the Bundesbank who watch monetary aggregates like hawks. Those influential central bankers know that money supply figures have passed a clear turning point that means we should be ready to tighten monetary policy from its current sluice gates open mode.

Exhibit #1 - Monetary aggregates

M1 is narrow money, mostly notes and coins in circulation. M3 represents wider demand and interest bearing deposits in banks. Note what has happened to both in recent years. Before the full onset of the Global Financial Crisis (GFC) M3 was rising at a generous pace. People were borrowing from banks, that borrowing circulated back via economic transactions into deposits in banks. The Lehman Bros happened, at the point indicated in the chart. Initially it led to people putting wealth into cash (so M1 increased with an immediate spike) and then the ECB began cutting interest rates, promoting further growth in narrow money. M3 virtually stalled, as people didn't want to leave wealth on deposit with banks and the borrowing and deposit (known as money creation) cycle collapsed.

So this state of affairs continued. Until earlier this year. While M1 is still rising as monetary policy remains lax and interest rates remain low, M3 has started rising. The money creation process appears to have been rekindled. That is good news, because a continued downward money supply (M3) spiral would be a harbinger of deflation. However, it is also ominous in the sense that it indicates that the type of emergency low interest rates and lax monetary policy (including generous ECB repo lending and open market operations - e.g. Irish government bond purchase) may not be deemed appropriate any longer. That means higher ECB reference rates (the Refi. rate), which in turn will push up interbank rates and hence lead to higher retail rates, especially (say it softly) tracker and variable mortgage interest rates in Ireland.

Exhibit #2 - Euro monetary aggregates recent rates of growth

This chart shows the most recent rates of growth, annualised rolling quarterly growth rates. M3 is now growing for the first time in over a year and not much below 5%, which would be within a range considered to be consistent with the long term inflation target of the ECB - 2%.

Exhibit #3 - Euro monetary aggregates annual growth rates

Even the annual (year on year) rate of change of M3 has turn positive, while M1 is growing at rates that would only be acceptable for short periods of time.

Ireland had better watch out, because nobody seems to be talking about this big smelly elephant at the moment.

Ireland versus Greece - the fiscal comparison

2010-10-21T12:16:00.013+01:00

Budget silly season is now in full swing in Ireland. There are two gigantic myths that appear to be circulating generally, fed to the media who chew and the regurgitate without so much as thinking. The two I had in mind are:

The much trumpetted and imminent 4 year fiscal plan is the initiative of the current coalition government to somehow rescue the economy, and

Ireland has been and will continue to lead the way on fiscal austerity programs, in particular putting Greece in the shade.

Both are pure unadulterated fiction.

Yesterday there was a pow wow between the most important political parties in the Dail (plus the Green Party) to discuss an advance copy of a much trumpetted 4 year plan. The claim made by the government of the day is that this is of national importance and that some form of cross party consensus is needed on its content. I won't comment on that (it is complete political bollocks), but just note that the requirement for this medium term fiscal plan is enshrined in the Maastricht Treaty under Stability and Growth Pact. Ireland, like Greece needs to submit for approval by the European Commission a "Stability Program" that explains how the general government deficit will be trimmed to less than 3% of GDP by 2014.

Point 1. This is a legal requirement, not some admirable piece of national governance.

Next to how we mighty Irish are showing up those lazy Greeks. The general government deficit in 2009 was estimated at 11.7% of GDP (output), or in my preferred numeraire for Ireland 14.2% of GNP (income) - it makes a difference, doesn't it. For Greece the number was 13.8% of GDP and essentially the same as a proportion of GNP.

The first myth running around Ireland and sold to the rest of the world (as only the Irish can) was that Ireland had already introduced the most massive fiscal adjustments, while the Greek government had been sitting on its lazy bum.

Exhibit 1. - Comparable primary deficits

Source: European Commission, Greek Ministry of Finance

The primary deficit excludes debt interest, so it is a measure of budget items under the direct control of government. Well, knock me down with a smoked kipper. It looks like those lazy, profligate Greeks have been significantly more masochistic than our own bunch assorted teachers and country solicitors.

Hopefully more people will note this and not wonder why the streets of Athens were turned into a type of European Beirut, while the Irish electorate were characterised by the local media as being "docile in the face of much more draconian fiscal measure". Let's agree right here and right now that this type of statement was and still is a bare faced lie. Regardless of the economic merits of such a fiscal contraction being implemented by Greece, there is no case that Ireland was making more significant budget adjustments. I know that a new raft of expenditure cuts and tax increases are about to be announced in Ireland, but even €5 billion in measures will amount to about 4% of GNP would only, at best, represent catch up with the measures already being implemented in Greece.

Of course these are primary deficits and they do not include interest on the stock of government debt. In the case of Greece , such interest costs amount to more than 7% of GNP and mean that they won't have completed the necessary fiscal adjustment until the primary balance is in significant surplus (that 7% of GNP deficit including debt interest would keep Greece on debt death spiral). However, that is irrelevant to the point being addressed here. The Greek government has been far more courageous (or stupid, depending on your point of view) than the Irish government to date.

Damien Kiberd ... aaaahhhhh!!!!!

2010-10-18T09:26:00.004+01:00

Another Sunday, another self inflicted hair loss. To be honest, it is my own stupid fault. Why can't I resist passing over Damien Kiberd's weekly rantings of ignorance in the Sunday Times.

How this man, who by all appearances is just some chancing journo, equally qualified to be writing about this season's womens' Autumn fashions as economics or finance continues to get access to national media is the comic indictment of ongoing economic failings of Ireland. Idiots in charge at all levels.

In his latest rantings Kiberd keeps beating his drum about "confidence" and "consumer spending". He goes so far to advocate an extension of the car scrappage scheme because it would "increase tax revenues". Words fail me how stupid and dangerous this man is with regard to issues concerning the economy and our future welfare.

Ireland as an entity - that means Irish people in aggregate - has consumed far far far too much. We have consumed everything we have and everything we will manage to earn over the next couple of decades. This goes for the government who has done the same on our (taxpayers) behalf. Kiberd is saying that we should build an even larger stock of personal debt and/or spend savings in order to hand money over to a government who needs to cut spending.

I imagine Kiberd would probably retort something along the lines of "well, at least everyone will have a nice shiny car in the driveway". Yeah, brilliant Damien. We can park them in one of the numerous shiny new housing estates that lie empty around the country. Don't think for a moment Damo that we forget your enthusiasm for the property boom, right up to the point the bubble imploded. Why, I believe you are in print claiming Ireland would be suffering a severe housing supply shortage in 2008. Unbelievable.

This man is worse than a fool (someone who speaks beyond their capacity), his media prominence on both radio and print make him a dangerous one.

"Capitalism" to the rescue

2010-10-17T10:08:00.002+01:00

I really shake my head at the persistence of failed Socialist views of the world. The supposed values that leftist thinking is supposed to bring is almost universally trumped by market-based solutions, which come from allowing personal and economic freedoms combined with just the right amount of regulation and law where it is needed (and no more)

One of the last places you would look for evidence of the massive benefits of this wonderful system might be the recent Chilean mining rescue. Have a read, it is revealing stuff.

So you want to become an internet squillionaire...

2010-10-14T13:43:00.011+01:00

The first thing to do is to learn some economics. Alternatively you might be naturally endowed with all the right sort of intuitive skills to help you make the correct commercial decisions.

Have a look at this review of the new Facebook movie that documents (to greater or lesser historical accuracy) Mark Zuckerberg's development of the ubiquitous social networking site. How did this not only become so successful, but also something of such commercial value? Here is a clue in the movie, if it is indeed true:

He resisted bombarding users with advertising, believing it best to let the service reach its natural market size without offending them. This is accurately portrayed in the movie; his early business partner Eduardo Saverin insists the company has to immediately "monetize" and Zuckerberg refuses. He still believes that growth is more important than short-term monetization.

A nice exposition of two important concepts; "switching costs" and "network externalities". Take the second first. The phrase network externalities refers to positive indirect effects that accrue to third parties. Elsewhere I have blogged on the more talked about negative externalities, but here is a case of positive ones.

A Facebook with two users provides very little "utility" or value for either of its users. If two more people join then instantly the value to the existing users increases. Why? Because of the additional connections, contributions etc. that those additional people bring. Let's say that the users find the larger Facebook network with twice as many contributors twice as interesting/useful/fun and that feeling is shared by the other users. The size of the network has doubled (from 2 to 4 users) but the value of the network has increased from 2 x 1 = 2 to 4 x 2 = 8; a multiple of 4!! That is network externalities at work; a network gains its value from the number of connections.

Zuckerberg was perfectly correct to resist those urging an early commercialisation of his network, realising (supposedly) that its value would grow exponentially relative to its size. The return to being patient was potentially - and subsequently proven to be - enormous.

What about the other concept - "switching costs". Not only did Zuckerberg appear to realise the need to wait and let the implications of network externalities run their profitable course, but he was reputed to have been concerned about "offending his users". Again, wise to the economics of his website. What is implicitly recognised here is that regardless of how much value the users of Facebook (customers) personally derived from being a member of the network, the only amount that he as owner of Facebook could extract from these same users was the cost any user would bear from leaving - that is each user's "switching costs". And when Facebook was smaller, before the Network externalities had really kicked in and there were other similarly sized and even larger networks around, the switching costs of Facebook users was probably very small. Any actual or perceived cost imposed on Facebook users at that time - for example a user fee or even annoying advertising, could have led to mass desertion of Facebook users to one of the other popular networking sites of the time. Imagine how easy it is to jump ship from a Facebook with 10,000 members, compared to jumping from one with 500,000,000 members. For one thing, there is no alternative...

But Zuckerberg held his nerve and allowed Facebook to grow to the point that it was big enough that:

The exponential growth via network externalities made Facebook very valuable to it users and
That same size and associated network effect increased the switching costs of users to something meaningful; users would now be willing to tolerate some advertising or funnel some money into their use of Facebook.

These are two simple concepts that have been exploit knowlingly or otherwise by Internet winners (Microsoft, Google, Facebook etc.) and not understood by a myriad of losers.

Just a final note. Again something that the astute reader should have picked up. These two concepts together mean that network type industries or businesses will tend to be "winner take all", or natural monopolies. It is no accident that technological, informational or network industries are more commonly dominated by a small number of large participants compared with production or cost driven industries like manufacturing.

For the astute and most likely wealthy readers, there is a lesson for investing here also. Don't try and pick winners in this space. Simply try and cover the field so that you will have some money on the eventual winner.

"Equality"? Give me a break

2010-10-13T09:53:00.005+01:00

The World Economic Forum is probably the most absurd "economic" organisations in the world. Famed for its ludicrous "competitiveness reports", it also produces other useless and complete harebrained "reports, like the "gender gap index".

The complete absurdity and nonsense of this type of work is apparent in its own methodology.

For example, Ireland demonstrates comparable "inequality" because men have a life expectancy of only 96% of that of women. The longer women live relative to men the more "equal society is apparently. So imagine if we could produce some "gender equality" policies that shifted this 96% figure to 90% or even 50% - hey that would probably generate a boost to the aggregate "equality" ranking.

The same absurdity appears in all the other comparable scores the boost the supposed "gender" equality as women increasingly dominate outcomes for men in education, representation in professional classes etc.

Next look at the male/female birth ratio. As pure statistical indicator, a low female to male birth ratio is in fact a boon to women - as China is now finding out. Women have complete control of the partner selection process. Men are increasingly left into the middle ages at the fringes of society. Perversely, this supposed "inequality" towards women is in fact leaving men not women disadvantaged in Chinese society.

I don't think I will bother with this report.

Tricks of the trade

2010-10-12T14:04:00.008+01:00

One of my favourite, non-moralist based, parables against protectionism or mecantilism comes via Brad de Long (I can no, longer find the link).

In a fictional country that exported grain and imported cars, a protectionist movement developed that demanded imports of cars stop in favour of domestically produced cars.

As this movement built political momentum (”protect the jobs”, "buy local") a billionaire announced that he had discovered a technology that would allow for the transformation of grain, of which the country produced plenty, into cars, which the country at present imported. On the back of a substantial government grant (!), the billionaire built a sprawling site on the coast, protected by massive security. He employed a workforce that was sworn to secrecy and then began buying up large amounts of the locally produced grain.

The grain was shipped into the secretive site in trainloads and amazingly cars were shipped out to be sold to customers. The billionaire was a national hero, lauded by politicians for single handedly ending the need to import cars. No longer were imports needed. In addition, he was also a big buyer from domestic farmers (buying "local"). And of course he employed people and made huge profits which provided corporate tax revenues.

The country was universally in awe of this national miracle of economics, except for one curious journalist who managed to infiltrate the secretive site, into which the grain went and cars emerged.

This journalist discovered that the site, hidden from outside eyes, consisted of little more than a massive rail freight and dock facility. The grain was being transferred from the incoming trains on to bulk transports sailing off to foreign countries. At a different point, car transports were arriving, unloading their cargo onto trains heading off to be sold across the country.

Green investor update

2010-10-08T14:20:00.005+01:00

With the end of the third quarter it is time to get an update on our green investments courtesy of HSBC.

It looks like another bad quarter, underperforming the broad equity market index by about 0.5%. On the bright side, performance is consistent. Consistently under performing the equity market, as I predicted but certainly not what HSBC or our friendly reporter at the Financial Times, Kate MacKenzie, predicted.

Since 2008 an investor in this HSBC green fund would have lost more than 20% against a standard global equity benchmark. Ouch. That is what I call suffering for your principles.

But then, maybe it isn't all about principles. Maybe some people do buy into the "green is the future" malarkey. There is an apt investment lesson in that case. Don't let your emotions bias your use of and interpretation of data. In this case, the data and facts pointed to subsidy reliant "green" industries and companies being poorly positioned to improve their profitability or grow their businesses. The clear message was sell.

More quantitative easing for the UK?

2010-09-29T14:25:00.008+01:00

Now here is an interesting news article in the Telegraph:

Bank of England's Adam Posen calls for more quantitative easing
The Bank of England should restart the printing presses and pump more money into the economy to prevent a "lost decade" of low growth and high unemployment, one of its senior policymakers Adam Posen has said.

So called "quantitative easing", or QE, accomplishes one thing and one thing only; it produces inflation. So how is that any use as a policy instrument to be used to "prevent a 'lost decade' of low growth and high unemployment"? Well, it does two major things:

It deflates real wages, on the premise that real wages are flexible. A fair enough assumption at the moment given that unemployment is high generally there won't be too much resistance from or bargaining power with sellers of labour who might see the true value of their time fall.
It deflates the stock of debt. Governments in particular borrow over long terms at fixed rates of interest. Inflation which is higher than expected at the time of issue will mean that the amount these governments will need to repay will be smaller in real terms (they will be paying back in the future using devalued money). In fact, if inflation is high enough they might end up paying back less than they borrowed.

Now think about that second point for a moment. Astute readers understand instantly that debt is a two sided coin. One person's debt is another person's asset. So, if higher than expected inflation means that borrowers might not have to pay back as much as they thought, or even as much as they borrowed, then the person who lent them the money is losing out by exactly the same amount. All we are witnessing is a transfer of wealth, not a creation of wealth or indeed a "destruction of debt" (which in fact is impossible for the reasons noted).

So what is the benefit? Is there any benefit? Well, I'm glad you asked, because the answer is yes/probably/sometimes.

Yes, in that for an economy facing the opposite case where inflation is unexpectedly negative and large (deflation) currently extended borrowers can easily find themselves in a debt death spiral. Instead of paying back less than they planned in case of higher than expected inflation, they might find themselves paying back much much more than they expected if prices fall over time. At the moment we certainly have over extended borrowers aplenty. An extremely widespread occurrence of such a debt death spiral (debt deflation) would indeed be a potential threat I for one would prefer to not test. Think of Greek, or Irish public finances for example. What if the debt stock which looks worryingly large and is increasing turned out to be a multiple of what we currently estimate it to be because every €100 that needs to be paid back in 20 or 30 years time turns out to be a massive €150 or €200 in today's money due to deflation? Can you imagine the crippling debt effect?

So inflation is probably a benefit in these circumstance, but not unequivocally so. Consider what happens if QE is successful. Debtors avoid the debt spiral and the €100 that, say, the Irish government needs to pay back lender in 20 years time turns out unexpectedly to be more like €50 or even €20 in today's money. Huzzah, the taxpayer is saved!!! Well, hold your horses there pilgrim. Who is on the receiving end of the now devalued €50 or €20. Look no further than yourself in retirement. Yep, pensions are funded predominantly by bond assets. The unexpected inflation has robbed you of the expected value of your savings in retirement. It isn't without reason that inflation is referred to as a tax on savers. In this case it is a tax, because the benefit mostly accrues via government accounts in reduced public debt repayment.

So that is the choice that we are looking at with Posen's policy suggestion. There is no outright economic gain here, but a potential aid to adjustment (reducing the price of labour), plus a potential redistribution of wealth, as noted from government bond holders to governments (and possibly from foreign holder of those bonds to your domestic government - which is a local benefit as a type of tax on foreign lenders) and from today's savers to today's debtors. If you fear the debt spiral scenario enough (and perhaps if many of your creditors are foreigners) it becomes a policy worth considering.

Implied default rates and compounding probabilities

2010-09-28T13:24:00.003+01:00

I nice little primer on calculating implied default rates over at irisheconomy.ie. These are calculated under the assumption of no arbitrage, in that the expected value of the security with (implied or assumed) zero risk must be equal to or in excess of (under risk aversion) the expected value (probability weighted value) of the risky security.

The example there comes out for Ireland at about a 40% implied probability of default at some point over ten years. Sounds high, but think about this; a 40% probability of default in any of the next 10 years is equivalent to 5% probability of default in any single year.

Risk compounds just like interest rates.

Irish politicians handy policy check list

2010-09-23T12:19:00.004+01:00

I thought I would post a handy reference guide to some of the things I think will range from being simply useless to downright dangerous as the government and assorted politicians strive to save their skins and make people believe the fantasy that they "manage the economy" (of course "the economy" just is - they can only meddle with it for better or worse).

A starter list of things for politicians not to do (as the verbiage continues this might build):

boost consumer confidence
restore foreign confidence
just about anything to do with "confidence" basically
training schemes
job "creation" schemes
just about any hairbrained scheme where the objective is to "create" jobs
"knowledge economy" strategy
"innovation hub" strategy
"global education centre" strategy
just about any type of "strategy" - meaning in truth industrial policy

When does a recession become a depression?

2010-09-23T11:49:00.008+01:00

About now in the case of Ireland I would reckon.

There is no formal description of what a "depression" is. Even the term "recession" is subjective and can vary in its definition.

I am using it to refer to a significant and persistant decline in real national income per capita. For Ireland, that means roughly looking at GNP (not GDP). And with the CSO release of national accounts data for the second quarter we find that Ireland has now moved into its third year of falling quarterly GNP:

It is also pretty meaningful, in that our real income (in aggregate) is 17% lower than immediately prior to the onset of this depression.

I would fully expect this to continue a bit longer yet. The economy is trying to deflate itself (i.e. Irish prices need to fall relative to other countries) and we have to repay a lot of debt owed to foreigners, which means no available capital to invest (it isn't the banks' fault) and a need to cut back on consumption to repay these foreigners.

These are pretty drawn out adjustments occurring. This is one drawn out depression we are in the midst of.

Thoughts on sovereign bonds #2

2010-09-17T14:41:00.002+01:00

The yield to maturity on sovereign bonds has generally represented the "risk free rate" for financial markets. No other financial asset could provide for less risk that a fixed stream of cash flows emanating from the government of a sovereign country.

What is the risk free rate in the Eurozone now, say from an Irish perspective.

It can't be Irish government bonds. In the past the domestic sovereign bond issuer was seen as "risk free" because in the event of difficulty in making repayments the government could either levy higher taxes or print some more money. Not so any more on either count.

It can't be a market basket Eurozone bonds - generally weighted by amounts on issue. You could hold German government bonds alone at a lower yield, but presumably lower risk than a basket that includes Greek, Irish and Portuguese bonds for example.

Can it be German bonds? They are issued in the same currency. Within the Euro is Germany able to meet all potential fiscal demands on it via taxes or money supply? Probably not, as the German people clearly fear - Germans look obliged to help bail out the financial troubles of other and again, they no longer have their own currency to print. Outside the Euro, a different story might apply perhaps - a renewed German fiscal and monetary autonomy, which could allow it an increased capacity and backstops to repay any debt it occurs (and to accrue less debt int he first place). Unfortunately, new bond issues in Euro would be forsaken for NeuDeutschmark. The amount of German issued "risk free" Euro bonds would wain.

Is that it then? While the Euro remains in its status quo there is no traditional "risk free haven"? Is a German departure from the Euro the event that would bring a return of a proper risk free rate, but in doing so kill the Euro risk free rate off?

Sounds bizarre, but no different really to US, Australian or Canadian state or provincially issued debt. In those countries we see a Federal issuer with fiscal and monetary primacy fill the role of "risk free" lending. Should the Euro survive, do you doubt where the constitutional structure of the EU is headed?

Thoughts on sovereign bonds #1

2010-09-17T14:37:00.003+01:00

Under pensions regulation derived from the European Commission, Irish pension schemes are restricted in the amount of financial interest they may hold in either the employing company or its wider group.

Is holding Irish government bonds now effectively a holding against the scheme sponsor for Irish banks? Let'e push that from the sublime to the ridiculous. Is holding German government bonds now the same as holding a financial interest in the parent of the sponsoring company of the pension scheme of an Irish Bank?

It's an interestnig philosophical question.

The Parable of Anglo Irish Bank

2010-08-18T15:14:00.003+01:00

A man is walking down the street. A massive and apparently bottomless fissure opens up in the ground before him.

He is panicked and instantly motivated to do something about this dangerous development.

Without wasting another moment, he rushes home and collects everything he possesses and packs it into his car and a trailer that he rented for the task.

On his way back to the hole he sees an old friend. He stops and gives him a ride, simply telling him that he is going to fill a dangerous hole.

He drives the car into the bottomless fissure in his valiant effort to fill the dangerous hole. His friend disappears with him into the void.

Home truths for Charlie Weston

2010-07-10T09:01:00.009+01:00

Charlie Weston is the Personal Finance Editor of the Irish Independent. The Irish Independent in turn is probably the greatest receptacle of garbage posturing as journalism in Ireland. It is match made in heaven.

Friday is the day refuse is collected up my street. Friday was the day Charlie wrote this "opinion" piece:

http://www.independent.ie/opinion/columnists/charlie-weston/charlie-weston-lenders-ignoring-home-truths-with-rate-hikes-2252146.html

This gives the gist of the column:

IT makes little sense, and it was probably never meant to. At a time when record numbers of homeowners are at the pin of their collars trying to repay their mortgages, lenders are piling on the pressure by hiking interest rates.
In the past year alone, mortgage interest costs have shot up by 16.5pc, according to the Central Statistics Office.
The CSO only looks at standard variable rates when it examines mortgage costs, so the statisticians are reflecting the pain being borne by those with these variable mortgages.
Lenders are free to push up variable rates whenever they want -- something households with these types of mortgages have learned to their costs in the past year.
It is hard to get your head around the 16.5pc figure, but what it means is that a family with a not-untypical mortgage of €250,000 has seen the annual cost of repaying it jump by €1,300 in the past 12 months.
In monthly repayment terms the original payment of €954 a year ago has now zoomed up to €1,110, based on two separate 0.5pc increases in the past year.

...

This is at a time when the European Central Bank has not moved its main rate off it record low of 1pc since May last year

Such drivel perpetuates ignorance of financial matters. That would seem to me to be at odds with the general job description of a "Personal Finance Editor", even at a newspaper that chooses to inhabit the lower reaches of the newsprint media.

The ECB rate Weston refers to is of course the "refi" rate. This is the rate at which banks can secure short term liquidity (but increasingly long term over the financial crisis and beyond) by handing over assets like government bonds as collateral. It is a bit like going to the pawn broker. Of course, at the moment the pawnbroker is acting like Saint Vincent de Paul, charging banks little in interest and allowing more freedom in terms of collateral and term. Nevertheless this is short term and requires assets to be handed over.

What this refi does not do is determine the total cost of money bank have available to lend at all times, because that is determined by the major sources of their capital which includes:

What banks need to pay to attract deposits
What banks need to pay as interest in short and long term bonds to investors
What banks need to pay other banks for short term borrowings (interbank funds)

All these are determined by a number of factors that are determined by the market in general and the specific bank concerned. Needless to say that the agents listed above (depositors, other banks, investors) have been and continue to be far less interested in giving charity to Irish banks - which is what the 1% ECB refi rate effectively is.

So the point good old Charlie should be making plain is that mortgages have gone up because that is the true cost of the money borrowed by Irish households. It is now better reflecting what they should be paying given what a risky proposition they are. In fact, what a risky proposition they always were, but haven't had to pay over the bubble times.

Of course I get the feeling that the intention of the piece is to make people think that banks are profiteering. As an unwilling shareholder in Irish banks, like every other Irish taxpayer, I only wish that was the case.

And just to put things into proper perspective, despite these shocking increases that Charlie is up in arms about standard variable rates range from a low of less than 3% for the most attractive customers up to the more typical 4%. To claim this is usury borders on outright lie. Strange how Charlie never specifically mentions these rates. I wonder why.

What figures Charlie does throw around includes the €1,300 annual increase in mortgage repayments for a hypothetical €250,000 mortgage. This is apparently beyond the pale according to Charlie, although remember this is price charged for something borrowers voluntarily agreed with the bank.

Here is something that is also putting "hard pressed homeowners" under pressure. It is also something that is dumped on homeowners with no choice on their part. Tax. Yes, if we imagine that this hypothetical €250,000 mortgage is held by a homeowner with a €65,000 salary (€250,000 is too much to borrow on that level of income, but it is a realistic scenario in Ireland - hence the problems) we would note that the tax burden of such a person has increased by about €2,600 over the last couple of years. And you can bet that homeowner didn't voluntarily enter into an agreement to set up one of the most over inflated, wasteful, inefficient and in far too many areas completely pointless public sector.

No the politicians decide that and simply send the bill.

But the following is the kickker as far as Charlie is concerned. This is what he wrote around a year ago, when the problem wasn't rising variable rates, but falling rates, which those people who had fixed their mortgage could not participate in and would need to pay some recompense to the bank if they wanted to welch on their deal.

http://www.independent.ie/business/personal-finance/fixed-rate-mortgages-fee-could--be-waived-1721541.html

Some people on fixed rates are paying up to €600 more a month more than those on variable home loan deals.
But to get out of these deals lenders impose a penalty, called a redemption fee. This is the cost difference between the rate the customer is on (which can be as high as 6pc) and the rate presently charged on its variable rate.
...
Granted, people locked into bad value fixed rates should have been aware of what they were getting into.
But as enormous flexibility has been shown towards our banks by the State, it is not unreasonable to expect banks to be flexible towards those stuck on fixed rates.

I would hate to enter into any type of wager with Charlie. Could you imagine the rules; "heads I win tails you lose".

"Unprecedented" warming (or, how certain are you of that trend?)

2010-07-07T09:55:00.020+01:00

Global temperatures have been rising for the last 50 years right? That is not to controversial. Look at most data that attempts to produce some average temperature for the earth over time (whatever that actually means) and there is a self evident increase. It has been warmer in recent decades that it was in earlier decades.

Ignoring potential sources of error over time (including unsatisfactory adjustments for urban heat affects, areas that haven't had sufficient measurement coverage in the past or even now, such as oceans and the poles) and just taking data as given, the increase over the last 50 years appears to be around 0.8 degrees. People get hold of this data, plot a line through it, proclaim that there is a positive trend. It is from that observational position that the hypothesis of the enhanced greenhouse effect is employed to explain the trend and then extrapolate into the future.

Think carefully about this. There are two distinct points here.

Historical observations.
Hypothesised causes.

The first is just acting as witness to what we can measure. The latter is an application of an hypothesis.

I make this point because, in this post, I want to deal solely with the former. What exactly does the historical data tell us with any certainty in terms of behaviour? Simply saying "it has gone up" hides a multitude of sins. What I am trying to investigate is whether the data we have witnessed is indeed extraordinary. Is it so unusual that we need to search for some, or even any, explanation or cause?

I am going to do this, like all statisticians by employing a model. I am going to start with a basic naive one the explains any monthly temperature anomaly as being zero plus or minus some random element. This random element will be described by a Gaussian (or normal) distribution, be centred around zero and have a variance of about 0.01 (which means a standard deviation of 0.1).

This would be written as Tt = N(0,0.01) ; Tt= temperature anomaly at time t.

Such a model would lead to a history of temperature anomalies over say 30 years that looks something like this:

No need for fancy statistics. There is no trend here. Just stable temperature about some constant average over time, affected by some random noise from month to month. This doesn't look anything like the actual record for global temperature anomalies, which everyone agrees seems to have risen over time. And therein lies a weakness. When people look at the actual temperature series and think "this is definitely going up", they are implicitly comparing it with the model above. Because it is clearly different, an intuitive reaction from most people is that:

"there must be something going on to push up temperatures"

And from that point a leap is made to try and find some hypothesis, possibly any hypothesis, that will "explain" the cause of the obvious positive trend. But what if this model is wrong. What if the nature of temperatures is better described by an alternative model that has different characteristics. Well, you might not be surprised to find out I think that is the case.

Let's think a little more deeply about (monthly) temperature anomalies. Our naive model above assumes that the temperature in one month is unrelated in any way to the temperature in any other month. But it is reasonable to postulate that maybe temperatures are related between months. The global temperature should reflect the transfer of energy around the world. It should operate with lags and so we might expect that the temperature anomaly witnessed in any month is in part affected by the anomaly witnessed in previous months. If it was unseasonally hot in January, then it should be more likely to be unseasonally hot in February. What this describes is an auto regressive process. We can investigate the data to see if there is any reasonable sign of such a phenomenon and to try and estimate the size of it.

So that is what I did. And a simple piece of statistics indicates that there seems to about two months months of inertia. In fact it tends to indicate our model should be more like this (the 0.65 and 0.25 drop out of the analysis:

Tt = 0.65*Tt-1 + 0.25* Tt-2 + N(0,0.01) ; Tt= temperature anomaly at time t.

So, let's now see what sort of series of temperature anomalies this type of model might be expected to produce. Here is simply one example, but note that this model will produce a much greater range of apparently different results:

Compare this with the first chart. There appears to be a clear trend (I have drawn the linear trend). In fact there is a trend that equates to 1.4 degrees per century - or about 0.7 degrees over 50 years. This is pretty much exactly what we have witnessed from actual temperature measurements over the same sorts of periods. Compare it with an actual temperature series over a similar period (this is from the University of Alabama Huntsville):

So what is going on? I have created this series of data using a very basic and naive model that reflects the actual measured characteristics and contains in it absolutely nothing that might cause warming. The trick of course is that this is but one potential outcome. I could generate another series and it might have a cooling trend, or no trend. But the salient point remains. Simple random data over time can generate what appears to be a material trend caused by something, when it is in fact simply an random outcome well within the range of what one might expect.

If you conducted some proper statistical tests on that series and the computed trend, you would find that the trend is not statistically significant. It would confirm what I have just said, that such an apparently significant trend - as high as that which is estimated from actual temperatures - is within the range of what might be randomly generated without any physical cause.

So, when I am asked to consider whether we are at risk of producing dangerous climate change, I have trouble getting past even the first obstacle. What does the data show us. Up until now, nothing that doesn't appear within the expected range of outcomes given the characteristics of the data involved. A trend that isn't particularly special.

Now this doesn't rule out human influence on the climate, in the form of CO2 forcing, or other localised influences (such as land use change). However, it does nothing to support the argument that we are definitely experiencing dangerous rates of warming that can only be explained by physical causes over time.

How regulation kills our quality of life

2010-07-05T13:13:00.004+01:00

I enjoy listening to music on the bus on the way to work. So I bought myself a new iPod. A great little piece of technology (except for Apple's anti-competitive business model). I have found out after buying it is is useless for listening to music on the bus because you can't hear over the ambient noise of engine, wind, tyres etc.

I initially thought there might be a fault with it, but to my dismay I found out that those useless drains of the taxpayers' pocket, the European Commissioners and Parliament, decreed regulations that set the maximum volume output for such devices.

What a piece of life diminishing regulation, proposed and decreed by buffoons looking for things to do. iPods have always had a volume limiter you could set so that you didn't inadvertently turn the thing up too loud. But apparently, the people eating the cake are to be directed and told what to do, so a permanent limit needs to be set by the manufacturer.

Thank you, stupid, idiotic, moronic, manipulating, parasitic, tax stealing politician and bureaucratic apparatchik. You have wasted €150 of my money, which I have blown on a device that can't do what I, reasonably, want it to do - let me listen to music on the bus.

The industrialised world is truly killing itself cut by cut.

Recession? What recession?

2010-07-02T10:33:00.005+01:00

Ireland's recession is over!!! Hurrah!!!!

After removing regular season influences, GDP increased by 2.7% in the three months to March, compared with the three months to December 2009. That must mean the recession is over, right? Growth has resumed right?

Wrong.

The Irish economy is a curiosity in that its underlying structure is badly distorted by government industry policy (read meddling) and the statistics we might use to measure it are tainted by accounting fiddles to the point they are almost as useful as measures of Bernie Madoff's investment performance.

Because the crux of the matter is that the amount of value added created in Ireland by Irish entities has continued to fall. While GDP increased, GNP fell by 0.7% in the quarter. As a nation we have continued to suffer a fall in our income and that is the only thing that matters.

Let's explore this in a little more detail. There is some useful background reading in this topic here and here.

The difference between GDP and GNP will be net foreign income. If you deduct that component of GDP (net output) that represent is effectively owned by foreigners and add net output created created overseas and owned by Irish residents you get GNP. Examples of the former would be profits generated (more accurately reported) by Microsoft or Dell operations in Ireland. The latter would be profits of CRH in the US.

Add to that the accounting shenanigans practiced by companies resident in Ireland and you have a recipe for a complete distortion of the true state of health of the Irish economy as you do here.

Exports may have increased and pushed up Irish output (GDP), but there is no way to know if that simply isn't the result of an accountant's pen. What we do witness is that the supposed rise in output in the economy, had absolutely no apparent positive affect on the income of Irish residents (GNP).

This tells us nothing new. As I noted in the blogs I link above, Ireland is not a "small open economy". Exports provide relatively little feedback into the economy. If Dell exports more (or records in its accounts that it exports more), that simply means that they are importing more parts from abroad to then crudely bang together and sell on, or they are just writing up their profits by claiming more revenues from abroad.

What appears to be happening here? I reckon it is most likely the latter, for two reasons. The import response to the rise in exports was muted (for any merchandised exports like pharmaceuticals, chemicals, IT equipment etc. companies need to import more to export more). Secondly, with some modest improvement in foreign European markets, there is increased incentive to record revenues in Ireland - over 2008 and 2009 Google or Microsoft for example would have recorded less in profit or even loss in higher tax jurisdiction. Once demand stabilises to the point that they are no longer loss making, they start to transfer more in way of revenue to Ireland in order to bring any profits within their low tax jurisdiction.

It all amounts to smoke and mirrors basically. Keep watching the GNP figures before GDP. The state of the labour market gives the best cues - unemployment is still on the rise the latest figures show.

A NAMA for the people

2010-06-28T10:13:00.011+01:00

RTE 1 on the weekend had a panel with David McWilliams and some other members of the Irish social firmament bandying around yet more blah blah blah (excuse my sudden inability to articulate intelligently) about the Irish economy and our mess.

Yet again the cry for a "Peoples' NAMA", under the now common belief that NAMA was designed as a type of debt forgiveness program. Well, it may appear to be run that way, but the cold hard facts are that a "NAMA for the People" would do this:

Transfer all the outstanding mortgages of those people deemed to be in "negative equity" to a special purpose vehicle - that just means a new company of some sort.
Call in the mortgages of all those people.
Begin to foreclose on those people who can't repay and plan for an orderly disposal of the houses.
Pursue the outstanding amounts (the amount of the mortgage shortfall following the sale of the house) out of any other asset these people might have to the point of bankruptcy.

In theory, that is what a "NAMA for the People" would be. I was surprised that David MacWilliams failed to point that out to the journalist, lawyer, politician and broadcaster present and the many people listening.

I wish people with their hands on the microphones to the nation would stop perpetuating this fallacy that NAMA is a bailout. It is certainly the case that people who had command of tens or hundreds of millions of Euros - albeit borrowed - can legally squirrel a nice wedge away protected from future creditors. But it doesn't mean the process to recover as much money as possible from them and their companies is a "bailout" simply because it is frustrated by legal financial shenanigans and the underlying fact that there simply isn't enough money to repay all the debt.

So let's stop the cute hoor nonsense about "NAMA for the People" and start being honest. How about a "Money Grab for the Stupid People". Sound harsh? Well, not harsh enough for those who would insist I and other prudent savers in Ireland now pay to give them a fresh financial start. This isn't a diatribe against those people who are now in negative equity -mistakes are made. Many of those people will quietly and diligently save their way out of their predicament and as a nation we should hold them up as admirable. But I reserve disdain for those who would demand the government expropriate the savings or income of others so that they get a free ride.

A must read

2010-06-24T13:53:00.004+01:00

Add this to your reading list. A most insightful and complete lecture from Deepak Lal.

http://www.econ.ucla.edu/workingpapers/wp814.pdf

Negative equity loans

2010-06-23T11:11:00.022+01:00

ADDENDUM 24 June 2010:
Something worth adding from a "macro" perspective. Current policy with regard to the banking sector in Ireland should be to support and facilitate an orderly shrinking of balance sheets. This simply means allow banks to reduce the amount they have out on loan on one side and the amount they owe (now increasingly to taxpayers) on the other.

What is described below allows that to happen, without banks taking any loss. To date balance sheets have been adjusting by writing off, rather than retiring debt (as below) and passing the loss to the taxpayer. How could you not love that?

========================================================================================

An interesting announcement this week in the press in Ireland. Negative equity loans. Simply floating the idea seems to have initiated a rash of negative comment, some from people who I wouldn't rate as knowing their financial or economic onions, and surprisingly others who do.

It led me to think because my first reaction was; this is an interesting development. Because among all the loopy ideas that people have been spouting that invariably require taxpayers' money to be used to redistribute wealth from people who have made good decisions to those who have made bad ones, this one is a purely voluntary option designed and entered into by those parties who are relevant - the lender and the borrower.

I also had a favourable initial impression because it was my idea a long time ago.....

So firstly what are the objections? Obvious really.

Allowing people to enter into a financial agreement that leaves them knowingly insolvent is just plain stupid - no objection there.
It replays all the stupid risk management that got us in this mess in the first place by lending to people who couldn't wouldn't afford it -that it does if available to all comers.
People would increase their negative equity and debt problems (see my first link above for an example) - that is true for the hypotheticals posited.

So it is a stupid and reckless idea after all then.

Well, no. It's a good idea and here is why.

What you have above is a knee jerk response based on fears of what might happen if such an mortgage was arranged inappropriately. That is a risk, no doubt. Did you read my post on "Risk versus Uncertainty"? If you did, you will know that having identified what might happen we have risk and risk can be mitigated against.

And what is the risk mitigation tool we have? Yes we have a freshly minted Head of Financial Regulation with new and improved ADDED BALLS(TM). And the appropriate responses to the early information we have on these mortgages have already appeared. Those BALLS(TM) seem to be more than the normal marketing blurb.

So all that is good. But why on earth do I think this stupid idea has some merit? I can think of at least two.

It can address the real problem in some instances. The real problem is of course the gross indebtedness of a household not the red herring of "negative equity" that is being bandied around. While providing such a mortgage to someone who wants to buy a more expensive house (or a new house) would be a bad idea, providing such a mortgage to someone who wants to buy a cheaper house could be an extremely good idea because they could reduce their debt. If you have a mortgage of €600,000 and a house now worth €500,000 and are struggling under the weight of the debt, would it really be a bad thing to sell up and buy a house for €300,000 with a mortgage of €400,000? And what about the bank? Would it be reckless to provide such a mortgage to a customer who is trying to reduce their debt? The risk position of the bank has surely improved, with exactly the same exposure to negative equity, but a mortgage that is now more likely to be repaid in full (including the negative equity!!).

And what about from the debt servicing side. What if the borrower loses their job, or finds a better paying or more secure job and needs to move to avail of the opportunity. Would providing a mortgage that facilitates that move, but does not increase the gross debt burden of the borrower any further be prudent or imprudent for both parties concerned.

In both those circumstances I would argue it is imprudent and extremely poor risk management to rule out such a "negative equity mortgage", because to do so would keep the debt burden higher, or make the debt servicing more difficult and hence increase the likelihood of default.

So this is what I suggest:

There should be no blanket ban on such mortgages.
The Financial Regulator should demand of any bank wishing provide such a mortgage that specific pre-agreed criteria need to be met by the borrower
Such a mortgage can not be granted to a new customer (i.e. current mortgage holders only)
Such a mortgage must not be greater than the present mortgage outstanding,
Such a mortgage can be of no greater term than the current outstanding mortgage (this might be open for negotiation).
The Financial Regulator should review the operation and experience after an initial period and reassess the rules and policy.
Such mortgages should be allowed for a specified period only (next 5 years say), which may be extended by the Financial Regulator if deemed beneficial and prudent.

In effect, these are extraordinary measures for extraordinary times. And this is one of the very few sensible ideas to float in the country that addresses our problems:

WE HAVE TOO MUCH DEBT!!!!!!!!

It may be appropriate at the margin only, but that would make it 100 times more effective than any other "initiative" I have seen advanced in Ireland to date.

Some better signs for global adjustment

2010-06-21T10:41:00.003+01:00

News breaking over the weekend that China has broken the Reminbi/Dollar exchange rate peg. It has been announced that the regime is to shift to a "crawling peg", where the central bank sets an adjustable target rate with some narrow bands for fluctuation. This is clearly a regime to allow the authorities to attempt an "orderly exchange rate adjustment" - note the inverted commas.

There is some background to this, hardly shocking, news, here and here.

What happens now? Well, the market reaction tells the tale. It is general perception, well founded in my view, that the Reminbi is quite undervalued in real terms (read the above links; in effect Chinese prices are currently set at an artificially low level relative to the rest of the world via the fix on the exchange rate). The Chinese authorities have indicated that rather than allow domestic prices to inflate as the process of adjustment, they are willing to let the exchange rate appreciate.

If this occurs, this should provide much more comfort all around. Less inflationary pressure in China, less deflationary pressure in the rest of the world. Common sense - shock horror.

The path from here is most likely to be one of bumps and detours, particularly as markets test the announced target fluctuation bands of +/-0.5%, but at least this is a positive move that the powers in China recognise the futility and potential destructive consequences of trying to centrally plan their economy - even if they don't like the fact.

Let's check on our "Green" investments

2010-06-18T10:34:00.004+01:00

Time for another quick check on how our HSBC (and Kate MacKenzie at the FT) recommended investment strategy is getting on.

For those who don't remember, the hypothesis was that windmills and solar panels and other industries that will help fight climate change and herald a new era of free energy and love and peace and milk and honey for all (or some such drivel) were a fantastic investment opportunity that had been hamstrung recently by lies and intimidation from dastardly "Climate Change Deniers" [cue evil music]. But now that the the institution of climate change hysteria was getting a clean bill of health from many "independent inquiries", such speed bumps were passed and we were all set to get massively rich.

My hypothesis was slightly more prosaic. Dangerous Human Caused Climate Change is bunk of the highest order. The "alternative energy" industry in all its guises was a subsidy farming scam - fuelled by stupid and duplicitous politicians taking money from people who earned it and giving it to sleazy entrepreneurs with low morals. And now that the public subsidy well is running dry with massive public deficits, the economics of these industries (pouring taxpayers' money into industries that have no economic rationale on their own) will inevitably collapse. My hypothesis suggests investors are best to remain out of these industries (at least until you think they will have the ability to steal more taxpayers money).

The latest results are now in for May . I know this is a short period and returns are noisy, but it still looks like the FT and/or HSBC would be better off simply reprinting this blog (hell, they can have it for free) rather than continue to pay the salaries of Kate MacKenzie and whoever is pumping out their "Green" research.

Total returns on the HSBC Climate Change Index were 12.5% less than broad Global Equities. over the last 12 months and 7.2% less in the year to date (so under performance accelerated). [the red line is the Climate Change Index returns and the green one is for Global Equities]

Economics for crash test dummies

2010-06-14T11:03:00.009+01:00

Time for a change of gear from recent posts. Every now and then it is interesting to see where economics has applications in the real world in areas that one wouldn't normally expect to see any relevance. I suppose you could call this a bit of a "Freakanomics" diversion [that was in fact the book I always intended to write - but I don't think Freakanomics will be bettered in this genre].

So, I was watching a car show on television the other day, not Top Gear (which is brilliant). In it there was a segment looking at car impact safety and how it has advanced over the last 10-15 years. The set up was that they crashed a 1990 something Volvo 940 into a 2007 Renault Modus. Now, Volvo have always had the reputation for being safe cars and the 940 is a significantly large car than a Modus - and crucially has a much longer front bonnet (better for providing an energy absorbing crush zone than the stub-nosed Modus).

http://www.youtube.com/watch?v=qBDyeWofcLY

What happened when they threw the cars at one another head on at 40 mph was a near total destruction of the Volvo, with very serious incursion of the impact into the passenger cell of the car. By comparison, the Modus showed virtually no sign of impact from within the cabin. A driver in the Volvo would almost certianly have suffered extremely serious injuries, while one in the smaller Modus may have escaped with light grazing only.

Interesting, huh? But where is the economics?

The economics is here - and it is in the form of an application of both externalities and game theory. To take you through it you need to go back a few decades in car design, to a time when big, strong and rigid was the order of the day.

In the 1960s a safe car was a big and strong car, able to withstand impact and keep the passengers inside within a protected shell.

By the 1970s engineers were working with new materials and technology and thinking shifted to provide for a rigid passenger cell, with softer, energy absorbing crumple zones at the front and rear. That technology existed into the 1990s - and is evident in the Volvo 940 here.

Now we have moved on further, with new technology entering into the industry, designed specifically to make smaller cars (now more popular) safe in high speed impact. That is the Modus, which has a very small crumple zone in the front, and extremely strong front firewall and just as crucially a small and light low mounted front engine.

What the display showed was how effective all those elements worked together on the Modus, but one thing caught my attention. As good as the Modus saftey features were, a large amount of the energy in the crash was absorbed by the Volvo, which all but disintegrated. In effect, the Modus used the Volvo as an additional crumple zone. Had the same test been run with a big heavy and rigid 1960s design car, I doubt the Modus would have fared nearly as well. Not only would there have been less energy absorbed between the two cars, the opposition would have been significantly heavier and we know that energy is equal to mass squared.

And there is the economics. You can design a really safe small car like the Modus, if you know that everyone else will be driving around with a big soft crumple zone on the front of theirs. You can get away with carrying less energy absorption around yourself. That is the externality - you can be safe by demolishing somebody else. Of course, that works only until other drivers recognise that change their cars to something that provides them with more safety in the event of a crash with a Modus - the alternative strategy is to drive a Hummer with a "roo bar" fitted. A Modus wouldn't survive so well as the Hummer would likely use it as a stopping aid.

And there lies the game theory. The safety of your own car in a crash is a function of what someone else drives. You modify your decision based on what the best payoff will be for you given the likely option chosen by others. The next time you run into that Volvo 940 driver in your Modus, it is more likely they will have switched to the aforementioned Hummer.

Are markets missing the elephant in the room?

2010-05-27T10:17:00.009+01:00

Greece is in dire fiscal straights, most would agree. A public budget and debt problem larger than they were willing to reveal to the world and now an inability to raise money to fund the growing debt pile and shortfall in government revenues with borrowings without an explicit guarrantee from fellow EU members.

The silly squabbling in Ireland is all about how we are in much better shape than Greece, or even Portgual or Spain. We have less government debt and are making "draconian" cuts in the public deficit.

If we have learnt anything from our recent economic history it should be to shun such ill judged hubris. We have proven to be a poor judge of our own policies or performance.

Let's have a more complete look at the problem.

First, nearly every measure of public indebtedness or annual borrowing I see is expressed as a percentage of GDP - a percentage of our national output. This is bad for Ireland. It should be expressed as a percentage of our National Income better appoximated by GNP or GNI. That increases all the figure by up to 25% (ie. 80% of GDP turns into 100% of GNP)

Secondly, we are being far too self congratulatory on fiscal initiatives to date. We have hardly made a scratch in the public sector imbalance between revenue and spending.

Third, while we have inadvisedly laughed at Greece hiding pile of government debt, Ireland has simply been doing the same in plain view. All the borrowing for NAMA related activities and bank recapitilisation is debt, but attempts are made to keep it "off balance sheet" without crudely hiding it.

But the final point is the big kicker. The problem isn't about public indebtedness, even though that is where all the focus has been. The problem is total indebtedness. How much debt in the public and private sector and consequently how much indebtedness to the rest of the world. It is pretty stupid to tihnk that an economy that has a reasonable large public debt stock and public deficit is in a more precarious state than one with slightly less debt and lower public deficit, but much more debt in the private sector.

When we borrow we are bringing forward future consumption. We then spend the subsequent years generating income to pay for the debt and pay it off. More debt (as a percentage of our income) means a large cut of our future income has to go to service and repay the debt. We also have reduced ability to serve our government debt obligations - which, let's face it, are just an extention of our collective private debt obligations as a nation.

That means reduced future standards of living. This trade-off is better for us if the we borrow to invest in assets that will reap income in the future (be that occupied housing, plant, infrastructure etc.). It is worse for us if we use it for final consumption (cars, furniture, holidays) or excessive investment (ghost estates etc.). Which of those sounds more like Ireland?

So to the data. The following shows the more comprehensive pciture of relative indebtedness across some European countries, including our fellow "PIGS". Now think about whether you would rather be exposed to Greek debt or Irish debt?

I wouldn't be so smug and probably wouldn't swap Greek bonds for Irish bonds, despite the contrary view that market is placing on the relative credit worthiness of the two countries at the moment.

Just how is that "climate change" investment getting on?

2010-05-26T15:11:00.002+01:00

Remember, being told that the HSBC climate Change Index had been underperforming global equity returns because some beastly sceptics were hacking emails and other such nasty things like calling honest hard working grant farmer, I mean climate scientists horrid names?

And remember, that now we had most of those unsavoury events behind us, we could all glory and profit in the wonder that is the Green Economic Revolution(TM)? Yes? A do you remember me saying that you probably want to be a little bit more conerned about how the shareholders of such wonders as windfarms and solar panels and other economically destructive industries, companies and interest groups would manage to get the massive subsidies they need to produce any sort of return at all?

Well, it is certianly the case that the overriding investment theme this year is "we have bled taxpayers dry and will need to squeeze some more, so your stupid windfarms can live or die on their own". Well, the relative returns of the HSBC Climate Change Index this year look pretty much as you would expect under such circumstances.

Returns relative to global equities this year to 30 April -5.5%

http://www.morningstar.co.uk/UK/snapshot/snapshot.aspx?tab=0&id=F000000OC5&lang=en-GB

Crimes against the sales descriptions act

2010-05-26T14:56:00.008+01:00

And today's is:

The "growth and stability pact"

One of the greatest problems with a common currency area is that it could leave constituent regions exposed to assymetric shocks. To the lay person that means, in effect, an even that pushes one or more countries into recession, but not others.

The "growth and stability pact" in general and the more recent "stability measures" announced by the European Commission force those countries mired in the worst recessions to impose the most pro-cyclical (recession exacerbating) fiscal policies.

How that enhances prospects for either growth or stability, I don't think I am clever enough to understand.

But. The big news is that we knew this a long long time ago...

....sigh...

Get rich quick, the green way

2010-05-01T17:19:00.007+01:00

An interesting blog here at the FT on recent comparative returns from Climate Change related stocks relative to the general market. The general thesis is that businesses that operate in climate change related areas, like wind, solar or nuclear energy companies have produced lower relative returns to investors over a period during which the market has been slightly rattled by questions over the integrity of those producing the "science". They go on to say that everything will be hunky dory once the final whitewashes, sorry, I mean independent expert inquiries report and a full and completely clean bill of health is awarded to this shower of chancers and charlatons that call themselves a scientific discipline.

Here is the supporting chart with all the relevant dates and events as exhibit A.

Well, guess what. I think this is spurious anlaysis, that HSBC are producing this"research" to convince punters to buy into their index now and Kate Mackenzie at the FT has fallen for it hook line and sinker.

Here are the salient points this HSBC report fails to mention and Ms Mackenzie fails to spot. The majority of constituents of this index are companies who will only produce a return to shareholders if they get lots of taxpayers money. That i how the wind energy industry has got to where it is today. Taken from our pockets by politicians and placed into those who own and run these companies. People like Al Gore.

And what has been happening recently in Europe? Well, there has been a collective realisation that the finances of governments across Europe are in such a parlous state that bankruptcy is a very realistic possibility for places like Greece, Portugal, Italy, Spain and Ireland. Money for businesses that add no economic value like wind energy or solar energy companies just isn't there and investors awakening to the fact that the "Pig at the Taxpayer Filled Trough" business model has no immediate future until we get ourselves out of hock.

This is the type of event that was occurring in January, just at the time the HSBC CC Index started to hit trouble. Kate should have spotted a report on it. This one came from her newspaper:

http://blogs.ft.com/money-supply/2010/01/06/stark-words-on-greece/

There will be no bail-out of Greece by other European Union countries, a top European Central Bank official has said. “The markets are deluding themselves when they think at a certain point the other member states will put their hands on their wallets to save Greece,” Jürgen Stark, an executive board member, told Italian newspaper Il Sole 24 Ore.

Put that event on the chart above and it starts to take on a different meaning. In fact 7 January has a much better coincidence with the actual decline in relative performance than the "Himalayan Blunder" used on the chart, which clearly comes after the gap between the red and black lines closes.

Let's face it, markets really couldn't give a lambs whatsit for CRU whitewashes or an other irrelevant political shenanigans (they see through it as being completely political shenanigans).

And that is what the markets really think of this game - a pork barrel free for all. And that is why returns have been under-performing the wider equity market. And that is why would be mad to put money into these companies now.

Solidarity "bonds"? Thank you but no thanks

2010-04-30T09:48:00.007+01:00

What a wheeze. The brains trust of the Irish government has launched a "National Solidarity Bond". Handing the cap around for our poor impoverished nation (hey buddy, can you spare a dime?).

Huzzaahhh. We're saved.

I wonder if they will get many takers? Let's pop the hood on this bad boy and check out what makes it go.

One problem right off the bat is that there is a blatant lie, right there in the name. This isn't a bond, it is a fixed term deposit. To make this a bond it would have to be a tradable security. It isn't tradable, so it isn't a bond.

Next, what do you get in return terms on this "National Solidarity Fixed Term Deposit"? A simple bit of financial arithmetic gives the answer as 4.1%. This comes from an annual 0.75% "coupon" after tax (a term we should on use for a real bond), plus an interest free bonus of 40% on maturity. You only get the bonus if you hang on for 10 years. If for some reason you need the money and have to withdraw, the maths is simple, you get a 0.75% after tax return. Is that a good return? Well, buy a real Irish Government bond today and you would get 5.2%. For the majority of the population that don't pay income tax it is a nice earner, if you think they are good for the money. Pay a top rate of tax and you would get around 2.9% per annum

Let's think a bit more about that 4% return though. So you get 4% annualised return, but all paid on maturity (your investment has a long "duration"). What might go wrong? Well, I mentioned that some misfortune might befall you, say after 9 years and you just have to take your money. Then you lose virtually your entire return.

Think also about interest rate risk. You are locked in to this return and if interest rates happened to go up significantly, say after five years, you would be sitting on a very poor return.

Think about inflation. 4.1% return is nominal. If inflation average 2% you get a 2.1% real return. But if it averaged 4% you would get a zero real return. It is easy now to think that inflation will always be low or non existent, but it is a dangerous animal. And the back end nature of your return, which cannot be sold on to anyone else (remember, this isn't a real bond), means that even if after a couple of years, you begin to get worried that inflation will rise, it is too late, you've lost.

So Buy real Irish Government bonds at 5.2%, or 2.9% after tax or a 10 year fixed term deposit with draconian early withdrawal penalties at 4.1% after tax? I think I would take the former, if I was stupid enough to lend anything to the Irish Government.

What puzzles me is why they didn't do something more sensible? How about a zero coupon government (real) bond issued at 34% discount to par (i.e buy for €66 and €100 is repaid in 10 years time). Capital gains on government bonds are not subject to tax for Irish residents, so there is your 4.1% return, but it is tradable. All they needed to do was arrange a deal with an Irish asset manager or life assurance company to package an investable fund for small investors. They could have even picked up the puny cost and fees involved (probably less than 0.1% per annum) allowing free entry and exit at a single price. Easy peasy. It is the same result for the Irish government - if they expect to fully repay interest and capital on everything they borrow.

And that is the catch (and why I lied). I do know why they went down the fixed deposit route. Think about it yourself. Why would you ask to borrow money from someone and promise to pay any material return only if they didn't ask for their money back before 10 years? In effect, allowing you to avoid paying any interest to anyone who, perhaps, started to worry in a few years whether you would repay anything?

You probably doubt your own creditworthiness.

But I just can't get passed the name. "National Solidarity Bonds". I just wouldn't enter into any bargain with someone who opens discussions with a lie.

Betting on the Euro

2010-04-26T14:05:00.005+01:00

Another day another crisis for the Euro. Greek sovereign debt has now ballooned out to a 13% yield to maturity. Quite phenom anal, when you think back to the inception of the Euro and all sovereign risk premia were rapidly priced out of the market.

The dispersion on sovereign spreads is now quite dramatic. Ireland's are back to 2% (a country not massively dissimilar in fiscal characteristics to Greece). One way to interpret these developments is as a price on Euro break up.

If Greece never leaves the Euro, any holders of Greek debt will suffer Euro inflation risk only. With a 13% nominal annual return to maturity, I reckon that is a bet well worth having.

Secondly, if Greece never leaves the Euro it is difficult to see a debt default occurring. The most likely scenario in which the more fiscally sound members of the Eurozone allowed Greece to default would be one where fiscal problems were so widespread and large (say to Spain, Ireland and Italy) that a bailout of Greece would require an unaffordable bailout for all. And should that happen, it is surely almost certain that the Euro would break up, leaving Greece on the outside.

Considering those factors combined and if you agree with the logic, what you have here is a bet that Greece will still be a member of the Eurozone in 10 years time. Markets would appear to think this is increasingly likely that Greece could bring down the Euro.

So do you feel lucky, Punk?

Risk versus Uncertainty - in the skies over Europe

2010-04-20T10:30:00.033+01:00

Planes are grounded yet again across Europe as volcanic ash and particulates disperse into the atmosphere out of Iceland. The "risk" to passenger safety is too great, so the authorities issue grounding orders across most of European airspace.

By all accounts the risks associated with flying an airplane into a cloud of volcanic emissions (catastrophic engine failure) are not worth the potential benefit (getting from A to B quickly). Hence, preventing planes from flying into such clouds is an extremely sensible risk mitigation policy. No argument. Then why are we starting to hear grumblings from airlines, complaining that they are being grounded unnecessarily?

Is it because they are just trying to turn a buck and there isn't much demand for a ticket on a plane that can't take off? Definitely.

Is it because airlines, driven by their profit motive, are more cavalier when it comes to risk? Almost certainly not.

So what gives?

It's all about risk versus uncertainty. So it is worth going back to basics to understand why these two animals are related, but different.

Risk is the extent to which any particular event may have multiple outcomes.
Uncertainty is the extent to which we have incomplete knowledge about the nature, range or relatively likelihood of these multiple outcomes.

For some people that is a "so what" proposition. However, I am pretty certain that for the overwhelming proportion of the population that is a "huh?" proposition. Assuming the former have already moved on, I will expand further for anyone interested in reading more.

Let's proceed by contrasting two examples. Let's first take a coin toss. Say we bet on a coin toss, so our fortunes are inextricably tied to the outcome. The toss exhibits "risk" for us, there are multiple potential outcomes - heads we win, tails we lose. However, there is relatively little "uncertainty" - a decent spinning toss should have a 50% chance of coming up heads and a 50% chance of coming up tails (rounded to exclude the odds of it landing on its edge). We can be pretty certain of those probabilities, if we know who is tossing the coin, how the coin is being tossed, the nature of the coin being tossed - these are all regular, observable (knowable) qualities. This example exhibits a lot of risk for us in our bet (one chance in two that we lose), but relatively little, if any, uncertainty (we are pretty confident that it is at least very close to a 50/50 chance)

Now lets look at flying in a plane. To simplify the infinite number of potential nuanced outcomes; the plane may complete its journey or the plane may crash. So, like the coin example, our next step is to try and quantify the relative likelihood of the potential outcomes (assuming we have correctly identified all relevant potential outcomes). In this situation the airlines and regulators have made decisions and taken actions that are designed to affect the relative likelihood of the outcomes (crash/not crash in our example). The plane has engines for example - always a good start. The pilots are trained professionals - always a bonus I find. There are copious check lists and scheduled maintenance routines. And so on and so forth. Moreover, we have emprical data for millions of commercial flights and only a very small proportion of those have resulted in crashes. So we are left with an estimate of the probabilities of Very Low (crash) versus Very High (not crash).

Where are the numbers, the hard probabilities this time I hear you ask. Well, I can't give them to you. Why? Because I am uncertain of all the various things that could possibly go wrong, be completely unanticipated, or are just so absurd as not to waste time considering them (shot down by an alien spacecraft). Such is uncertainty. In technical-speak, I am unable to specify the probability distribution function. In this example, we have low risk (the odds of crashing are estimated to be extremely low), but we have a lot of uncertainty (is the probability of a crash 0.01% or one hundred times greater at 1% for the specific flight in question? - we can't tell. It may in fact be 50% if someone happened to leave the work experience kid to do the pre flight engine check).

So what are the implications of this and how does this relate to plumes of volcanic ash?

Well, first off, note what is the most important implication of this understanding for risk and uncertainty. We act to mitigate against risk - that is try and prevent the known potential bad outcomes occurring. The more successful we are at doing that, removing risk, the more we are left with uncertainty. People who are scared to get on a plane because they are scared of the "risk", are actually scared of the "uncertainty" - the unknown or unknowable factors that might be at work. And you can't do anything about uncertainties directly - obviously because you don't know about them. And there is the crux:

Uncertainty is just a condition dependent on how much information we have - remember that because I will return to it.

So, on to the ash and trying to understand why airlines seem willing to fly their passengers into ash plumes, while regulators aren't. It isn't profit motive per se, although it must be accepted that the regulator isn't affect by whether the planes fly or not. In this particular instance there is specific cause to believe that a tussle between risk and uncertainty is taking place and one party might be confusing the two concepts.

According to reports, the Europe wide ban on flights is largely the result of the work of the UK Met Office. They model the atmosphere and predict where the volcanic emissions might drift. They come up with a result and recommend that flights be banned in the areas around which their model suggests the ash will be. Very sensible in itself, it is an attempt to assess the risk. However, what this work does not incorporate is physical measurements of where the ash actually is at any time. So, there is also significant uncertainty at work here.

Planes are being grounded because of the risk (the estimated odds), certainly. But, they are also being grounded because of the uncertainty (the not being confident of the estimated odds). Now, this is where things could possibly end. When we make such a decision, the uncertainty needs to be considered in conjunction with the risk and combined they suggest that it is prudent to ground planes.

So the airlines are wrong you might say. Well, not necessarily. What the airlines are validly pointing out is that the uncertainty part reflects our lack of sufficient information, which affects our confidence in assessing the risk. And they go on to point out that there is more information that could be obtained. That information is where is the ash in reality (as opposed to where it is modelled to be), which they suggest can be obtained by making measurements, possibly by flying suitable test flights in certain areas, or using balloon based sensors maybe. The simple analogy is that you don't put on a heavy coat when you leave home simply because you are uncertain about whether it is cold or not - you take whatever practical steps you can to gather a bit more information, like walk outside, so you can remove more of the uncertainty and leave yourself with the risk that it may or may not get cold later.

The airlines are saying that some of the uncertainty, which is part of the reason for the blanket flight ban, is not because we lack sufficient information, but because we aren't even bothering to gather the relevant information. And that is a valid point.

So who is right? Well, both are and neither are. We just don't know. We are dealing with uncertainty, remember? But one thing is certain. If we understand the difference between risk and uncertainty, we can make better decisions. In this case minimise the possibility of a crash, but also minimise the possibility that we are unnecessarily curtailing air transport.

Because life's too short

2010-04-14T16:20:00.002+01:00

I want one:

http://www.martinjetpack.com/

Some budge in the Reminbi?

2010-04-07T09:10:00.003+01:00

Are we about to see a revaluation of the Reminbi and/or a shift to a floating exchange rate regime? A widening of trading bands for the currency, which is pegged to the US Dollar, would be a typical place to start the process:

Beijing lays ground for renminbi shift - Financial Times

See more on this topic and the inevitability of this change here

Won't somebody think about the jobs??!!!!

2010-03-31T15:32:00.004+01:00

OK, so Quinn is looking wobbly and creating rising angst among the chattering classes. Most comments I have seen to date are of the "we have to support Quinn because of all the jobs the company provides".

If I was PR advisor to Sean Quinn himself, I couldn't think of a better approach to trying to secure a nice fresh wad of taxpayers' money in order to prop up my children's' inheritance.

While there is indeed a large number of people employed across the Quinn group of companies, the truth about the prospects for those employees is a little more prosaic than the general hysteria would suggest.

If the Quinn group does pass from administration and into receivership it is not the case that 5,000 jobs would be lost to the Irish economy. I think I have written about this before - in fact I have ( "Jobs"). Jobs are not things that get misplaced or dropped between the cushion of the sofa. They are the labour required to produce goods or services in the economy. The extent to which the Quinn group is providing goods and services to the economy means that the jobs have a place, they are required.

The salient point is that we are confronting the possibility that Quinn might go to the wall, not the demand for Quinn products and services vanishing.

In the worst case scenario that Quinn is placed into receivership, various elements of the business will have value and that includes the people turning the cogs. Sean Quinn and family will no longer own the operations, but what does that matter? Your and my taxes shouldn't be a source of billionaire welfare.

Now, parts of the business do look bit dodgy operationally. Those exposed to the construction sector for example. But those parts of the business will survive or fall regardless of ownership. Also, we might expect some sort of synergy if the group is broken up and sold off, but that will be a modest proportion of the total employment and would help deliver increased productivity and hence increased income for the country in time.

So let's, please, not fall into the trap of pouring taxpayers' money into "national champions". Quinn made some massive mistakes. If his empire flounders, the blame lies at his door. From the remains of the group activity will go on.

The NAMA amateur players

2010-03-31T14:31:00.015+01:00

I predict that NAMA is going to be the most entertaining theatre seen in the State since Oscar Wilde was in short pants. Already we have high farce, turning effortlessly to abstract fiction in the blink of an eye.

The first round of invitations to the NAMA drama, the opening night one might say, included the debts of one Ballymore Properties. This is a private company, originally the brainchild of Sean Mulryan - one of Ireland's "Masters of the [property developers] Universe". All I can gleen at the moment, given the paucity of information about how someone else is spending your and my hard earned income, is that Ballymore debt has been transferred to NAMA and the average NAMA discount was 47%.

Now, a logical conclusion to reach about a company that has had its debts sold on at a 47% discount is that the company in question is insolvent. It is a question of balance. Sheets that is. If NAMA, on the back of their own bottom up valuations and financial investigations think that 47% of the total obligations will not be recovered (remember this figure is supposed to include a premium for Long Term Economic Value), then the total value that will be recoverable from the assets of the company is extemely likely to be less than the orginal total value of the debt. If that is the case, there should be nothing of value left at any point for distribtution to equity shareholders of the company.

In other words, a shareholder of any company that has had its debts NAMA'd, should not be expecting any money back - because there won't be any after the debt and interest on the debt has been repayed (and then repayed only partially).

So what price would you put on a share of the equity of such a company? Go on, have try:

>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>tick
>
>
Doo-doo, doo-doo, doodoodoodoo, boing

Did you guess zero? Well, you're wrong.

I have some sympathy. I can understand how you would make such an elementary mistake. The correct answer is anything from 30 cents per share to 79 cents per share.

That's right. Ballymore themselves, with the help of their mates at Davy Stockbrokers, reckon shareholders have a healthy 79 cents per share in the bank.

Some asset managers in the Irish market who were clever enough to drop a wad of client cash into this vehicle at inception are a bit more conservative though. Some of them think that shareholders can count on 30 cents per share and book that value in their clients' or pooled fund accounts.

So it's all fine, hunky dory, AOK. You see in NAMA world you can get something out of nothing.

And leaves us with a graceful transition to light opera. Cue Gilbert and Sullivan...

"A paradox, a paradox, a most amusing paradox,
haha haha haha haha a pa-ra-dox...."

The implosion of Quinn

2010-03-30T12:00:00.004+01:00

An interesting devlopment for the Quinn Group.

http://www.rte.ie/business/2010/0330/quinn.html

It is always worth waiting for details before offering an opinion, but fools jump in so I might as well.

This was something that has been waiting to happened for some time. In fact I am amazed that the general insurance business was managing to stay above water. I flagged that rather racy investment strategy pursued by Quinn around 18 months ago on thepropertypin

http://www.thepropertypin.com/viewtopic.php?f=19&t=12955&p=121085&hilit=quinn#p121085

The company must have lost a bucket load of assets as property and equity markets fell (and we don't even know how much of the "stocks and securities" recorded on the balance sheet of Quinn were Irish companies, or more specifically one particular bank....)

This will be worth watching. Get your popcorn in now as I suspect there could be all manner of skeletons falling out of this closet.

Fair thee well sovereignty

2010-03-23T17:07:00.001Z

March 23 (Bloomberg) -- Germany and France have agreed to back International
Monetary Fund aid for Greece, a German Finance Ministry official said, signaling
a joint position after weeks of dispute over how to resolve the Greek crisis.

http://www.businessweek.com/news/2010-03-23/germany-france-agree-on-imf-aid-for-greece-official-says.html

Very curious.I wonder what this means. There is nothing as far as I know contained in any EU law that gives France or Germany any say over Greece's decision whether or not to ask the assistance of the IMF.

Very curious indeed.

National Pensions Framework - heading for double taxation?

2010-03-04T10:20:00.005Z

There are many things to be said about this "framework". This is not a novel model, following roughly the "Chilean" or more recently "Australian" approach. What caught my eye (as a cynical and inveterate critic of politicians) was this bit:

There will be matching State and employer contributions. The State contribution will equal 33% tax relief - the delivery mechanism for this to be decided;
The same matching State contribution (and delivery mechanism once decided) will apply to existing occupational and personal pension schemes and will replace the current system of tax relief at the standard and higher rates;

There is a cut in the tax relief for higher earners (and and increase for low earners), but that was known already. What is more interesting is the monetisation of the tax credit.

They appear to be moving from a system where you current pay less tax on your income (i.e. you employer diverts you gross income into your pension, rather than send some in tax to the Revenue), to one where you will make you contributions after paying tax on your income and then a direct payment will come from general government revenue as a supplement.

This has no immediate ramifications for what you save. It should be revenue neutral. However, it would appear to me to be a system that is more conducive to change. It will be a much easier task, for example to, reduce the amount of the "credit" or put a cap on it at some monetary ceiling., or even scrap it altogether as an "expenditure cut" rather than as a tax increase.

I reckon this is the sign that tax credits for pensions saving is on the way out. And this is a bad thing.

Why is it a bad thing? Well, from an equity point of view, it means that taxpayers in the future would be subject to double tax. You would be taxed on your income when it is earned. You would then lock it away in an account for 10, 15, 20 years or whatever, and then when you access it in retirement it will be taxed again.

Make no mistake. This is no different from the government subjecting you to income tax on any bank withdrawal you make. It is the same.

How many people would tolerate that? Well, it looks like we're on that slippery slope.

Miracle Energy

2010-03-03T11:56:00.005Z

More than one "alternative energy" subsidy scam, I mean electricity generation project has emerged from the cracks in the floorboards in Ireland in the last year. The most prominent of these has surely been Spirit of Ireland (sounds inspiring doesn't it), but there is at least one other I have seen.

What are they about? I'm glad you asked. You see they make FREE ELECTRICITY, by "harnessing the natural wind resources of Ireland" or somesuch nonsense. In the world of sensiblespeak they use wind turbines to pump water into reservoirs which then generate hydroelectricity. OK, it is a batch of windmills connected to a big battery.

Sounds great. If you don't dig too deeply. Let's do that.

Our starting point is that wind generation of electricity is a complete waste of time. No matter how many windmills you have, you can never have the type of certainty of generation that a modern society requires. Today, we will never accept "sorry you need to be cut off for a while because there is no wind". Nor should we.

Simply put, windmills provide electricity when the wind blows, not when people need it. It is only by random chance that those two conditions occur at the same time. And even a 90% concurrence is 10% too low.

So we need an alternative for when the wind isn't blowing, noting that sometimes there is next to no wind across the entire island of Ireland. In which case we need alternative methods of generation available at all times for immediate supply of electricity. Of course, that begs the question; why have the windmills at all then?

Quite.

So windmill buffs come up with a weeze. Why not store the electricity generated when the wind blows so it can then be provided only when people need it. A big battery, like a hydroelectric reservoir where we pump the water uphill to be released downhill when electricity is needed.

Sounds lovely, until you try to mount this baby and ride it full tilt down the wrong side of the motorway of the real world.

It turns out that the reliability of wind in Ireland (the windiest place in Europe supposedly) is such that even with massive storage capacity such a combined generation and storage system is still likely to run short of electricity. Don't believe me? I got into a discussion about this hair brained scheme some time ago. I like to check things out for myself so I modelled such a system using data for actual electricity generation yields from the Irish wind network combined with different theoretical stored capacity. This is what I found using data at the time (note, this is from last year, but I didn't cherrypick the time period, I simply took the current month).

The chart below shows how much potential electricity would be stored in such a system with different level of storage capacity; from a pretty hefty 100 Gigawatthours up to a massive 500 Gigawatthours. Just note that 500 Gigawatthours is about enough electricity to keep all of Ireland running for about 10 days. It is alot.

Next I assumed that the reservoirs were full to the brim at the start.

Next I simply calculate how much electricity would remain available to meet demand from households and industry if it was attached to a flock of windfarms with a theoretical 5 Gigawatt output (i.e. if running at optimal generating speed they would generate 5*24=120 Gigawatthours of electricity in one day, at 50% they would generate 60 Gigawatt hours)

We then compare how much such electricity was being generated and how much electricity was being demand across Ireland over the period and can track how much storage would remain over time (it being used to meet demand when the wind wasn't blowing sufficiently strongly).

This was the result:

Even ,with a massive 500 Gigawatthours of storage at the start of June last year, Ireland would have been blacked out by the middle of the month. We would have needed an alternative backup generation system available to meet 100% of the country's needs on top of this very expensive hair brained scheme. So, why bother with the hair brained scheme?

Some people might try and quibble by pointing out that I have simulated how this system would operate meeting the electricity needs of the entire country, when the proposal is only ever to meet a proportion of it.

Well, leave aside the fact that some of these proposals claim we could use this for all our electricity needs, all you need to realise is that this analysis shows that the system could not be relied upon to meet any arbitrary amount of electricity demand on its own. It would need 100% backup.

So again. Why bother with this, when the backup works on its own?

Something wrong

2010-02-16T17:22:00.017Z

Want a little insight into one of the problems with the Irish economy? A problem that not only isn't even acknowledged or commented upon anywhere, but something that government and public opinion would like to see exacerbated. That's right, make it worse.

Exhibit #1 - the [income] tax distribution:

Irish income tax revenues are raised from such a concentrated proportion of the population. This is perceived locally as "good" because "they" are "rich". The political momentum is for more of the same. Ireland leaves France in the shade for its distorted tax burden and narrow base.

Exhibit #2 - the welfare benefit replacement ratio:

Go on to welfare and you can replace 70% of your income from going to work [note that by income this means average earnings, not some measure of basic or subsistance income]. Why bother work if you dont have an immediate prospect of being int he top half of earners in the country? And and the risl of being lambasted as some Neocon Nazi, I might suggest there is a strong correlation between those people who might, how shall I put it, be less endowed with self motivation, gumption and stoic character that is generally required of people everywhere to start at the very bottom if necessary in order to work your way to a better situtation.

I might provide some more charts in a later post to show how this adversely affects peoples choices and brings poor outcomes. Just a note here. Earnings are falling, benefit rates are not. This replacement ratio is rising.

This adds up to a lot of disincentive to either:

take personal control over your welfare
aim to succeed

Playing with fire

2010-01-10T10:04:00.005Z

One of the consequences of the large current account surpluses being run by developing Asian economies - see related posts here and here - is that these countries have an increasing pile of foreign exchange they need to spend. Add to the fact that some of these countries have, let's say, a tenuous grasp on liberal market economics (let alone western democratic civil liberties) and we get some interesting stories. Like this one:

TWO senior Qantas employees prevented from leaving Vietnam after financial losses on fuel markets have done nothing wrong, Qantas chief executive Alan Joyce said in Sydney yesterday.
Jetstar Pacific chief operating officer Daniela Marsilli and chief financial officer Tristan Freeman were refused permission to leave Vietnam on December 19 and are being investigated over losses linked to a practice known as fuel hedging.

http://www.smh.com.au/travel/travel-news/australian-staff-in-vietnam-did-nothing-wrong-20100109-lzv2.html

As a main board director of a publicly listed company could you place your employees at risk of such behaviour from your supposed co-shareholders or business partners. I for one would feel that I had some responsibility for employees not being treated in such a fashion.

Should boards be factoring in their responsibilities in these areas and potential risks to themselves if nothing else before they get into bed with such unusual capitalist bed fellows?

Climate, meet economics. Economics, meet climate.

2009-12-07T15:24:00.003Z

Who could fault government grants to foster research into clean energy technology?

http://www.phillyburbs.com/news/news_details/article/92/2009/december/04/feds-give-clean-coal-projects-979m.html

Me actually.

Subsidies and grants of this nature do indeed create an environment of corporate innovation and discovery. Unfortunately, companies tend to use the money to discover increasingly innovative ways to harvest yet more money from taxpayers' pockets.

I met a climate scientist the other day...

2009-12-03T11:44:00.004Z

...the conversation went sometihng like this...

Scientist: Look at my marvellous study. Do you see that squiggly line? It shows that temperatures 1000 years ago were not very high compared with today because tree rings show smaller amounts of growth then. The earth is much hotter now than it has ever been.

Me: Fascinating. What do those same tree rings show about recent history, say the last 50 years?

Scientist: Well, they show very little growth over the last 50 years.

Me: You mean just like the periods in the past where you claim they indicate low temperatures.

Scientist: Well, yes

Me: So, doesn't that imply that the tree rings indicate that temperatues over the last 50 years aren't higer than 1000 years ago?

Scientist: No, because I take them off the chart and you don't see them, so we can just ignore that.

Me: But isn't that, sort of, cheating?

Scientist: Of course not. It is a "trick" - that is a technical scientific phrase meaning a special adjustment.

Me: But doesn't this hide a decline in the tree rings that would indicate temperatures in the last 50 years aren't particularly high compared with 1000 years ago?

Scientist: It is very technical, but there is something in the data that has caused the decline which isn't related to temperature, so it makes sense to leave it out - hide it if you will. We call call this problem the "divergence problem"

Me: What is this "something" that is effecting the data over the last 50 years? What is the cause of this "divergence problem"?

Scientist: We don't know.

Me: Might this same "something", that you don't know about have affected tree rings in the past?

Scientist: We don't know.

Me: Doesn't this make your analysis all a bit, what is the technical term, ropey?

Scientist: Not at all, we can employ this trick. You see if we hide it then you can't see the decline.

Me: Didn't we cover this...?

Yet another vignette showing climate scientists at play.

2009-11-26T13:46:00.008Z

What a lovely bunch they are. After reading his work and his communications with others, one can but admire a man like Roger Pielke Snr. He is someone who has been contributing to the science of climate in the way that Darwin intended. On merit rather than on the extent and influence of his academic coterie. Even as a layman observer of the climate science community, his looks like a lonely position.

In a recent blog piece Roger retraces a distasteful (but increasingly familiar) looking episode of climate science in action. In that post by Roger is one email that made my jaw hit the ground. I reproduce it in part below with the bits that caused my mandibular dislocation:

Subject: Chapter 6: an alternative? [email not for the faint hearted?]
Resent-From: CCSPTempTrendAuthors.NCDC@noaa.gov
Date: Wed, 10 Aug 2005 13:22:32 +0100
From: Thorne, Peter

To: CCSPTempTrendAuthors.NCDC@noaa.gov
Dear all,

Health warning: This mail does not hold its punches as the youngest member of this panel I suppose that I have the most to lose through Chapter 6 in its current form in terms of future research career. I also suspect that I am the most likely to run around making a pain in the proverbial of myself. My apologies for that! I’ve tried over the past few weeks to help others in the Chapter 6 redrafting, but I really think that the structure we had just will not work. Therefore I took the liberty of spending 3 hours this morning developing an alternative, which I attach. I will caveat that David has looked at this, but the rationale and most of the text is my responsibility, not his (in other words the buck stops here).
[SNIP]

What does this say to you? I know that it is not in context, blah blah blah. But let's just cut to the chase. A young and (by all indications) ambitious researcher felt that a scientific report might not be good for his career advancement and so personally redrafted it as a replacement for the combined work of the team.

Just as background, this was a CCSP report. CCSP stand for Climate Change Science Program. They provide the scientific basis for the US, a bit like the IPCC role at an international level. So this was a biggish deal and should have had an objective and inclusive approach to the broad base of scientific views, including those represented by (NB not held by) Roger Pielke. Could it really be true that some young buck thought such an approach might stimey his scaling of the greasy pole of success and so, with or without the support of others, arranged to hijack proceedings? Hard to believe and yet hard to rationalise otherwise the self stated conflict of interest and resulting actions detailed in that email.

And it is the Climate Change preachers who constantly parrot on about how sceptics are compromised.

"proving" Dangerous Anthropogenic Cimate Change

2009-11-26T10:48:00.007Z

I entangled myself in "discussion" with Richard Tol over on irisheconomy.ie. I say discussion, but Richard seems quick to jump to use of epithets.

The issue I (quite politely) took Richard up on was a statement he made about the efficacy of the hypothesis of Anthropogenic Climate Change. Note I have remove the "Dangerous", because I don't believe that the issue had been extended to that (additionally hoary) question.

Richard's contention was that because, using the DACC hypothesis, we could mathematically model past temperature changes we had all the "proof" we need.

Here is where I introduce some terminology and two important concepts:

NECESSARY condition:
This is something that must be true (i.e. is necessary) in order to support a particular hypothesis. As in test of the statement "Serena Williams won the Ladies Singles title at Wimbledon in 1999". If I wanted to test the truth of that statement, I could start with a necessary test - is Serena Williams a woman? Answer: yes (cut the giggling up the back there Thompson!). What does that information prove? It proves that Serena William could have won the Ladies Singles title. Another NECESSARY condition would be was she entered that year? But again, this only proves that she could have won, not did.

So what do we need to move from a helpful could to more useful did. For that we need a SUFFICIENT condition. If this condition holds then that is all we need to prove the claim. So, did Serena Williams collect the All England Club Ladies Singles trophy in 1999? If she did, then we can say she did win.

So what use are NECESSARY and SUFFICIENT conditions? In mathematics, statistics or everyday logic a NECESSARY condition is something you can use to falsify an hypothesis. You can rule things out. A very useful tool and vital in science. A SUFFICIENT condition is used to move an hypothesis in the territory of a theory - not only can we not rule it out as an explanation, but we must rule it in. Exclusively.

Back to Richard and the hypothesis of DACC. Richard presented a claim that modelling past climate is SUFFICIENT to test the hypothesis. The problem is that this is only a NECESSARY condition. I have posted on this blog before about modelling hypotheses and the long and short is that only by making correct predictions (correctly modelling future and otherwise unknowable events) with our model can we meet NECESSARY conditions.

Don't believe me? Here is someone who isn't an "anonymous lizard" who agrees with me.

So there you have it and it deserves repeating, and repeating and repeating. DACC will not be "proven" until they start accurately modelling future climatic outcomes. And the track record on that isn't good to date.

I'm just wild about Harrrryyy....

2009-11-24T15:24:00.002Z

One of the hacked/leaked/lost files from the Climate Research Unit is one called HARRY_READ_ME.txt

It opens with this line:

READ ME for Harry's work on the CRU TS2.1/3.0 datasets, 2006-2009!

Note the exclamation mark (!).

Even for non programmers like me it provides some mild chuckle moments as you scan down the code and comments as the programmer codes their building exasperation into posterity via comment lines, like this:

As a glutton for punishment I then looked at the tmin/tmax db format. Looks like two extra fields (i6,i7) with mvcs of 999999 and 8888888 respectively. However *sigh* inspection reveals the following two possibilities:

It makes you wonder who Harry is, as I came to pity him so. Maybe this is him?

http://www.cru.uea.ac.uk/cru/people/#Research%20Staff

More on the IPCC

2009-11-23T14:54:00.007Z

What a treasure trove of intrigue can be found in the leaked CRU emails. Here is another one that is an eye opener for anyone of a trusting nature. First the background. We all know the Intergovernmental Panel for Climate Change is an august body that is the authority on "the science". Here is how the IPCC describes itself:

The IPCC is a scientific body. It reviews and assesses the most recent scientific, technical and socio-economic information produced worldwide relevant to the understanding of climate change. It does not conduct any research nor does it monitor climate related data or parameters. Thousands of scientists from all over the world contribute to the work of the IPCC on a voluntary basis. Review is an essential part of the IPCC process, to ensure an objective and complete assessment of current information. Differing viewpoints existing within the scientific community are reflected in the IPCC reports.

My bold; I just wanted to draw your attention to the complete and objective nature of the work of the IPCC as well as its welcoming attitude to different views.

OK, that's enough of the bedtime stories (they all lived happily ever after). The R rated (X rated for any North American readers) can be gleaned from this email from Phil Jones of the CRU:

Quote:

From: Phil Jones p.jones@xxxxxxxxx.xxx

To: "Michael E. Mann" mann@xxxxxxxxx.xxx

Subject: HIGHLY CONFIDENTIAL

Date: Thu Jul 8 16:30:16 2004

Mike,

Only have it in the pdf form. FYI ONLY - don't pass on. Relevant paras are the last2 in section 4 on p13. As I said it is worded carefully due to Adrian knowing Eugeniafor years. He knows the're wrong, but he succumbed to her almost pleading with himto tone it down as it might affect her proposals in the future !

I didn't say any of this, so be careful how you use it - if at all. Keep quiet alsothat you have the pdf. The attachment is a very good paper - I've been pushing Adrian over the last weeksto get it submitted to JGR or J. Climate. The main results are great for CRU and alsofor ERA-40. The basic message is clear - you have to put enough surface and sondeobs into a model to produce Reanalyses. The jumps when the data input change standout so clearly. NCEP does many odd things also around sea ice and over snow and ice.

The other paper by MM is just garbage - as you knew. De Freitas again. Pielke is alsolosing all credibility as well by replying to the mad Finn as well - frequently as I seeit. I can't see either of these papers being in the next IPCC report. Kevin and I will keep them out somehow - even if we have to redefine what the peer-review literature is !

Cheers

Phil

Mike,

For your interest, there is an ECMWF ERA-40 Report coming out soon, whichshows that Kalnay and Cai are wrong. It isn't that strongly worded as the first authoris a personal friend of Eugenia. The result is rather hidden in the middle of the report.It isn't peer review, but a slimmed down version will go to a journal. KC are wrongbecausethe difference between NCEP and real surface temps (CRU) over eastern N. America doesn'thappen with ERA-40. ERA-40 assimilates surface temps (which NCEP didn't) and doingthis makes the agreement with CRU better. Also ERA-40's trends in the lower atmosphereare all physically consistent where NCEP's are not - over eastern US.I can send if you want, but it won't be out as a report for a couple of months.

Cheers

Phil

Prof. Phil Jones Climatic Research Unit Telephone +44 (0) 1603 592090

School of Environmental Sciences Fax +44 (0) 1603 507784

University of East Anglia Norwich

Email p.jones@xxxxxxxxx.xxx

NR4 7TJ

HIGHLY CONFIDENTIAL indeed!

Phil Jones and Kevin Trenberth?

That's right, the "Coordinating Lead Authors". The guys who "coordinate" the "complete and objective assessment of the different views from the scientific community"

Pardon my French, but what a load of bollocks.

Did someone say "conspiracy"?

2009-11-21T16:11:00.002Z

Here is a nice little vignette of some of the dubious nonsense revealed in these email. All previous comments about the authenticity of this material still holds.

Background:

In the IPCC AR4 (Assessment Report 4) there was a desire to keep the famous "Hockey Stick" in place. If not the discreditted Mann stick, then a substitute that could be used to say something like "it's hotter than when Jesus played fullback for Jerusalem"

Now in order to do this, IPCC rules stated that any research to be included in AR4 would HAVE to be published no later than July 2006. As it turned out a paper by Wahl and Amman appeared to scape in by it teeth, phew.

But after a little time over which people could read all the publications, it appeared that there was something strange about this savious W&M paper. Hidden in the citation was an absolutely crucial one to a paper (also by W&M) with a publication date AFTER July 2006. In fact, the citation was even worse, it was to a paper "under review" after July 2006 (and was in fact subsequently rejected for publication!!).

How did they do that. Were W&M time travellers?
Had someone at the IPCC bent the rule for them because they wanted the specific "flavour" of findings (jolly Hockey Sticks) their paper had?
Had someone at the Journals in question bent rules to allow citations to unpublished papers?

It was all very murky. Even after a year, as shown in this post:

http://www.climateaudit.org/?p=3110

Well, up to now, it was not possible to do anything but look at the circumstantial evidence that there had been some manipulation of peer review processes and IPCC rules (supposed to be so stringent and credible).

Until now. Look at this email:

Alleged CRU Emails - Searchable

Quote:

-----Original Message----- From: Phil Jones [mailto.jones@xxxxxxxxx.xxx] Sent: Wednesday, September 12, 2007 11:30 AM To: Wahl, Eugene R; Caspar Ammann Subject: Wahl/Ammann

Gene/Caspar,

Good to see these two out. Wahl/Ammann doesn't appear to be in CC's

online first, but comes up if you search.

You likely know that McIntyre will check this one to make sure it hasn't

changed since the IPCC close-off date July 2006!

Hard copies of the WG1 report from CUP have arrived here today.

Ammann/Wahl - try and change the Received date! Don't give those skeptics something

to amuse themselves with.

Cheers

Phil

Do I have to spell out the conspiracy here?

The highlighted bit showed they knew they need to change the dates after the fact (don't forget, this email is dated 2007 talking about the final changes to a paper supposed to have been published in by July 12006.

Phil Jones was a Coordinating Lead Author for the relevant part of the IPCC report. He was helping this scam as this email clearly shows.

http://www.ipcc.ch/pdf/press-ar4/wg1/wg1authors.pdf

And everyone holds up the IPCC Report as some form of high science.

A note on scepticism

2009-11-20T09:59:00.006Z

In the Blogosphere of climate debate a major earthquake has hit. Supposed data and email communication has been allegedly obtained by fair means or foul from the Climate Research Unit (attached to to University of East Anglia). The material was brought to the interwebbie via this blog:

http://noconsensus.wordpress.com/

Now, of course, given the nature of the contents, which variously paint a picture of a distinct cabal of "insiders" looking to promote their own research and conclusions of that research by any means at their disposal, this has been dynamite.

I am not going to comment on the contents, but rather about the blog response to date and what this rapidly evolving story says about scepticism in general and scepticism as it specifically relates to the hypothesis of Dangerous Anthropogenic Climate Change.

One of the pitfalls of human behaviour is "confirmation bias". It happens everywhere, especially in financial markets. It is the natural human tendency to put more weight on new information that supports your own views or prior conclusions.

This is one of my personal criticisms of the many proponents of the DCC hypothesis. Even some nominally well credentialled academics in the field appear to do it, hence creating an environment where these proponents and the resulting media and lobby organisations exaggerate their case.

This new information (the validity of which we can not yet establish and may never will), offers the potential for confirmation bias to reveal itself in those who have to date been sceptical of the main claims of the DCC lobby (including the IPCC). The email communications in particular appear to confirm what most sceptics have suspected and appeared to be indirectly implied by the belligerent behaviour of many notable academics in the field and the incestuous relationships between key academics, and government and policy organisations (including the UN's IPCC).

As someone who (possibly mistakenly) prides himself on being a genuine sceptic in the best sense, I have to try and recognise in myself that same instinctive reaction that "this proves exactly what I thought" and restrain it. Instead, the issues are; what more do I need to know before I can properly assimilate this new "information" into my thinking?

The first and primary requirement is the provenance and accuracy of any of this information I would use. If there is an email communication that clearly shows some form of academic bias, collusion or worse fraud, I need to be convinced first and foremost that it is genuine before I consider what it might mean.

I believe everyone else should do the same or further damage the case of true scepticism even more than I believe proponents of the DCC hypothesis have already done to date.

A mind map of Ireland's economic travels

2009-11-17T15:49:00.003Z

I have been playing with mind maps as a way to convey the connections and interactions between ideas and event etc. Here is one that I have been working on to describe the last 15 years of Irish macroeconomic history.

Please be forgiving; this is an experimental work in progress.

Where now central banks

2009-11-02T16:00:00.013Z

Funny how we often see commonalities across disciplines. A famously clever man once said about the field of physics:

"There is nothing new to be discovered in physics now, All that remains is more and more precise measurement."
Lord Kelvin

Similar sentiment was probably held with regards to monetary economics until very recently. We just seemed to know it all, more or less, and the fruits of that understanding appeared to be ripening on the vine with low and stable inflation and interest rates.

Prior to the recent difficulties economists were probably guilty of complacency. Central banks seemed to have found their ideal role as independent guardians of price stability, with sole discretion over the use of monetary policy. That is entirely understandable. It was and still is believed that (1) "money is neutral", that is it has no long term influence on real incomes and that (2) inflation creates net costs and (3) inflation is purely a monetary phenomenon. Those three beliefs led to the 1990s craze for independent central banks tasked with meeting specific inflation targets.

An associated development was the division of roles, traditionally both held by a single central bank, where responsibility for regulation of the financial system went to a new and separate organisation.

And things appeared to be moving swimmingly. Monetary policy from Britain to Australia, via the US and Euroland was tweaked up and down by the various independent price guardians as demands appeared to dictate. Inflation was subdued and relatively stable everywhere that this was practiced. Sure, there was debate about rapidly rising asset prices (asset price inflation) and the need for monetary policy to consider this in an inflation targeting remit. But that argument didn't gain traction and was really at the periphery while goods and services inflation remained low and apparently under control.

The rest of course is history as the financial world neared complete implosion and we entered into a deleveraging process that might lead to anemic growth in a number of countries for a few years yet. So what will come out of this in the form of debate and possible reform of regulation and monetary structures and policy approaches? Here is a a few things that I think will come to the fore:

Rethink on the separation of financial regulation and monetary policy roles. Many now better understand the potential for the two to be closely intertwined. A purist might say that things worked as they should; the world levered itself up on debt and tried to inflate itself via excess demand for goods and services (as well as assets), but central banks held tight on the money lever and inflation never took hold and eventually led to the end of the party before inflation could take hold. However, a more circumspect view might be that given the deflation that has now occurred in many countries policy wasn't optimal - was there a way to understand that non-monetary developments were a threat to price stability (i.e. a potential for a collapse and deflation) and that the regulatory environment might have had some role to play in mitigation? That is the debate to be had. Should financial regulation and monetary policy be closely considered in such a way that only a single organisation should be tasked with overseeing both in a coordinated fashion?
Appropriateness of monetary targets. Up until today, despite some differing views, it is accepted in the mainstream that monetary policy should be used as an instrument to meet an inflation target defined as goods and services price inflation. Some have questioned in the past whether asset price inflation should have some weight in monetary policy decisions directly (as opposed to indirectly), but that argument has not held sway. Maybe that question needs to be opened afresh and rethought.
International interdependence. With a floating exchange rate and an independent monetary authority (central bank) it is thought that an economy is insulated from monetary shocks from abroad. It doesn't matter if Ben Bernanke goes off on a bender and inflates the US economy because other countries can follow their own inflation targets and allow nominal exchange rates to adjust for changing relative prices. This adjustment occurs through money and foreign exchange markets. But have we seen, via highly integrated and increasingly large asset markets and importantly increasingly large balance sheets on financial intermediaries that straddle national regulatory boundaries, a potential short circuit to that independence? It is something that is worth understanding better.

It will be worth watching, but monetary economics should be one area of research that returns to focus over the immediate future, after suffering recently from being "pretty much solved".

A bottled water frenzy

2009-10-27T11:22:00.004Z

The Grauniad appears to have saved the day again by quickly alerting us hoi polloi to the imminent danger/disaster/apocalypse into which we were plummetting. This final warning on the complete depletion of Adelaide's water supply seems to have done the trick:

http://geckkosworld.blogspot.com/2009/09/rip-quality-journalism.html

You will recall that last month Adelaide had but one week's supply of water left before emergency bottled supplies would need to be shipped in. It seems that the local population has been extra busy, by pouring the emergency bottled supplies directly into the drinking water reservoirs, which have increased from 90% of capacity to 93% capacity.

Apocalypse averted. Keep up the good work guys.

NAMA. "It's about getting liquidity flowing"

2009-10-21T15:38:00.007+01:00

I was in Cork yesterday attending the Chamber of Commerce conference there. One phrase that was oft repeated was that we needed to "get the liquidity flowing from banks again". That doesn't really make a lot of sense from an economics point of view. Liquidity in the strict sense of the banking system related to the workings of the money market; being that market for short-term lending (under 30 days by general convention). This is dominated by banks that use it balance their immediate needs for funds - say to fund withdrawals of deposits.

But I think what everyone meant was that they didn't think that banks were lending large enough sum to enough companies - my general impression was that this included any company that wanted/needed it.

A couple of observations on that line of thinking that seems to be too prevalent and, in my opinion, likely to meet a sudden stop against the cold hard facade of reality.

Firstly and briefly, should banks be lending? No. Banks should be managing risk. If a loan, line of credit or overdraft does not make commercial sense from a risk and expected return basis, it should not lend.

Secondly, what is likely to happen when the Irish banks wend their way to the ECB and exchange their NAMA bonds for some freshly minted Euros? As some commentators have already indicated, the likely outcome is that they will pay down some of their liabilities. They will shrink their balance sheets.

Why would they do this? Simple. Because their balance sheets are too large. Don't tell me you have forgotten already how we came to be in this mess? Let me remind you. We (the collective people of Ireland) borrowed until we had put into hock virtually all our future income earning potential. And then we borrowed some more. That, dear readers was the expansion of the balance sheets of Irish banks.

And flowing directly from that, we have our present economic obstacle. Too much debt - synonymously bank balance sheet are too large.

And flowing from that is the unavoidable economic correction that needs to take place. A contraction in the balance sheets of Irish banks.

The following things will cause this to happen:

Writing off bad debt/defaulting on some liabilities starting from the top and moving down the capital structure (e.g. shareholders' equity, unsecured bond holders etc.).
Use any excess liquid assets (thank you NAMA/ECB) to retire short-term laibilities

The following things would not allow this to happen:

Increased growth in lending

And are you curious about how big the balance sheets of Irish financial institutions became of recent years? Here is a handy comparison. The UK is considered one of the more leveraged countries in the world. Total assets held against residents (i.e. outstanding lending to UK residents) reached 1.9 times annual GNP at the end of 2008. The equivalent for Ireland was around 2.5 times annual GNP. For the US the ratio is about 0.6.

People really need to be told. There is too much debt, which means banks will be taking every opportunity to shrink their balance sheets. That means no free money.

Need credit? State owned enterprises to the rescue

2009-10-21T11:01:00.010+01:00

An interesting announcement yesterday. Bord Gais, the state owned gas monopoly, have announced that they are moving into the market to provide a wide range of consumer energy related services. Not only will they supply you with gas, but they will sell you all manner of insulation, heating and associated services.

All very good, thinking at the margin and employing their core comparative advantage (direct access to households) to their strategic corporate gain. Let's leave aside concern about market power that one might have (they might easily throw other suppliers out of the market due to their size, brought by their state enshrined monopoly in gas supply, or their very favourable access to capital markets as a state owned monopoly utility). No, what I am thinking about is the way they are going to allow customers to pay for such big-ticket capital expenditures.

It is the intention of the Bord Gais that customers will be able to "pay via their gas bill". That is just another way of saying that Bord Gais will extend credit to allow customers to undertake expenditure. No need to borrow from a bank (that has quite rightly tightened up its lending criteria). Bord Gais will, in the words of their CEO John Mullins at the Cork Chamber of Commerce yesterday, let customers have it "on the never-never".

There seems to be a general clamour for banks to open up the taps to all comers. The Irish government is happy to play along. I find this a curious development in such a context. With credit comes euphoria, if only for a short time until the never-never arrives for payment.

How are the recapitilisation plans going boys?

2009-10-20T11:15:00.003+01:00

One thing that gets pushed off the front pages during the NAMA debate is the fundamental question of how and by how much Irish banks will recapitalise themselves.

So far we know:

The banks were insolvent, regardless of fiction that appeared in company accounts
The Banks are unloading 77bn of assets on their balance sheet in exchange for 54bn in sovereign paper (and then on to cash via the ECB Refi window).

So how big is the capital hole, how is it going to be filled and by whom? Plans really should be afoot now, but I have not seen so much as a rumour appearing in the press.

Associated loans - what the hell are they?

2009-10-19T12:06:00.007+01:00

Yes, NAMA again.

This question has been keeping me awake at night. The Draft Business Plan for NAMA identifies 36% of loans to be bought as being "associated loans", without any clear explanation of what that might mean. The Department of Finance is only marginally more enlightening with this:

Associated loans will be those loans which are not in the land and development category but which are held by individuals/companies that also have land and development exposures or the borrower may be a systemic risk to the financial system. Associated loans will take account of cross collateralisation and other associated loan exposures of borrowers.

which is pretty much what one would have guessed, but gets us little closer to the purpose for which these funds were advanced and to whom.

I have been searching for more detail, but have found nothing. And in the absence of facts the imagination runs riot. Are they unsecured? Do they represent advances to insolvent creditors (like rolled up interest for example)? I don't know, but would sure like to know.

I think we, as taxpayers, have over 27 billion good reasons why we should be told a bit more about this.

NAMA - how much write-down?

2009-10-16T13:41:00.011+01:00

One for the greatest unknowns about the NAMA escapade is the proportion of loans that will be recovered by this newly conceived Naughty Bank (increasingly naughty by the day). Under the Plan, the loans to be acquired will have a nominal value of €77bn and will be purchased by John Q Taxpayer for €54bn. The Draft Business Plan for NAMA assumes that €62bn of the €77bn will be reapid - an 80% recovery rate. 62 is greater than 54, brilliant, we're laughin'. Let's just ignore for the moment the matter of interest on this €77bn pile of debt, which is a tidy sum itself, which may or may not be paid.

Now, you may have read in the press that NAMA is going to make us taxpayers a tidy €5.5bn in profits. That of course depends on the ability to recover from the various borrowers 80% of what they borrowed. If we get only 70% paid back, that is €7.7bn lost and there goes the profits and up go the taxes. Not much wriggle room in those assumptions, I think you will agree. I wonder what type of robust analysis has been done to arrive at the 80% recovery assumption. How certain can we be that it will be achieved. Well, here it is:

"Over a five year period in the early 1990s, one UK bank experienced a default rate of less than 10% on its whole book. Given the concentrated nature of the prospective NAMA portfolio and the risk of a prolonged recession, a 20% default rate assumption has been made."

Looks impressive, doesn't it? We have found out via Karl Whelan at irisheconomy.ie that this "one UK Bank" was in fact Barclays. So let's have a little gander at Barclay's accounts.

In the five years between 1990 and 1994 inclusive Barclays recorded realised losses on write-offs of £7.0 bn. At the start of 1990 Barclays had a total loan book of £77.7bn. Now what I am about to do is a massive fudge, as it assumes that all the write downs occurred on loans on the balance sheet at the start of 1990. But I am writing this on the hoof and in the spirit of NAMA I don't think it appropriate to get to pernickety about precision.

Barclays realised default rate was 7/77.7 = 10% near enough for any Naughty Bank.

Excellent. This seem quite robust then. But, just for fun, let's dig a fraction deeper. Let's look at the type of loans NAMA is taking on. This is taken from the Draft Business Plan again and is a broad breakdown by borrower:

Doesn't look great to me. Lent to people to develop property assets, to buy land to develop property assets and to buy things associated with buying land and developing property assets.

I think we can safely say that there is a comprehensive diversification of exposure right across the property development/construction sector of the Irish economy. It is the contention of the government that this Naughty Bank will recover all but 20% of lending from this portfolio of loans.

Now let's look what Barclays did in 1990:

Yes. Do you see that pale blue slice around 6 o'clock. That is the amount that Barclay's accounts for 1990 identify as being to customers in "property and construction". The rest is spread all over the place (what were these guys thinking?????).

Do you want to see where the UK economy generated its income around 1990? Here is a breakdown of Gross Value Added by sector. Not directly comparable, but the best I could do on my budget (45 minute lunch break):

Note that I have taken out the public sector as best I could. Also note, that I have built in a novel "Individual" sector; this doesn't exist of course, but I need some device to compare with Barclays lending. I could have allocated that lending across the Barclays book - and maybe should have, but the affect on what this data is telling us should be the same.

Now look at those two compared. The proportion of Barclays loan book exposed to any sector minus the size of that sector in the economy by income).

It looks like this:

You can see the affect of my fudge. It assumes that Barclays exposure to individuals was neutral on a sectoral basis (i.e. it wasn't all to people in finance for example). You can also see the overweight and underweight position of Barclays' loan book. A maximum exposure of around 10% to broad sector. Underweight manufacturing and finance and overweight services and property and construction.

That isn't too bad I would suggest, when you compare with NAMA, which is 100% overweight property and construction.

Now, this data isn't particularly robust. But it is certainly more detailed than that revealed in the NAMA draft Business Plan, which is a type of finger in the air exercise. But I think it tends to suggest that if Barclays managed to confine their losses to 10% of their loan book with a good amount of diversification, then NAMA will have one hell of a time trying to confine its losses to 20%. Even 30% seems a bit racy to me.

You can make up you own mind. Then cross your fingers. That is what the architects of this seem to be doing.

Water charges - some political slight of hand

2009-10-13T14:40:00.006+01:00

I blogged about water charges a little while back. I don't think they make sense in the form of water metering in Ireland.

Now those Red-Green (does that make purple?) political advocates for around 2% of the electorate are proposing a flat rate household water charge. All my points about water as a scarce resource in Ireland still apply. Little reason to set the marginal price of water above zero.

What I want to highlight here is this bit:

"Charging for water in every house was agreed by the government parties, at the Greens' behest, as a way to reduce waste and fund local government."

Do these people really think the electorate are that stupid that they think they are presently getting water for "free"?

This is ludicrous beyond belief. The overwhelming majority of houses in Ireland have mains water. This makes a flat rate household charge a type of "poll tax" - although levied per household rather than per head.

It is also coming on top of the tax paid that presently funds water catchment, storage, distribution, treatment and maintenance. This is more tax on top of the tax that currently goes towards paying for our mains water.

Is a little bit of honesty too much to ask. Even if you are purple?

Negative equity - what to do?

2009-10-13T10:15:00.011+01:00

Negative equity is back in the headlines in Ireland again over the last couple of days. Here is a paper from the ESRI on this issue released this week.

Negative equity is when people pay too much to capitalise their future housing costs. This can be because:

They over estimate the likely rate of increase in real rents, or
Under-estimate the discount rate over the long term.

In Ireland, it is likely to be a function of both. People were expecting low interest rates over a long time that would, by the miracle of compound interest, make future rental payments very high in today's money. This is the fallacy of the "affordability" approach to property. Low short-term interest rates certainly make it easy to finance a variable mortgage, but to work out the price of a house you need to consider what interest rates will be in 5, 10, 15, 20, 25 and sometimes 30 to 40 years time.

When you get a decision like this wrong, by that I mean the decision to buy a very long series of cash flows (when you buy a house you a buying a lifetime of market rents), the ramifications are significant. Small changes in the actual increase in real rentals, or changes in expected interest rates will cause a large change in the capital value - i.e. the price of the house. A bond trader knows this. House buyers should also.

So Ireland now finds itself in a position where too large a proportion of the population got caught "on the wrong side of the trade". And they have a capital loss. What are the potential implications for the economy?

The loss in wealth. Those people with no debt against their homes have suffered little. They were perfectly hedged - they had enough capital to finance their future rental costs and they still do. Those with mortgages have suffered because they were geared. They never had sufficient capital to pay for their future rental costs, they borrowed to do that and paid to much.
The loss in mobility. This occurs geographically and demographically. Growing families need more room. Unemployed people need to go to where the work is. And people get together and separate.
Lack of well functioning property market. People in negative equity can not sell their house for less than the mortgage. It is a legal impossibility unless the lender agrees to it. And no lender is willing to agree to it on this scale (size of potential shortfalls and number of borrowers affected). That means there is a significant proportion of the housing stock that has a an artificial price floor. The market wants to adjust to lower prices (there is excess supply), but sellers are not free to drop prices as far as they need to clear the market.

Those are the big ones. So what can be done? About the first, nothing in aggregate. You could transfer wealth from those not affected (the sensible/prudent) to those who have suffered loss. The loss hasn't vanished, it has just been redistributed. Would that be sensible? I would be most concerned about the clear message that sends to people making decisions in the future - don't worry about the risk. That is the "moral hazard" problem. So I think it a bad idea. People made a decision, a bad financial one and lost. It happens all the time. They can work hard and rebuild. It will be better for everyone in the long run if they do that.

What about the second. This is tricky. The benefits of mobility are not explicit. It is no doubt important that people are able to change their circumstances, but how important is not really quantifiable. Qualitatively, I would say it is pretty important.

The final point is perhaps the most transparently important one. Ireland is in for a long period of real house price deflation if nominal prices have a floor under them due to the extent and size of the negative equity problem. Like he removal of a band aid, getting you pain in one short burst is usually the best. So it is with prices. Just ask the Japanese.

Thinking about those points on balance, my default position is typically that public policy has a limited role. People need to save their way back to solvency.

However, I am ready to be convinced that there is a social and economic benefit to finding a way to facilitate a much faster resolution to the negative equity problem, due to the mobility and price adjustment issues, but would object to a policy based on wealth transfer.

On that basis I would strictly oppose some of the following, which are all a variation on a theme of wealth transfer:

Debt forgiveness
Government subsidies
Any public funded sale and lease-back type agreements

So what would I propose? I would suggest a government financed unsecured loan, to the value of the negative equity. This would have the following characteristics:

It would be a charge against the owner logged against their tax number by the Revenue.
Recovery would come in the form of a levy on all income (say 5%, but could be more) through the tax system, until the debt is repaid.
Interest would be charged at long term fixed rate at a modest premium to the current 30 year government bond yield.
Repayment in full could be made at any time without penalty.
An optional charge on the estate at death could also be include to strengthen the recovery.

That type of arrangement would keep the proper incentives in place:

You would still want to get the best price possible for your house.
You would not be getting a bail out, helping to mitigate against moral hazard problems.
It would allow more efficient adjustment in the property market, by allowing losses to be crystallised by sellers at price buyers are willing to pay.
Tax payers would not be bailing anyone out, although more public debt is required in the short to medium-term.
With the correct interest rate, this could self financing - noting that some people will never repay all of their debt in their lifetime.

Green tax proposals

2009-10-12T10:34:00.004+01:00

The Green party are using their NAMA brought political leverage to play in Ireland by extracting some concessions out of the senior coalition partners. Natural, being Green, these are of a particularly Red hue.

One change was lifting the ceiling on PRSI, which was in fact raised not long ago. Since I ran some analysis of Irish marginal and average effective tax rate recently, I thought I would update the charts. I have had to assume that lifting the PRSI ceiling will not come with a revision of the "health levy" that applies to high incomes. Otherwise it wouldn't make much sense to do it in the first place. By removing the ceiling on PRSI, you would increase the marginal rate of tax by 4% on all income over €75,000 approximately. The implications are illustrated in the chart below.

Ireland already has very high marginal rates of tax applying very low down the income scale. This will reinforce that general approach. A 54% marginal rate of tax would apply before you hit twice the median earnings. and 56% would be incurred further up the income scale. This is an implicit statement from the Greens (and to be fair most of the Irish political industry) about who they believe have the primary rights over the market value of your time and expertise.

It isn't you. It's them.

The average rates that would take effect are illustrated below. Ireland's tax structure is already punitively progressive in my opinion. This is another notch on the ratchet of a couple of percent. Given that the massive open pit mine that is Ireland's public finances, I anticipate that we will be seeing more of this type of shift; a couple of percent here, a couple of percent there.

What I hate about climate "debate"

2009-10-08T11:09:00.007+01:00

In a word. Strawmen. Making up a statement or claim by an opponent so you can knock it down. One which is a popular target for "debunking" is a strawman that a climate scientist (specialising in oceanography) and contributor to the IPCC, Mojib Latif, was now forecasting a decade or two of falling average global temperatures. The usual suspects and others are no all abuzz pointing out how Mojib Latif has not made any such predictions.

Let's get one thing straight first. There appears to be different reporting of Latif's comments in the media and across the interwebby. Some indeed suggesting that he made a "prediction" of cooling. I am happy enough that he did not make a prediction, but made a hypothetical along the lines; "if there was a cooling, and I don't think that is impossible".

A journalist called George Will is a particular target of this manufactured argument. He is thoroughly disliked by a large proportion of the Dangerous Climate Change lobby because he takes an opposing view. How distasteful. But regardless of whether Mojib was making prediction of or not, this was never the issue. Look at what George will wrote. Verbatim:

The Times says "a short-term trend gives ammunition to skeptics of climate change." Actually, what makes skeptics skeptical is the accumulating evidence that theories predicting catastrophe from man-made climate change are impervious to evidence. The theories are unfalsifiable, at least in the "short run." And the "short run" is defined as however many decades must pass until the evidence begins to fit the hypotheses.
George Will
Cooling Down the Cassandras

This isn't written in ancient sanskrit. It is pretty plain English. The point is not what anyone is or is not forecasing - including Mojib Latif - but the apparent impossibility that any data might falisfy the DCC hypothesis. It clearly says what skeptics have difficulty with is the way nothing (even a hypothetical two decades of cooling) would still not falsify a theory of global warming.

That is what skeptics are getting increasingly frustrated with. The proponents of the DCC hypothesis would advance their standing in the eyes of skeptics immeasurably if they began drawing some clear lines in the sand, which if they are truly scientists they should do. Does Latif imply that no amount of cooling would falisify the DCC hypothesis? His quote doesn't say that wouldn't be they case, he just leaves it at "cooling would not falsify".

My question for any such climate scientists would be; what outcomes or data are you looking for that would falsify parts of the DCC hypothesis?

An answer of "none", leaves me in no doubt that we aren't talking science. And that is the answer skeptics are getting at the moment.

The "demise of the Dollar" - what it's really about

2009-10-07T09:08:00.011+01:00

I posted yesterday about this buzz doing the rounds. I didn't know at the time, but it was Chinese whispers (pun intended) started by Robert Fisk. Enough said.

But that doesn't mean that some of the facts reported could be correct and most probably are. Various oil exporting countries like Iran, Venezuela and developing economies such as Russia and China have almost certainly been thinking about the Dollar for some time. However, not for the reason and economic ramifications that the widespread reports all declare.

I dealt with the issue of the ramification of changing commodity pricing to a different numeraire. Here I will discuss what is the more likely reason behind the supposed deliberations about the role of the Dollar in international markets.

The background to this is exchange rate regimes. Every geographical region - not necessarily defined by sovereign national boundaries but usually so - has over time developed a currency to aid in the exchange of goods and services, the accounting of prices and values and as a way to store value. Those are the three primary function of money:

a unit of account
a medium of exchange
a store of value

These work fine within the regions in which they operate, but hit a road block when one currency region wants to exchange goods or services with another. Hence we need some exchange rate that will price one currency relative to another. This can be set by decree against some durable globally traded item (fixed to gold for example), or against the currency of another region or a basket of such currencies (fixed against the US Dollar for example), or left for the market to price it freely (a "floating" exchange rate). Note that there are all sorts of varieties of fixed rates with names likes "pegs", "crawling pegs", "currency boards" and others, but they are variations of a theme only.

Some floaters include the Australian Dollar, Sterling, Euro, the US Dollar. Some fixed rates include China, Iran, Venezuela, Russia, Saudi Arabia. Are you starting to see the pattern here? Well spotted. Those countries named as the ones colluding to bring the demise of the Dollar are those that fix their exchange rates to the Dollar. And this is what this story is really about.

This story is about the fact that these countries have tied their local currencies to the US Dollar, which means that they have effectively set the price of everything they produce (their income and output) to the price price of everything produced in the US, set in US Dollar prices. So if the US goes through an inflationary bubble and the price of things in US Dollars goes up, pressure will build in the country for prices to do the same thing, bringing in the first instance pressure on output (excess demand) and then inflation. That might seem confusing, but the simple point is that with a fixed exchange rate you will import inflation (or deflation) from the currency to which you are tied.

So it is with some of these countries. China in particular has been struggling with prices in Reminbi that have become out of kilter with the US. That means lots of demand for Chinese goods to be exported to the US. Current account surplus for China, deficit for the US. This brings pressure on Chinese productive potential, the economy is at full capacity and creates shortages and pressure for an increase in the price of these Chinese goods.

What is going on in the background is that this flow of demand for Chinese goods and services is creating a big demand for Chinese Reminbi in exchange for US Dollars at the fixed exchange rate. The Chinese government has agreed to give a fixed amount of Reminbi for each US Dollar and people are flocking to them in droves.

The Chinese authorities have two options.

They keep selling the Reminbi to all comers at the fixed exchange rate. As they do this they accumulate more and more US Dollars, which they need to keep in the form of currency, deposits, bonds etc. This will mean there are more and more Remminbi out in the world looking for a home. That leads to Chinese prices rising - inflation. They try to sell some of the Reminbi for other currencies, but the Dollars are coming in thick and fast and it is a difficult task. Witness the recent Chinese spending spree around the world buying up all manner of foreign assets and interest. This is them trying to unload all these US Dollars. And more are coming in every day.
The alternative is they "revalue" the exchange rate. Each Reminbi will now cost more Dollars in exchange. This chokes off the flow as it has increased the price of Chinese output relative to US output. It also relieves the Chinese economy of the inflationary pressures it was under. They might alternatively just let the currency float and allow the market to push the exchange rate where it will, most likely up in the first instance.

And this is what this story is all about. China in particular, but increasingly many oil producing nations since oil oil prices increased from the lows experienced over the entire 1990s, are following track #1. It is unsustainable as a policy, so they are being forced to consider #2. But there is a political problem with this. Having the exchange rate where it is, undervalued, is not healthy; the Chinese economy for instance is eroding under the inflationary pressures being put upon it the excessive growth that is occurring forcing much investment and expenditure that it might likely regret in years to come (the over-hyped expansion of a small number of urban areas for example). However, the Chinese government (and people to be honest) get a nationalistic pride out of a booming economy that is buying up foreign assets. That is not a criticism of the Chinese people, it is a common human trait. Anyone living in Ireland over the last 10 years will recognise instantly the swelling chests that come with an inflationary boom at home and the ability to stride foreign property markets like kings.

It is a familiar choice. Sensible economic policy, or populist sentiment and beliefs. The latter usually wins in the short term until the proverbial inevitably hits the fan. These countries have been dialling up the speed setting on their fans for a few years now and the projectiles are being stockpiled.

So Robert Fisk might have simply stumbled on the latest discussions about this problem, or this might be a straw in the wind indicating that the time of inevitable revaluation (or even currency float) for these countries is on the way.

That is a big story and an investment opportunity if you can find some cheap way to access it. Go long these mainly developing and OPEC currencies that are under pressure to revalue and short the US Dollar (the second part not necessary if you are US based already).

Trading oil in Dollars - who cares...

2009-10-06T11:09:00.022+01:00

This story, sometimes appearing in different guises, always gets tongues wagging. The end of the Dollar, the decline of the US. This is BIG news.

No it isn't.

When we want buy something from someone else we need some way to put a price on it. We could say, for example "this car will cost you 50 goats". No reason why we couldn't. The most astute readers will spot some potential problems with such an arrangement; for those buyers who don't own a herd of goats it will be difficult to properly assess exactly how much of your wealth such a purchase will require. How much other stuff, like housing, food, holidays etc. today and in the future will you have to forgo in order to buy this new car?

Follow this up with a couple of questions. Does the simple act of stating the price of the car in goats mean that:

The seller will takes goats and nothing else in payment?
If you don't currently have any goats you won't be able to buy the car, or it might cost you more than if you did have 50 of the critters munching on your front lawn?
The seller is strictly demanding goats in payment (#1) so that they can be added to the ever growing flock in the paddock around the back of the car dealership?

Are we going to get any arguments if I suggest the answers to those questions are:

No,
No and
No?

No.

So what's the fuss about oil (or any commodity for that matter) and Dollars, or Yen, or Euros? We price stuff using some historical convention because it is convenient and communicates a lot of information to the largest number of people. Trading a global commodity sold and bought by everyone around the world is far easier when we talk the same financial language and the US Dollar has been the lingua franca of the industrial age. I can immediately compare the price of oil being sold out of Venezuela with the price of oil being sold out of Kuwait, make any adjustments I need to for differences in composition or quality and transport and know where the best deal is. That is why we use a single currency as a numeraire - which is nothing more than an accepted unit of measure. Sure, goats might make a better numeraire for a Tibetan goatherd, but the world has just naturally come to use Dollars.

But of course I am missing the point aren't I. There will be no need for Dollars any more. People won't want them. Really? Did you think about the questions I posed earlier? Saudis, Venezuelans, Iranians don't sit around thinking "damn, what can I do with all these Dollars I am getting?". They either buy US Dollar assets with them (anything from US government bonds, to real estate or equities or simply cash stuffed under the Persian rug), or they sell them to someone else so they can buy Euro government bonds, Chinese real estate or whatever.

Take the buy side. People aren't sitting on piles of US Dollars simply to buy oil. They trade what ever currency they hold to buy US Dollars (assuming that settlement is in fact in Dollars and not some other currency).

But what about currency risk you ask? If that is of concern, you hedge the currency. Changing the numeraire won't alter the economic implications of exchange rate movements. A 20% appreciation of the US Dollar (with oil price in Dollars) will bring the same affects as a 20% depreciation in the Euro (with oil priced in Euros). In both cases oil will become more expensive for some, in this example Eurozone buyers, relative to others, US buyers.

So, any change to a new numeraire for oil will not bring any earth shattering implications for the global economy. Nor will it happen at the whim of a group of people who think it matters and will try and enforce such a shift - those efforts will fail if buyers and sellers don't find it convenient. It won't be some catalyst to a dumping of US Dollar assets - this would have been done already if people didn't like US Dollar assets.

What it might do is:

Reduce the trade in US Dollar foreign exchange markets a little. But hardly to the extent that it would have any implications for spreads or liquidity
Reduce the seinorage that the US enjoys. This is the interest free loan that the US gets when someone holds some of their currency. This isn't a lot in the scheme of things at the moment and for reasons discussed above, changing the numeraire for oil trading is unlikely to dramatically reduce foreign holdings of US currency.

No. This story is just another round of penis comparison geopolitics. I fully expect that one day the Reminbi is very likely to become the global financial and trade numeraire. Nobody will need to legislate it, it will just happen over time. It will make nobody worse off and nobody better off, but simply change the language in which we talk numbers.

UPDATE: Just goes to show how poorly this blog is read. I have amended the incorrect reference to "Yen".

Talking taxes

2009-10-05T14:31:00.020+01:00

Income taxes that is.

Deep recessions following boomy booms almost invariable entail nice big fat public deficits. What usually happens has now happened again; our elected public representatives fool themselves into thinking that the tax revenue windfall associated with a monetary bubble are genuine, when in fact they are transient. When economies correct, the fact that politic ans have been spending far beyond the country's (i.e. tax payers') means is revealed and large deficits appear.

The economic concept is that governments may have been running significant cyclically adjusted deficits. Simply, the public balance (tax less spending) adjusted for economic output above (or below) its long run potential may be quite different to headline numbers.

And when we get deficits like this, tax rates are in the firing line. The UK Chancellor has announced a nice juicy new 50% top marginal tax rate (up from 40%). Ireland is incurring a raft of new taxes levied on income. The US is threatened with similar. The affect in Ireland is quite phenomenal, talking from personal experience. What, I would argues, is an extremely unbalanced income tax regime, raising the massive majority of incomes tax from a narrow band of earners, is becoming almost unbearable.

Consequently, I thought I might look at how Ireland's income tax system sits relative to others.

What follows is a brief look at some of the marginal and effective average tax rates that apply to Ireland and compared with the US and UK. This is only one abbreviated way to look at the data, given the fact that their is an almost infinite number of ways to cut things, given that most regimes treat different people in different ways for tax purposes (married versus single for example). But what follows looks at rates that apply to single earners and ignore any manner of tax concession that might apply. I would suggest that the extent to which different classes of tax payers receive significantly different treatment represents a failing on the part of a tax system.

Here is exhibit #1. Marginal rates that apply, including national insurance contributions in Ireland and the UK. Note for the US, these are Federal rates only, so they are good for Texas for example.

The X axis is local currency units, £, $ and €. Ireland starts with low marginal rates kicking in at relatively high minimum earnings levels. The US has low rates throughout, but more grades. The UK has higher rates kicking in lower down the earning scale. Both the UK and Ireland have much higher top marginal rates that take affect much earlier than in the US.

Also note some of the quirks. Irish (and UK) tax rates jump to very high levels very quickly. 50% of marginal income going in tax is a lot. Beyond that the government is effectively saying there is some income over which you don't have the right to keep even half. Note the spike in the UK marginal rate, which is an artifact of National Insurance rates hitting a ceiling.

While these lines appear on the same chart, they are not of much use for cross country comparison. We need some way to compare different income levels across countries. The way I propose to do that is to adjust the scale to a common currency (Euros), using a Purchasing Power Parity rate of exchange. I have used consumer expenditure PPPs and I lift these from the OECD and the most recent data is for 2007. If we do that we can compare $ and £ to Euros on the basis that we have tried to adjust the numeraire to a basis of common purchasing power.

If we do that the chart looks like this:

I have added some vertical lines to denote where Irish median (and 150% and 200%) earnings fall.

What you first notice is the shift in the lines. The top rate of tax in Ireland clearly begins to bite at a much lower level of income than in the UK. In fact it kicks in at the median earnings - so by definition half the income earners in the country should pay some tax at this rate of 50%. Let's now compute what this would imply for average rates of tax paid across the earnings scale:

Now this is the money shot, so to speak. This is the average rate of tax that would be paid under the marginal rates shown above. Here are some of the striking characterstics of the Irish structure, especially compared with the US and UK:

There is no tax paid until someone earns at least 50% of median earnings. Not even a token 5%, that might encourage some sense of social contribution.
By the time someone earns the median wage (nearly €38,000 per annum), they will pay less than 15% in tax. Note that this is before any types of legal tax avoidance measures that are available.
Beyond the median, income tax burdens rise at a dramatic rate. at 150% of the median you will pay around 25% of you earnings in tax.
The pace of increase slows only marginally beyond that and at a mere 200% of median earning it has increased to 33% of earnings in tax. That means someone earning twice the median earnings (€75,000) pays nearly 5 times as much tax as someone on median earnings.

Now personally, I would favour something more in the style of the US. It is progressive, in that the higher your earnings, the higher the proportion you pay in tax. But it is not massively progressive as evident in Ireland.

Secondly, A larger proportion of earners pay something and something material relative to everyone else. Low to median earners might pay 5-10% of their income in tax, compared with 20-25% for those on 2 or 3 times median.

One thing is clear from this. Ireland is no "low tax" country.

Tax Commission report – congestion charges

2009-10-01T17:12:00.015+01:00

Economists just love congestion charging. Academic economists I mean. It pushes all the hot buttons for them. A widely accepted source of “market failure” (negative externalities), loads of primary data collection and analysis, scope to play with prices and estimate demand curves in a real life situation. It is one of the very few areas where economists can play at being real scientists, with experiments and stuff, like.

I tend not to like them so much. Not in theory, that is pretty sound in an abstract way. But in the practice. It turns out if you really dig into this, congestion charging in most standard real world conditions is wasteful, produces an inefficient allocation of resources, opens up potential inequities (in particular regressive ones that punish lower income groups) and creates a dead loss to society in terms of welfare (I mean like making everyone pay up some money only to put it in a pile and burn it).

Let’s start with the theory. We tend to get more efficient allocation of scarce resources when there are clear and transparent prices that incorporate all costs of production. That way, people only do something if the price is less than or equal to the utility (pleasure, sustenance etc.) they derive from it. It means resources don’t get wasted where they aren’t really needed or wanted.

The concept of “externalities” in economics was identified some time ago. These externalities can be positive or negative if they impose a benefit or a cost on someone else. A lighthouse has positive externalities, while a cigarette being smoked in a confined place has negative externalities (cough, cough). The issue at hand here is negative externalities. The concept is that in the act of doing something, or consuming something I impose a cost on others. The theoretical economic framework for this is that the marginal social cost exceeds the marginal price I pay. Consider this. I drive to work at 8am and base my decision on how much petrol and wear and tear etc. on my car will cost me for the journey. I do not consider in my decision the inconvenience that my presence on the road might cause others (the congestion effect). So I base my decision on a price, but the price I am paying is less than the marginal cost. That means I am doing too much of it. Well, not me specifically, but those people for whom the price is only just worth paying. If you made them pay more, they would not drive and hence reduce the congestion affect that have on others.

The problem with the use of this type of analysis in support of a congestion charge is that it ignores a fundamental characteristic of congestion costs; they are perfectly reciprocal. What do I mean by that? I mean any costs you impose on others bounce back in equal measure to you from them. Just think about it. If my decision to drive to work at 8am has the affect of increasing the journey time of every other person on the road at that time (say 10,000 of them) by 0.1 seconds. So the total cost I impose on others is 10,000 times 0.1 seconds = 17 minutes of total lost time. But everyone else is equally guilty and each of my commuting buddies impose the same cost of 0.1 seconds of increased journey time on me. So I suffer a 10,000x0.1 = 17 minutes extra commuting time.

So, although I am indeed imposing an external cost on others, they are imposing an identical cost on me. Perfect symmetry and most importantly perfect information for me to make my decision.

When deciding whether to drive to work at 8am in the morning I am not expecting a clear road. I know I am going to suffer congestion costs. And I have an excellent idea of precisely how much they will be. And I don’t think that makes me particularly clever, everyone else will have the same information. So if I drive I am doing so on the basis that it will cost me an extra 17 minutes in travel time, which is exactly the same as the external costs I will impose.

All this means that there is no place for policy intervention. I am making an efficient decision that reflects all costs, including the external ones. To place a congestion charge on my journey would create an inefficiency, not address one.
A nice analogy is a “smokers’ room”. Smoking in an office would create external costs that fall on others. But if you have a smokers’ room where people can go to smoke you will instantly internalise the externality in the same way that road congestion does. Everybody in the room is there of their own volition, knowing that they will have to put up with the inconvenience of other people’s smoke. The only real issue is who pays for the smokers’ room. As long as the smokers pay for it, maybe on an entry fee basis, everything is efficient and equitable. Road users are similar in this way. The more you drive and the more congestion you sit in, the more tax you pay on the petrol you burn – hence paying for the road system on which you sit.

Instead, with a congestion charge, we layer even more cost to monitor and account and administer the scheme, we prevent people from driving as much as they would like (even after correctly pricing the cost of congestion they impose) and underutilise the roads that we spend a lot of money to build. This creates a dead loss to society.

So congestion charging is typically inefficient and an abominably poor application of economic theory.

But what about equity issues? These are usually brushed under the table a little when it comes to congestion charges. But consider for a moment the range of people you might see sitting in that rush hour traffic jam. They will range from shop assistants and nurses, to bankers and company CEOs. Now think about how they price their time. People in lower paid jobs would typical value money over time (it is an awful expression, but their time is cheap, so to speak). For high flyers, the opposite is true. So if you introduce a congestion charge you are actually setting a price for time, because that is where congestion has its economic affect. And who suffers most? Those who would rather spend an extra 30 minutes getting to work than have to pay €10 in a congestion charge; the lower paid. This makes a congestion charge regressive as it favours those who place a higher value on their time, which is invariably those on higher incomes. Think of the case of Michael O’Leary who went to the expense of buying a taxi licence so he could drive in bus lanes and beat congestion. A hypothetical congestion charge of €50 per day would delight Michael O'Leary and increase his welfare, but would be detrimental to someone struggling by on a below average wage.

So all in all, congestion charges are a bad idea, creating economic inefficiency, regressive welfare affects and a financial and social dead loss.

RIP quality journalism

2009-09-30T11:57:00.016+01:00

The Gruaniad is a newspaper that seems to pride itself on notoriously poor standards of fact finding and editorship, but I have just been bowled over by a superlative piece of garbage that went up on their web site this week. No surprise that it appears in their "environment" section and no further surprise that it is yet another lame piece of climate change alarmism.

Have a look at the article and then do as much fact checking that you can in, say, nine tenths of a second.

Adelaide latest victim of global water shortages
Australia's fifth-largest city could be reliant on bottled water as early as next week as overuse and drought stretch the Murray river to its limit
http://www.guardian.co.uk/environment/2009/sep/28/adelaide-water-drought

Pretty self explanatory really, but also seriously alarming. Adelaide (the fifth largest city in Australia) must surely be in a state of emergency given such an imminent event. Can you imagine the logistics involved in the supply of a city with bottled water, the restrictions one would need to place on any water use at all in order to prevent all manner of disasters and even death?

Google must be running hot with links to local press warning the populace of the danger they face and the things they need to do....

Oh.

9 potential news articles. Only one referring to this disaster, from the Gruaniad itself.

No bother, this means nothing. The Gruaniad journalists are quick off the mark. They get the scoops weeks before other inferior news hounds. A quick look at primary sources will reveal the astonishing speed with which these paragons of the news media have pounced on cold hard verifiable FACTS:

Oh.

Adelaide reservoirs 90% full. Maybe they are filling the bottles at the reservoirs for distribution to this thirsty city.

Never mind, the South Australian Water authority are consummate professionals. They will be on the case and will be ensuring that water is being used for the most essential purposes only. Sure enough, they have put everyone on LEVEL 3 ENHANCED WATER RESTRICTIONS!!! This is definitely serious.

Dripper systems and hand-held hoses fitted with a trigger nozzle can be used for a maximum of 3 hours a week

What? Don't these dolts realise that there will be NO WATER NEXT WEEK? And they are still letting people waste it on their gardens!?! They are rushing headlong into this disaster.

I await the upcoming Gruaniad reports of this unfolding crisis in the coming days with great anticipation.

UPDATE 14 OCTOBER:
I received this disturbing e-mail today [I do hope this poor soul survives]:

Still waiting on the bottled water to arrive. Can't hold out much
longer. So... thirsty...

"Jobs"

2009-09-24T08:48:00.015+01:00

Language is a powerful influence on the way we think. Take the word "jobs". An innocuous word in itself, used in many and varied context. Most people would be familiar with its use in forms such as:

"protecting jobs"
"creating jobs"
"exporting jobs"
"this will cost jobs"
"this government policy will cost jobs"

or my favourite at the moment:

"turning our back on Europe will cost jobs"

All leave a visual impression of a tangible object, like a book or a cup. Things that can indeed be "protected", "created" or moved from one place to another or even lost forever down the back of the sofa with all that loose change and lolly wrappers. The natural extension of such thinking is to believe implicitly that these things are fixed in number, that if I have it you can't. In economics speak, we would say rival in use, or consumption.

On those general impressions, reinforced by that language, the electorate in every country I can imagine believe they are involved in a global economic tug of war, fighting for these "jobs". This isn't good. For one, it provides the fuel for protectionist behaviour that adversely affects everyone's welfare.

The problem is, like many widely held beliefs about economics, this impression of "jobs" is wrong. It simply is not true that the relocation of output from one country to another (for example Dell moving from Ireland to Poland) will leave a hole created by a theft, or exportation, of "jobs". Nor is it true that some form of government policy (read public spending) is needed to fill such an imaginary hole.

And why is that the case? The reason is because there are no "jobs" per se, but an amount of labour that is needed to produce a given quantity of goods and services for the available technology and capital stock. And the amount of labour you use, relative to the amount of capital used (the level of known technology is simply a given at any point in time) will be determined by how much labour costs compared to capital.

If your production process requires you to open cans and labour is very expensive, you will buy an automated electric can opener and employ one person to operate it. If labour is cheap, you will buy 6 manual can openers and employ 6 people to operate them. The key is in the price of labour, or wages. "Jobs" will be there so long as wages are flexible and an economy is allowed to move from one state to another. They won't be lost, stolen, created, exported or anything else.

You can see the crux of the issue here though. It is all about the flexibility of wages; by which I mean the level of wages relative to everything else, including stuff in other countries. This is the only way that a shock to the economy, or any policy will "cost jobs" - if we refuse to allow wages to adjust.

So the only way that an economy is likely to be left with a shortage of "jobs" (i.e. persistent excessive unemployment) is if the price of labour doesn't adjust, or if some obstacle to movement of labour from one region to another, or from one industry or skill set to another is impeded. Note here that large scale government "training ", like the Irish FAS can in fact be such as impediment - but that is for another post.

What may happen is that wages might need to fall to restore full employment, which could imply a lower level of income on average. But there is no point in fighting that. It is a superior outcome to what would be a lower level of income and a larger number of unemployed people who are without employment for longer periods of time.

Here are the important implications of this that everyone should bear in mind:

A government does not, can not, "create jobs". Reject outright any rhetoric based on such a lie, it is usually a political ploy from the CEOs of the most dominant and powerful industry in the world, the political one.

Buying goods or services from abroad does not "cost jobs". Nor does buying domestic goods "support jobs".

When myth meets economics

2009-09-23T11:43:00.009+01:00

Economists get a bad rap a lot of the time. And, on occasions it is well merited. But more often than is commonly imagined fault lies in alarming widespread and firmly held beliefs that support damaging policies by government.

Trade is a goldmine of examples. Take the experience of the Great Depression. One feature of the this tragic period in modern history was a descent into protectionism and an unwillingness to trade (i.e. import) goods and services from other countries. The graphic below is modestly famous, appearing in an Economist article on the Hawley-Smoot Tariff, that was arguably the catalyst to a general retreat into economic isolation around the world. Some think it ugly, or contrived, but I find the chart illustrates the annual contraction in the volume of trade. Each circle encompasses an amount of trade which gets smaller and smaller. Hawley-Smoot brought into effect more than 800 different tariff increases. Naturally, other countries followed suit. The result was less trade.

While supporters of these tariffs might try to maintain that the affect was as intended (keeping out foreign imports in favour of domestic production), they might baulk slightly when one explains that the chart below shows the decline in total world exports; most anti trade proponents tend to be of a mercantilist flavour and believe, no insist, that imports are bad while exports are good. Everyone was exporting less. This is of course a trick, every import is in fact an export, but the point is valid. There are no exports without imports. A type of Yang and Yin if you like.

What you don't see when you look at this chart is the loss in income and welfare around the world as we stopped trading with another.

That is an interesting trip down memory lane, but what relevance is it for today. Well there is more than one point to make.

Firstly, economists fight a never ending battle against the enemies of trade. Strangely, over time, this continues to be the overwhelming proportion of the population.
Secondly, trade protectionism is a classic knee-jerk response that comes at time of recession. It is intuitive, but badly flawed, to believe that you can "save jobs" by buying locally produced goods or services only or preferably.
Third, we are facing a rising specific threat at the moment. This is partly related to the point in the economic cycle in which we find ourselves, with unemployment high and rising nearly everywhere. But we also have to deal with Climate Change catastrophists who are lobbying and legislating for taxes on anything with a carbon-based energy component in it. Unfortunately, that is everything, because the use of energy has been the bed rock of our improving welfare ever since man lit his first fire and dramatically reduced mortality from hypothermia, nocturnal predictors and bacterial infection from eating raw meat. And given our present technology there is no cost comparable alternative.

One of the darrrrlings of the Climate Change Catastrophe industry is the Waxman-Markey Bill in the US which has plans to place an explicit or implicit tax on fossil fuel use. This would increase the cost of energy as a way of reducing its use. However, such a law introduced in the US would simply mean that production would move overseas. So the Bill has provision for tariffs to be applied to imports of goods from other countries. Bad news.

It doesn't end there, Nicolas Sarkozy is a fervent admirer of such an idea (what, an anti trade Frenchman???) as it could also help square the political circle for the EU thinking of doing something similar.

And people lap it up, keeping out those nasty imports.

I live in dread.

At last a "rock solid, steady" PC application

2009-09-22T14:11:00.005+01:00

Is there some way we could convince these people to design a PC operating system?

The Conficker worm

"Conficker has proven to be the gold standard for botnets. It's rock solid,
it's steady and it has mechanisms built in that have made it impossible for us to actually crack," Joffe said.

The next religious war

2009-09-22T09:14:00.008+01:00

It is embarrassing to admit that this bloke is Australian. The stereotypical national character (perhaps self delusional) is of a skeptical, bordering cynical, nature. A person most likely to take a pause, look through the bullshit and call a spade a bloody spade; most usually to end in the appraisal of most situations with an assessment of "no worries".

I hope that strength of character isn't dead, because the country has bred the Flannery, a pale imitation of an Australian. A panicky scare monger who now foresees war, yes war, if countries don't toe his preferred line. That preferred line is a halt in the generation of income, goods and services as a way of stopping the production of a natural trace gas that is the very base of the food chain on this planet.

The only reason a war could come of this is over attitudes like Flannery's themselves. A self-fulfilling war arising out of demands by one group of people that everyone else adheres strictly to a set of punative and inequitable ideological principles and rules. Yes, we have been there before. This is just the threat of another religious war.

A note to Mr Flannery. I believe nothing good ever came from wilful subjugation. I will not bow to your destructive religious crusade and I doubt I am alone.

Reap what you sow

2009-09-17T10:00:00.006+01:00

Oxfam are now worried about the possible implications of diverting scarce resources from one problem to another.

Maybe they should have thought a little harder about their own actions when they started to spend their limited budget on political lobbying:

The reason I won't give to Oxfam. The road to hell is paved with good intentions and this mob are finding they might end up doing more harm than good.

Climate change madness

2009-09-11T09:15:00.004+01:00

In the mad rush to avert that non-problem that is dangerous (man-made) climate change, we are told we need to pass laws, regulate and spend lots of taxpayers' money (glibbly taken by voracious government) to force the production of "renewable" energy sources. Stuff like wind, solar etc.

Of course the problem is the technology just isn't commercially viable yet. We would either have to pay a lot lot more for the power we use for transport, light and heat etc (especially nuclear, solar). or we would simply layer a another sum of capacity on top of fossil fuel (especially wind) because it won't be dependable enough to meet demand on it own.

If you dispute this, look at that paragon of sustainable energy, Denmark. After pouring a massive amount of taxpayers money into subsidised wind turbine production it finds it has to draw on foreign electricity production and charge the highest prices for electricity in Europe.

Compare Ireland - hardly a low cost electricity model. We pay more than twice as much as Americans and three times as much as Australians and Canadians. Consumers price is around 15 cents per kilowatt.

with Denmark, with its mass of windfarms consumers pay 24 cents per kilowatt.

I don't want to pay that. Irish electricity is too expensive as it is. But if individuals don't stand up to this madness that has captured the political agenda globally, that is what you face for no practical gain.

Now there's an idea

2009-09-09T16:56:00.004+01:00

Smaller government and less social meddling. Why, it's soooo crazy, it might just work. I wonder if Peter Davies has any Irish grandparents?

This is an experiment worth keeping an eye on. Alas, I fear Doncaster might find their central government grant funding curtailed a bit more in the coming years.

Tax Commission report – water charges

2009-09-09T15:47:00.006+01:00

This is the first of a couple of comments on the report by the Tax Commission, starting with the issue of water charges.

Some general points quickly to open. Why charge for water? Well, it is an efficiency thing. If you pay a fixed a price, or no price for a good or service, you will use an excessive amount. That is the efficiency argument. There is also an equity issue, in that heavy users might pay no more than light users.

Such is the basic premise behind the recommendation for the introduction of water charges in Ireland. But, as a grumpy old man, I find fault with most things and this is no exception. I have a short list of some of the difficulties I have with this proposal.

This is a charge that is going to be layered on top of charges (i.e. taxes) already levied to pay for water catchment, storage, treatment, distribution and maintenance. So in the guise of a more efficient and equitable approach to funding water supply we are actually facing a ramping up of cost. A ratchet affect.

Next is the efficiency point. And there are multiple problems here. Let’s start with the underlying commodity being delivered – water. As I mention above, the establishment of a marginal price for water use will lead people to use as much as the need/want and no more. Just like eating that extra Mars bar; the first one was worth the 80 cents you had to pay because you enjoyed it, the second one, not so much, the third one was worth a lot less than 80 cents so you stopped. In economics speak, they will align the marginal utility of water usage with the marginal price. The reason this is generally a good thing in economic is because it allows, in theory, for the most efficient allocation of a scarce resource. But water itself is not a scarce resource in Ireland. There have never been any water shortages in Ireland to my knowledge. It is for all intent and purpose unlimited in supply and hence should have zero marginal cost as a commodity. It requires no rationing by price or any other mechanism. To try and introduce a positive price would lead to an inefficient economic outcome by forcing people to under-use a resource that has no limit in supply. This case is certainly different in places where demographics, climate or geography do create a limit to supply (e.g. US, Australia, Africa etc.) but not in Ireland.

Next we turn to what is the more important point. It is not the water that needs to be allocated more efficiently (as I argue above it should have a zero marginal cost as an unlimited resource), but capital employed in its catchment, storage, treatment, distribution and maintenance. It is this inconvenient truth that creates a lot of the difficulties. I will suggest one here, but there are others. Consider that largely the capital required to collect, store, distribute water and maintain/repair the system is a large fixed cost for any population centre. Think of the water mains system. It doesn’t matter if you use 5,000 or 8,000 litres of water per day per household, you will still need the same pipes running the same mains pressure, with the same amount or maintenance. There is no efficiency to be derived from put a marginal price on water, making people use less in this instance. In fact, it could be detrimental, if you consider that it could lead to lower total revenues, which would impede the ability to meet the fixed cost of building and maintaining the distribution system.

Next, let’s consider the behaviour of the supplier. In normal circumstances the existence of a price allows for consumers not simply to choose the appropriate amount they want to consume (and not use wasteful amounts), but it also provides mechanism that allows for the more efficient use of capital. More efficient (hence lower cost) suppliers of a good can price at a lower point and entice consumers from competitors. Capital gets used and managed by the best companies. The desire to minimise costs and prices in order to attract customers is driven by a desire to maximise profits. But what are we considering here? The proposal is that a state owned monopoly will be setting charges for water usage. This can not be a sensible approach to achieving a more efficient allocation of capital when the two most essential ingredients are missing:

The existence of a profit motivation
The existence of competition.

For that reason this proposal will, if instituted, fail to produce more efficient outcomes. The state owned monopoly won’t be interested in maximising profits, so no need to work capital or labour more efficiently to minimise cost. With no competition it doesn’t matter how it prices (in fact it will need to be regulated), because it won’t lose any customers. Also consider that if the whole point of this exercise is to “save water” (use water more efficiently), this state owned monopoly will have no interest in reducing the greatest source of water loss – leakage during distribution. Why? Because the stuff isn’t scarce and so it doesn’t cost them if they lose a lot of it.
All in all this is a very lazy proposal. It will do nothing, where nothing is needed and simply ramp up household charges. And I am not stretching the truth to much to suggest that this format is simply a tax.

Finally, start totting up the extra costs that will necessarily be added to the provision of water in Ireland. Metering will be required for every household, which is a significant capital cost, billing and accounts sytems and employees will be needed as will yet another quango to regulate yet another state monopoly.

When the Irish economy is so broken, with poor policy and woeful insight from the supposed “professional economist” cabal, this is at best a distraction.

Life as a consumer

2009-09-09T14:47:00.006+01:00

Sometimes it’s hard not to be cynical about business and their approach to their customers. No more so than in the telecoms industry, which in Ireland is a complete basket case. This is supposed to be a deregulated competitive market where the “local loop”, the line that runs to your door, can be leased via any available supplier on request. Theoretically, this opens up competition in stuff like broadband. Unfortunately this is more in theory than practice.

Take my current broadband experience for example. I am fed up now with my current provider of telephony and broadband services. No names or pack drills, let’s just call them GT Ireland. In the last 6 months they have left me without internet service for 4 weeks and presently are delivering a consistent 0.6Mb speed while charging for a 7.6Mb one. Yes, I know what contention is, but this is clearly not a contention issue – especially when you get 0.6Mb at 3am.

Thanks to the glories of competition (as drawn up by a raft of politicians) I can move to any number of alternative suppliers using a variety of technologies. Let’s investigate the possibilities:

Alternative DSL providers:

Yes sir, we would love to sign you to a 12 month lock in as a new customer. Yes
sir, you will actually be getting exactly the same signal down exactly the same
wires via exactly the same exchanges. No sir, we don’t actually have any
proactive technical support that will leave a call centre and take a look at the
situation on the ground. Just send us your money each month instead and if you
continue to get the poor service, just call our technical support, who would be
glad to keep you on hold for 10 minutes before patronising you and telling you
it must be a fault with the way you have set up your router, or don’t have
filters on telephony lines etc.. Oh yes, we can get an engineer out to check it.
That will be €99 plus VAT thank you.

Cable suppliers:

Sorry, we don’t “do” that well established suburb of the nation’s capital city.

Wireless suppliers:

Yes, our technology is great. You see no wires and exactly the same price as the
DSL alternatives. Well, yes it is true that if you want to have a telephone line
for something silly like a landline telephone, a monitored alarm, or a cable TV
box. You will need to pay an additional €25.99 per month minimum to someone else
for that.

Mobile suppliers:

Did you talk to the wireless guy?

So in practice, you are in fact left with the original state monopoly supplier. But you do get to choose the letterhead you would like on your bills. How lovely.

And a nice little anecdote to go with this moan. My much-loved supplier GT Ireland was fiercely marketing a “special offer” of a free upgrade to 24Mb service a number of months back. I thought I would like some of that and gave them a call. Unfortunately this 21st century technology had the strange quirk that had I been switching from a competitor they could switch me over seamlessly. But alas, I was only a humble customer of 5 years standing and so would have to have my service turned off for a minimum of two weeks should I want it. It didn’t make me hurry to take up the opportunity.

But lo, what now? GT Ireland has just announced that it has sold its household customers to another, unnamed telecoms company, let’s call them Modafone. And no sir we can no longer change your service. And we aren’t really interested in your problems any longer and your new supplier won’t be either until the sale completes next year some time.

You don’t suppose that 24Mb offer was a cynical attempt to boost subscriber numbers before a sale of the business do you? No, neither do I.

From the "how do they get away with that?" department

2009-09-04T12:12:00.007+01:00

Just heard Michael O'Leary on the radio this morning. I don't think I have ever heard anyone who could rival O'Leary for the logical contortions he is willing to conduct to justify himself. This morning it was about the Lisbon Referendum and how he is campaigning for a Yes vote (is he using shareholders' funds???), when following the first failed referendum he was arguing that there shouldn't be a second one - because the people have spoken and they said NO!

His logic being; "well there is going to be one now, so I am going to tell everyone they should vote yes". When a more logical position would surely be "well, I was against a second referendum because people voted no and I don't like this idea of double jeopardy, so I would urge everyone to vote no again to effectively render it void". Maybe its just me.

But that is just some topical flavour of a man we all know and love. The meat of this post is the relatively recent change in Ryanair pricing. It is well understood that Ryanair are no frills and follow a business model where the strip out any frills from core fares and so deliver the core service at as low a cost as possible, while reserving the option of charging like a wounded bull where the can get away with it.

I admire that model. It is not the only model, but a strong one. And as a consumer it gives me ample opportunity to minimise cost by planning carefully (book well in advance) and studiously avoid the add ons. And when I see Ryanair trumpet some ridiculously low fare I know that it means without any of these "luxuries". I know that if I book ahead of time and plan my travel I can avail of the price advertised and only have to pay taxes on top.

But something has changed. Ryanair have made a small, but very significant change. At the end of my booking I get to select my preferred method of check-in. To check in at a desk on departure will cost €20. Fine, I can avoid that. Option 2 is check in on-line for €5. There is no option 3.

Here is the point at which Mr O'Leary is taking the piss completely and displaying another one of those yogaeque positions in logic. On one had he is saying I can buy a ticket for, say, €20 (subject to taxes). Then, with a completely straight face he is telling me that if I want to enjoy the luxury of actually boarding the plane it will cost a minimum of €5 extra.

I would call this a case of misrepresentation. Surely a "fare" must include full payment for the minimum services necessary for travel. In this case, some form of check-in. If it doesn't, then the "fare" quoted is a lie.

So how does he get away with that?

Why, you're welcome Mr Desmond

2009-08-31T14:31:00.002+01:00

You will go a long way to find a much clearer and damning indictment of the way the banking crisis has been handled in Ireland than the reported cases of Dermot Desmond in the Sunday Independent. The articles reports how Mr Desmond divested himself of around 14 millions shares in Bank of Ireland and AIB that he had acquired in January, netting himself a supposed €20 million profit.

Let's just review what has happened here. Over the course of 6 months it has been possible to make a staggering windfall return on, what everybody explicitly accepted at the time of purchase, were two insolvent banks. No extra capital required, just a share of the negative net asset value purchased and then sold for a higher sum.

How is this possible? John Q Taxpayer of course, via the globally patented "bank liability guarantee" and more recently "NAMA". Entirely predictable; the government effectively took financial responsibility for these entities but left ownership (potential upside) to the current shareholders. Desmond, among others, was too shrewd to let Christmas pass buy and did the rational thing.

But the real travesty in this case is that this is unlikely to be the end of the story if the NAMA plan results in a taxpayer funded recapitalisation of the banks (via overpayment for assets, or invocation of the liability guarantee or both - see earlier blog) without a proper equity stake (probably 100%) in return. NAMA might not lead to this. The government might stand strong and insist shareholders and bondholders lose all - but the track record is not encouraging. After nearly a year we are still not yet in a position to ring fence the cost to taxpayers to any meaningful degree - we still might end up recapitalising the Irish banking sector using taxpayers' money, but with equity left in the hands of the current shareholders and also possibly bond holders fully repaid.

NAMA is a bad idea because it leaves this possible outcome open.

That is the long and short of it.

NAMA and "long-term" economic pricing

2009-08-28T16:46:00.005+01:00

The basis on which NAMA buys assets from the Irish banks is a key issue, as highlighted below. Something that all should bear in mind when making any sort of forecast for the prospect for returns on Irish property (be it equity or debt exposure) is likely to be remote when there is so much spare capacity:

http://www.businessworld.ie/livenews.htm?a=2465998

A survey from the Irish Brokers Association has today found that the number of buildings left vacant in Ireland rose 150pc from 140,000 last year to 350,000 today.

To put that into perspective, there is around 1.5 million household in Ireland. So this represents more than 20% of present demand for housing and is spare capacity. OK, there is likely to be some mismatch in terms of type of accommodation and/or location wanted versus available, but that is a second order concern when you consider the amount of excess supply. And excess supply in economic terms generally means only one thing; lower prices and poor returns (if any).

In this case the "long-term economic value" of these assets could be far, far less than people think.