Economics

Fed signals pullback in liquidity supports

Via FT.com / US / Economy & Fed – Fed signals pullback in liquidity supports, we learn:

The Federal Reserve on Wednesday upgraded its assessment of the US economy and highlighted its intention to shut down most of its crisis-fighting liquidity facilities in early 2010.

And consequently:

Stocks eased slightly after the Fed statement, while the yield curve in the bond market steepened.


Which brings us on to Roger Koppl’s Big Players and the Economic Theory of Expectations.

I am indebted to Cobden Centre supporter Bruno Prior for introducing me to Koppl’s work which extends the tradition of Ludwig von Mises, Friedrich Hayek and others, unusually, applying empirical methods to demonstrate the application of the theory.

Koppl demonstrates, with extensive reference to other scholars, that investment and all other economic actions depend on “subjective” expectations. He then presents a theory of expectations which assumes people interpret their situations in unpredictable ways. This theory includes a theory of “Big Players”:

Big Players are privileged actors who disrupt markets. A Big Player has three defining characteristics. He is big in the sense that his actions influence the market under study. He is insensitive to the discipline of profit and loss. He is arbitrary in the sense that his actions depend on discretion rather than any set of rules. Big Players have power and use it.

We learn that Big Players reduce the reliability of expectations, thereby disrupting markets. They encourage herding and produce perverse effects on entrepreneurship: traders must pay attention to the Big Player and not the fundamentals.

And so we find today, for example, the markets moving in response to the Fed not the realities of the economy…

Economics

Labour’s dishonesty is leading us down the road to sovereign default – Telegraph

Via Labour’s dishonesty is leading us down the road to sovereign default, Liam Halligan launches a scathing attack on Alistair Darling, Gordon Brown and British political class:

Over the past 10 years, Labour has turned a budget surplus into a deficit equal to 13pc of GDP – the biggest in our peacetime history.

Government borrowing is at its highest since the Second World War and almost twice the previous post-war peak. And yet, and yet … when he stood up to deliver the PBR on Wednesday, the Chancellor, Alistair Darling, managed to make a ghastly situation even worse.

Read on…

Economics

Cllr Ian Parsley’s humorous take on the Pre Budget that never was

See http://ianjamesparsley.wordpress.com/2009/12/10/lies-damned-lies-and-spending-plans/

Economics

Can Government Create Wealth?

In this article, I argued that a useful measure of GDP needs to extract the government sector, as all it represents is a movement of wealth from the productive private sector to the productive and not so productive government sector. The private sector is the well spring of wealth creation and the government sector can in itself create no wealth, it can only redistribute it to achieve outcomes that it determines to be more desirable.

One of our regular readers commented as follows:

I have trouble with the suggestion that government spending cannot — at least in theory — result in wealth creation.

The commentator goes on to give an example of taxes creating a useful service, that of a national railyway that creates wealth and an example of printing money that, given to the right projects, will create wealth. They are as follows;

Suppose FooCorp sends their packages by carrier pigeon. This is slow and expensive (pigeons need to be trained and fed, and packages go missing when they fly past hunting grounds). FooCorp realises that they can increase efficiency by investing in a private rail network. The cost savings delivered by the network are greater than the cost of the investment, and FooCorp reaps the rewards. This, presumably, is wealth creation. If so, why is wealth not created if a taxpayer-funded rail network benefits the taxpayers more than it costs them?

And:

Suppose that rather than confiscating our wealth directly through taxes, the government confiscates it indirectly by printing money. The government spends its new money not on bank bailouts or welfare programs, but instead on the fusion researchers, who eventually deliver cheap power for all UK citizens. Again, it would seem that though the original funds were ill-gotten, the result has been genuine wealth creation.

I do not deny the possibility that in these specific individual, stylised examples a government can create wealth. However, in the round, they can never create more wealth than a freely functioning economy.

Economic Calculation in the Socialist Commonwealth

This is the title of a very famous essay – for the full downloadable PDF, see here.

Ludwig von Mises masterfully shows us how rational economic calculation in a socialist system is impossible. Only a half-baked system of production is possible under socialism. Empirically, we saw this in Eastern Europe and the Soviet system. The message is very simple;

  • In the free market, people transact for goods and services via voluntary exchange, facilitated by the use of money.
  • Money is the price you pay for the goods.
  • The price mechanism tells us all sorts of information as to the scarcity of those goods and services (higher prices) or their abundance (lower prices). They also indicate the need or wants of consumers as they will pay more for more wanted goods and services and less for less wanted goods and services.
  • Entrepreneurs look out for these price signals so they can direct the factors of production in better ways and combinations to satisfy those most urgent needs of the consumer.
  • If government owns the means of production, there is no price for capital goods.
  • The central planner has to make up a price to get a capital input.
  • How is this done?
  • It can only be done at best by educated guesswork.

The Pretence of Knowledge

This is the tile of a very famous speech by Hayek: see here

Also see Hayek FA 1937 Economics and Knowledge, Economica V4 N13 33-54 and 1945 The Use of Knowledge in Society, The American Economic Review .

Hayek built on the work of his teacher Mises by adding the following;

  • Planning the production process in the free market economy is done by billions of people exchanging goods and services, facilitated by the medium of money.
  • Prices to entrepreneurs are indispensible communication points in their planning process, showing the entrepreneur what factors of production and being demanded to produce what goods and services.
  • This knowledge is dispersed and comes from a multiplicity of sources.
  • Central planners cannot possible have brains big enough to take over the role and plans of all the entrepreneurs in society and all the spending individuals, thus they have a “knowledge problem.”

Although this was all debated well before the advent of super calculating computers, no program can ever take into account the changing needs and preferences of individuals. Also getting into the computer all of the combined information all the time in all circumstances for all times and places to replicate the market place cannot as of yet be done and I suspect never will be done.

Conclusions

So in answer to our commentator, I would advise a quick reading of the above mentioned classics as I think they are unbeatable in their logic. A government may get lucky with a plan and subsequent taxation of wealth to spend on that plan but, overwhelmingly more so than not, they will fail for the given reasons.

In the mixed economy we exist in today, Lord Andrew Adonis, the current Secretary of State for Transport, is doing just as our commentator suggests and is planning to build a high speed rail network that will undoubtedly bring benefits by moving the great cities of our nations closer together. More trade will take place than before, that is for sure. This I hope will be one of those lucky central planning projects.

The reported £34 billion is a lot of money to spend. Would the private sector have undertaken this? We do not know the answer to the latter for sure, but I would note the following pre big government;

  • All the great roads until the 40’s, but now only toll roads as the road system has been nationalised, were built by the private sector;
  • This is the same for all the railways, the canals and other infrastructure systems;
  • And all the bridges;
  • All the health care provision;
  • All the education provision;
  • Power supply;
  • The tunnels;
  • And the sewers.

I could go on and on…

If we consider food retail, we find Tesco created with £34 billion of private money invested in its capital. Do we really think that the government could provide for this in a better way?

When governments issue debt, it crowds out private sector bond issuance and fewer big capital projects are provided for by the market system.  To create a better functioning market place, governments should be forbidden from raising bonds, then the needs of the market could be met as people will still want to save and they would look more favourably on corporate issuance.

Indeed, we should look once again at how bonds could be the basis of all welfare provision, as I discussedhere, from “How do we fund a Deficit” onwards.

Our commentator gives the second example of using QE or creating money out of nothing to give to some scientists who develop a superior technology that drives masses of benefit. Again, I would say this is possible and more down to luck than having the many millions, if not billions, of economic actors, working through the price mechanism solving problems and allocating resources in the most efficient way, as only entrepreneurs can.

I would back the market, comprising all of us cooperating, over any central planning agent any day of the week!

Government can create the climate for lasting wealth generation by:

  • Upholding the rule of law;
  • Upholding the sanctity of contract;
  • Avoiding war unless attacked;
  • Removing legislation that obstructs the market.

There is much more but these are some key areas. I would like to refocus our commentator on thinking of ways the government can create the climate of wealth creation, rather than attempting to be the wealth creator itself.

Further reading

Economics

How to avoid future encounters with financial meltdown

Cobden Centre Advisory Board member and Chief Executive of Tyler Capital, James Tyler, sets out the case for 100% reserve banking.

Background

In October 2008 the Federal Reserve briefed a secret congressional committee that the US economy had, at one stage, been only a few hours away from a total meltdown in the financial system.

How did this come to pass, and how can we prevent it again?

The Problem

Fractional Reserve Banking (FRB) is an inherently unstable complex system.

Each and every bubble and crisis has some kind of link to FRB, going back thousands of years.

Even where financial crises are caused by natural disasters (the San Francisco earthquake of 1906 being a prime example), the financial crisis only followed because banks did not have enough reserves to pay out worried depositors – due to fractional reserves.

In a nutshell, depositors wanted what they thought was their property back, only to find it did not exist.

Over 70% of people in the UK believe that money placed in an instant access account remains their property.  This is not the case.

Fractional Reserve Banking

  1. Person ‘A’ deposits £100 of cash into his instant-access bank account.
  2. At this point, he signs over property rights to the bank – the bank gives him a promise to return on demand
  3. The bank retains a small reserve (say £3), and lends out £97 to Person ‘B’
  4. Both ‘A’ and ‘B’ both have a claim to instant access on this money.
  5. In one move, the bank has turned £100 into £197 of useable money
  6. ‘B’ buys a Widget from WidgeCo for £97
  7. WidgeCo deposits the £97 with his bank ‘Z’.
  8. Bank ‘Z’ now lends out around £94 to person ‘C’ keeping just under £3 as a ‘reserve’
  9. Person ‘C’ borrows to buy computer, and pays £94 to ‘D’
  10. Money supply has started its process of mushrooming:
    • ‘A’ Has the right to £100
    • ‘B’ has spent his claim to £97, and owns a widget
    • WidgeCo has a claim to £97
    • ‘C’ Has spent £94 and owns a computer
    • ‘D’ has a claim to £94
  11. This process continues until there is no more money to lend
  12. If any one person with a claim to their money exercises their right, the inverse pyramid collapses.
  13. If person ‘A’ claims any more than £3 of his money, the inverse pyramid collapses.

In 2007/8 this money pyramid almost collapsed.
Continue reading “How to avoid future encounters with financial meltdown”

Economics

Now State takes over bankers’ contracts – Telegraph

Via Now State takes over bankers’ contracts – Telegraph:

The new rules, which critics are likely to suggest amount to a State-enforced “incomes policy” for banks, will be contained in the Financial Services Bill to be announced in the Queen’s Speech.

The bill will give the Financial Services Authority (FSA) the power to cancel bankers’ contracts to prevent them receiving payments that it believes would cause instability in the financial system.

The FSA could stop bankers receiving bonuses that it believes are too high, or cancel remuneration packages that it thinks reward undue risk-taking.

It is hard to see this proposal as anything other than political posturing given the forthcoming election.  Are we to establish a new quango/ regulator “Ofpay”?  What will be the cost of that?  What access will individual bankers be allowed to their assessors?  How can the state decide which bankers have performed socially-useful functions and made positive contributions to the long term good of the bank concerned?  Working in a structured finance role in a dealing room environment is like being an MEP in the EU.  You have to be part of a team.  Management will only negotiate with voting blocs! One member of the team has to play the internal politics as in many other businesses, but this is of course an unproductive waste of time as far as shareholders are concerned.    How much more unproductive time will be spent trotting off to Ofpay to explain your achievements?

The root of the problem is the unreliable nature of banks’ reported profits. If the p&l was a sound number, surely the state could rely on employers to reward?  This news affirms my fear that the Government knows that the front-ending of prospective profits from derivatives trades and treating them as today’s “profit”, along with similar bank specific accounting wheezes, produce unreliable reported accounts.  That is the mischief the legislators should be focussing on.

Get that right and wages will look after themselves.

Further Reading

Economics

Happy days are here again? Another view from the City

UK Household Savings Ratio (click to enlarge)

UK Household Savings Ratio (click to enlarge)

Equity Strategist Ewen Stewart makes the case that the national debt will within 5 years be over £150,000 per family of 4 with debt repayments of twice the present defence budget, up from £31 billion in 2008/9 to £70 billion in 2013/14. He explains the root causes of our difficulties and indicates a route to recovery.

It’s all over. What a fuss about nothing. The economy will soon be growing again and, look, the FTSE100 is up almost 50% since the March low. Even house prices, according to the Halifax, have risen 6 months in a row. The doom mongers were wrong. Central Banks and Keynesian public spending programmes, together with QE, have worked. Brown indeed has saved the world!

Well that would be one interpretation and a very short sighted one too, for this recovery shows all the hallmarks of a drug addict who claims to be going straight injecting a further mighty dose of the substance that has caused such decay in the first place to prolong the party.

The problem is that the underlying fault lines in the UK economy remain and, thanks to the Government’s response, are even more pronounced.

The underlying problem is, in my view, an addiction to debt, a banking system which is over-leveraged, and now government finances that are out of control. This country that has been living considerably beyond its means for a very long time. Artificial efforts to prop this up, through printing money or inappropriately low interest rates, at best are a short term delaying tactic and at worst risk stoking a loss of confidence and ultimately inflation.

It is my central conjecture that much of the economic growth over the last decade was less the result of genuine private wealth creation but more the result of a number of unique factors which were both unsustainable in their nature and damaging to long term growth. If this view is correct the scale of the over-leverage and the action required to alleviate the problem become even more pronounced.

Continue reading “Happy days are here again? Another view from the City”

Society

Britain’s Business Community – Your Country Needs You!

Chris Neal explains how the reports of the Centre for Social Justice and Conservative Party policy are converging in a direction which tends towards Cobdenism: people having more to do with one another and the government less.

The Centre for Social Justice’s 2007 “Breakthrough Britain” report identifies five pathways to poverty: family breakdown, economic dependency and worklessness, educational failure, addiction and serious personal debt. This seminal work has led to the development of over 190 policies to reverse social breakdown.

The CSJ’s influence at the 2009 Conservative Party Conference was evident with their policy recommendations influencing much of the modern Conservative approach unveiled in Manchester. Decentralisation, Social Action, Accountability, Housing, Welfare Reform, Family, Law and Order, Schools, Skills, Re-training, Apprenticeships were among the topics on the main agenda for this Conference and it was clear that Breakthrough Britain had permeated Conservative Policy on each. Iain Duncan Smith has shown great courage in tackling issues of social justice head on with his team at the CSJ and was rightly acknowledged by David Cameron who said about IDS in his Conference speech “I am proud to announce today that if we win the election he will be responsible in government for bringing together all our work to help mend the broken society.”

David Cameron vowed to devolve power to communities in his landmark speech to the Open University on 26th May 2009 and this again was underlined in Manchester. Empowering local people and communities to take control or as Iain Duncan Smith puts it “Our approach is based on the belief that people must take responsibility for their own choices but that government has a responsibility to help people make the right choices.”

This all makes great reading and when combined with Tory promises to sweep aside great swathes of bureaucracy and quangocracy would have been music to the ears of ‘Manchester Liberals’ such as Richard Cobden. But are we ready for this as a Nation? Has society become too reliant on economic dependency and worklessness after 12 years of top down government? Are some of the poorest Britons now so emasculated and devoid of aspiration that they won’t be able to adapt to a less intrusive state, one that encourages enterprise and personal choice?

The modern Conservative message makes a lot of sense and could doubtless see the revival of our Nation’s fortunes. Prosperity based on production rather than spiraling debt and replacing a culture of instant gratification with one of hard work and thrift. A Government committed to rewarding social responsibility, families, savings and enterprise. Government can create the framework but unless corporately we embrace the opportunities on offer all the elegant oratory heard at the Conservative Conference and the profoundly accurate conclusions made by the Centre for Social Justice will amount to nothing.

David Cameron in his Conference speech on Thursday 8th October spoke about opportunity “I know how lucky I’ve been to have the chances I had. And I know there are children growing up in Britain today who will never know the love of a father. Who are born in homes that hold them back. Who go to schools that keep them back. Children who will never start a business, never raise a family, never see the world. Children who will live the life they’re given, not the life they want. That is what I want to change. I want every child to have the chances I had.”

Opportunity has been missing for the poorest in society and they need more than a lottery ticket to escape poverty. I am not talking just about the children growing up now but the preceding generation, the so-called NEETS and NINJA’s. They are entrenched in economic dependency with no motivation to work as frequently they are better off financially by staying on benefits. Many aren’t interested in working even when offered the opportunity, as the old saying goes “you can lead a horse to water but you can’t make it drink”. Well they certainly know how to drink but they have never been led to water! What would happen if real opportunity came crashing in on their lives? Opportunity in the form of skills training, mentoring and micro venture funding. The opportunity to begin apprenticeships without formal qualifications. Opportunities that can build respect, self esteem and encourage ambition. Some would respond and through hard work begin to benefit from the change in their circumstances, in turn maybe their success would rub off on others.

Top down state solutions do not work as public servants have to tick boxes for ministers and are not free to react to individual needs. Those of us in the business community however are unencumbered by bureaucracy therefore allowed to think laterally and react appropriately to individual needs. Stop for a moment to consider your own situation and how you might be able to contribute. I was inspired by the Get Britain Working Campaign to set up local Job Clubs and can testify first hand the good that comes from people getting alongside one another when facing the difficulties bequeathed by unemployment. I have introduced a second strand to the Clubs where those prepared to start their own ventures have the opportunity to be mentored and even funded by members of our local business community. Mentoring in itself is socially cohesive creating friendships between people whose paths would not otherwise have crossed. This is more a case of leading someone to water and having a drink with him! Could you start a Job Club in your community or support budding entrepreneurs?

We assume Great Nation stature in times of adversity and maybe this deep recession will manifest the legendary but dormant British qualities of cooperation, courage, determination and hard work to overcome looming economic and social bankruptcy. David Cameron’s vision of a modern Conservative Britain deserves to succeed and we must take responsibility to make it happen.

I would enjoy hearing from anyone who might consider forming a Job Club: please use our contact form.

Further Reading

Economics

The Government’s asset fire sale

Gordon Kerr explains the futility of the Government’s planned asset fire sale.

The Government plans “a fire sale of assets worth £16 billion” to raise funds for our national coffers. All of the assets mooted -– the Tote, the Dartford Crossing, the Channel Tunnel rail link –- generate cash. In normal market conditions, they would be highly valued by the private sector. But these are not normal market conditions and, even if they were, the sale would be absurd.

Since these assets all generate cash, there is no net gain to the public purse from selling them. When their cash yield is greater than the interest cost of Government debt, the public purse is better off holding them than selling them to pay off debt.

More importantly, the sales are likely to be only partial. Recent experience has shown that the Government cannot bring itself to allow major infrastructure companies to fail. If Dartford Crossing plc teetered on the brink of collapse, the government would almost certainly support it but that which the private sector produces better than the public sector should be in wholly private hands, free of all taxpayer-backed guarantees.

Lenders to these “privatised” businesses would benefit from at least an implicit government guarantee. The government will be selling the upside of investing in the assets to the private sector whilst underwriting the bulk of the risk.

This amounts to selling assets to oneself, while giving away free money.

Economics

CentreRight: We’re all fiscal conservatives now?

Via CentreRight: We’re all fiscal conservatives now?:

There is an enormous weight of expectation riding on George Osborne’s speech on Tuesday. But in the meantime, it looks as if voters – even Labour ones according to our poll – have not only accepted that public spending at the level we have seen cannot continue, but don’t even want it to.

Our Founder and Chairman, Toby Baxendale has commented there:

What we need is not just a debate about what services should be cut back, but actually about how we should fund services i.e. alternatives to the blanket taxpayer funding that we have become accustomed to since the War.

Here is one suggestion I offer to the readers of Conservative Home; how about the privatisation of the entire welfare budget to Friendly Societies?