The whole nature of the way we absorb information as a society has to be one of the fastest and biggest changes of the last 50 years. The increase in information flow, though, has not necessarily been matched by an increase in the ability to process that information, and to separate the proverbial "wheat from the chaff". Often the "chaff" is more compelling, and simpler to understand, so that tends to be where large sections of society tend to get their context from, which doesn't necessarily mean that society is using increased information to make better decisions.
In the post WW2 world, merely getting access to information still remained key; channels of information were extremely limited, relative to today, and much of the flows of information were state or semi-state controlled, even in the 'democratized' West. On top of that it tended to be a relatively privileged class that would have domestic access to television, radio and even newspaper channels of communication at this point. In the UK the government funded BBC had a monopoly on television until 1955 and on radio until the 1970s. In the US, likewise, TV competition was limited to 3 channels, ABC, NBC and CBS into the 1950s. Radio was somewhat more widespread, as the cost of the "wireless" diminished over time, but still relatively limited. Newspapers had been the main form of information dispersion over the previous several hundred years, so were not new, but the number of different newspapers widely available, still relatively limited.
Today access to information is virtually universal. Seeing children on mobile phones in remote parts of the developing world is testament to that, and it would be a struggle to travel to a place in the world that couldn't provide at least some access to the Internet. I can read the Times of India, The New York Times and the Sydney Morning Herald all for free sitting in front of my computer, from pretty much any location in the world, and have 3 different global perspectives on the same piece of news.
The channels of communication and information transfer can be at least as numerous as the number of people in the world, with the range of media having developed from TV, radio and newspaper into a whole variety of offshoots of the digital age, with much of this content or 'information' user generated. Blogs, like this one can be accessed from anywhere in the world by typing in an address which is about a quarter of the length of any domestic address. Wikipedia, the online encyclopedia, now has 12 million articles written collaboratively by 'volunteers' (i.e. anyone who has an internet connection), and is currently the most popular general reference work on the Internet, yet its content is only "expert" because its 'volunteers' believe it to be so. One of the best known mis-uses of Wikipedias openness happened when in 2006, a US journalist complained that his Wikipedia entry implicated him in the assassination of President Kennedy. The decision of a member of the public, Brian Chase, to insert the claim "as a joke" to fool a colleague exposed the openness that Wikipedia is based on as potentially flawed.
The most valuable commodity a media company can attract now is user focus, whereby they establish means by which their content is always at the top of the pile, and that people look at the longest or the most number of times. Internet search engines make money, by charging internet content providers to appear at the top of the list when searches are carried out through their engine. The engine itself doesn't filter on the basis of quality of content, but on the basis of the words used in the search combined with who is paying money to Google in that category. As a consequence people tend to find out answers to their searches that they want to hear, as opposed to answers that are necessarily right. By way of example, with my wife being pregnant, and neither of knowing much about what we're doing, the internet can yield completely opposite answers to the same question both of which will be generated by remote, unaccountable, self proclaimed experts. Trying to decipher what is good information and what is bad, is quite difficult - particularly in this instance where we aren't experienced.
In contrast to 50 years ago the scale of competition for information "air-time" has changed dramatically. Institutions like the BBC were set-up with an almost paternalistic outlook in mind. The content they were producing was the biggest focus, and the controllers of the Beeb were the filtration device in terms of quality that is missing from search engines today. The lack of competition meant that it was less likely that someone would channel hop in the event that they didn't like what a program was about, or when they disagreed with it's opinion. Focus was a natural given, because alternatives were limited.
I recently re-watched the film Good Night, and Good Luck, which was made by George Clooney in 2005. The film takes place in the 1950s and plots the passage of anti-Communist sentiment which US senator Joseph McCarthy uses to both stifle political debate and push his own political status forward. The film focusses on the conflict between Senator McCarthy and Edward Murrow, who is a CBS news journalist, who had become popular on US radio broadcasts during the Second World War. In Murrow's Sunday evening editorial TV show, See It Now, he defies corporate and sponsorship pressures, and discredits the tactics used by McCarthy during his crusade to root out communist elements within the government.
Murrow first defends Milo Radulovich, who was facing removal from the US Air Force because of his sisters political leanings and because his father subscribed to a Serbian newspaper. A public feud develops when McCarthy responds by accusing Murrow of being a Communist, for his defence of Radulovich. Murrow is then accused of having been a member of the leftist union "Industrial Workers of the World", which Murrow rightly rejects as false. In a growing climate of fear and reprisal, with sponsors reluctant to be involved with CBS/ Murrow, there is pressure for Murrow to be taken off air. Thankfully he wasn't and he ultimately strikes a historic blow against McCarthy.
The reason Murrow was so important to this debate at that time, was that he was looking to inform US society, that the simplified tactics of McCarthy were not in the best interests of moving the US democracy forward. McCarthy tried to simplify the world for the US voter - Communists are evil, and I am going to root out evil from our society. Murrow was given the air time, to both say that things weren't that simple and also to try and re-open political debate about the unfairness of judging a citizen guilty before trial. The fact that people were willing to pay attention to Murrow, when he was flying in the face of sentiment at the time, I would say was in large part a result of the limited scope of broadcast media at the time. There wasn't much alternative but to listen to Murrow if you were watching TV at home on a Sunday evening. In the modern broadcast age viewer attention spans have dropped, and consequently Murrows quest to broaden the minds of a 2009 audience may have produced a channel switch to "I'm a D-list Celebrity, Get Me Out of Here", or a pre-programmed recording of "Big Brother".
Paul Saffo, who is a futurologist, is pessimistic about how society will be affected by the media revolution. "Each of us can create our own personal-media walled garden that surrounds us with comforting, confirming information and utterly shuts out anything that conflicts with our world view," he says. "This is social dynamite" and could lead to "the erosion of the intellectual commons holding society together. We risk huddling into tribes defined by shared prejudices".
Likewise, Michael Moritz, the venture capitalist who became famous for spotting both Yahoo! and Google, worries about "amplification of the internet soapbox" and imagines what role user-generated media would have played in "1931 in Munich, how easy it would have been to broadcast the message; I think the Nazis would have got to power quicker". He also believes Ed Murrow's stand against McCarthyism in the US in the 1950s, would have fallen on deaf ears. In essence, the herd mentality that seems to be central to the human condition isn't reduced by the apparently secular nature of news media in the 21st century, it is increased. People find their common ground with others, albeit that those "others" may not be their neighbours, or even from the same village or city. With more than 6bn people in the world, most of whom are "connected" the chances are that you will find someone out there who is happy to reinforce your views on the world, however daft they may be.
Both the Blair government in the UK, and George W. Bush's governments in the US were often criticized for a "dumbing down" and "simplified soundbite" approaches to politics. It was a successful strategy for winning at elections, but the longer term health of both democracies have probably suffered as a consequence. Instead of being encouraged to look deeper and have informed opinions, voter apathy was often willfully encouraged in order to create a more "manageable" electorate. This enthusiasm for apathy I think has spread wider than just the political spectrum, and was probably a contributing factor in the current financial crisis, through a form of collective ignorance. Donald Rumsfeld, who was a big advocate of this sort of governance, was once quoted as saying:
"There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don't know. But there are also unknown unknowns. There are things we don't know we don't know."
At a guess I would say that the scale of unknown unknowns has grown over the past 50 years. People think they know more than they actually do, because their prejudices are reinforced by access to "comforting, confirming information" which "shuts out anything that conflicts with their world view." Many of the financial decisions that have led to the current crisis come from a form of collective ignorance that was not diminished by more available information, but actually reinforced by it.
Sunday, 18 January 2009
Sunday, 11 January 2009
Cheeseburgers - the next legal tender?
This year the total amount of sovereign debt (that is national and state governments) that needs refinancing globally is estimated to be $3 trillion. In addition to that, the sums for future years are being added to daily by fiscal stimulus packages aimed at kick-starting waning economies. Taxable revenues are falling as unemployment is increasing - this past Friday saw non-farm payrolls in the US for December fall by over half a million for the second month in succession.
Also in the past week, investors chose not to take up all the debt on offer at a German Bund auction, leaving nearly €2bn of debt unsold. Across the board the price of insuring government debt is rising: it costs more to insure against US and UK government default with a credit default swap (an insurance policy against default) than against the collapse of McDonald's, the fast-food chain. This quirky situation is one of the easiest demonstrations of how the efficient markets theory that underlies our economic policy-making can be quite daft; any country with a central bank can always service its debt by printing money, and as of yet cheeseburgers albeit good value, aren't legal tender.
To be clear, however, investors have not sated their appetite for debt backed by strong governments. The "failed auction" was partly a quirk of the German bond sale process. Rather than holding a reverse auction for debts, it fixes a price. If debt is left unsold, it will try again on another day. It was certainly not good news, but is not a reason to panic. France, Spain and Ireland all held auctions after the Germans and these passed without incident (oversubscribed in some cases) while there was strong demand for Commerzbank's German-state-backed debt. Lenders still want large quantities of safe, liquid assets.
The municipal bond market in the US has not held up quite so well, and may well be a leading indicator of where some national governments may be heading. Rising bond expenses are forcing municipalities to postpone projects, with estimates that the backlog of offerings to fund public works has grown to more than $120 billion. Examples of project postponements are a growing subject category in local newspapers across the US (and around the world). The school district in Fort Bragg, California, a town of 6,600 located 170 miles north of San Francisco on the Pacific coast, put off construction at its high school and delayed a solar-power project after shelving a $7 million bond sale when interest rates jumped following the collapse of Lehman Brothers in September.
Worryingly the state of California, which if separated from the US would still be the 5th biggest economy in the world, saw its credit rating downgraded again last month (to A-). It now has the joint lowest credit rating of all of the US states, tied for that unenviable position with Louisiana, which more than 3 years later is still recovering from the devastation that was Hurricane Katrina. California's state shortfall will reach a record $41.8 billion over the next 19 months, and the State Controller has said the state could run out of cash within weeks. Consequently they may begin delaying tax refunds, student grants and vendor payments by the start of February if lawmakers do not resolve the States fiscal problems by then. Arnold Schwarzenegger has proposed to borrow $23.3 billion via the municipal bond markets to cover immediate liabilities, but the sense is that it would be impossible for the markets to clear that quantity of debt in any short time frame at any reasonable price.
The next stop for California, should the bond markets fail them directly, is not likely to be bankruptcy. They will almost certainly be tacked onto the growing list of targets for Federal level bailouts - Barack Obama is proposing that the Federal Reserve and the US Treasury Department together design a "funding backstop" for state and municipal debt that is similar to the Fed's program for commercial paper. "This new facility should be designed to protect taxpayer resources while ensuring that state and local governments can continue to provide vital services to their residents." said Obama. As a consequence the attractive yields on existing municipal bonds traded in the market should be a compelling alternative to US Treasuries, which as investors have been globally taking flight to their relative safety have seen yields drop precipitously. Nonetheless, given that California has a problem that is not isolated, and the US municipal bond market is close to $2trillion in size, it's disturbing to think how much could be tacked onto the overall US Federal bailout package, and the overall amount that will need to be raised via the bond markets to cover these liabilities.
To restate this; the UK is the worlds 5th largest economy (with GDP in 2008 at around $2.8trillion). California, if not part of the US would be the 5th biggest economy. Although it's not a comparison of like-for-like, as California does contribute to national tax revenue in the US, it is a scary proposition that an economy the size of the UKs cannot fund itself directly, and its liabilities are going to be assumed at a national level.
The US has a financing requirement in the next 12 months of $2trillion, based on current estimates. I think that figure will realistically be higher, as they grow the number and scale of their "funding backstops" to corporations (GM/Ford etc), to agencies (Fannie Mae, Freddie Mac), and to a growing number of municipal authorities (California, New York etc.). The $3trillion funding tag for sovereign borrowers globally this year, is in my view more likely to be closer to just the US portion of the funding requirement. Globally the real number could be substantially higher.
At current yields on benchmark government bonds in the "strong" nations of the world (US, Japan, Germany, France, UK etc.) the current cost of funding available is strikingly attractive. The US 10yr Treasury is trading at a yield of well under 2.5%, 10yr UK Gilts are yielding little over 3%, and likewise 10yr German Bunds, so borrowing costs at a Federal level are perfectly affordable. Given the asset price erosion across the board - stocks, real estate, corporate bonds etc. - it is understandable that there has been a "flight to safety" into government backed assets. However, given the scale of funding that is a requirement globally over the coming years, there must be a saturation point for investors. The ever growing list of liabilities being assumed by these governments will need to be accounted for in terms of either much higher yields or a complete unwillingness or even inability to invest.
In the Eurozone, there are similar situations where at a Federal level (i.e. from Brussels) there may be calls for bailouts of some of the peripheral, and even not-so-peripheral states. Already Italy and Greece, who were largely scale funders through the international bond markets are struggling to tap the markets at either reasonable rates, or at all. They may find that the value of their EU membership is greater than was previously thought if the likes of Germany, France and the UK play the role of providing similar "funding backstops" to those being proposed in the US. Perhaps more worrying about the European situation is that Italy and Greece, unlike California don't seem to be producing companies like Silicon Valley can in California, the Apples of the world; so tax revenues that would be used to pay off future liabilities will not be as forthcoming. For example the protracted process of privatising Alitalia will cost the Italian taxpayer more than Euros 3bn in written-off debt. The number of layoffs across the country in December was up 528% on last year, with the central provinces of Lazio and Abruzzo the worst affected; everything from steel to textiles is showing signs of weakness. In Greece, recent riots and proposed union strikes are commensurate with exponential rises in government bond yields. Greece has to rollover debt in 2009 that is greater than 20% of 2008 GDP, and the credit insurance market is pricing in a default probability of close to 20% over the next 5 years. It's highly questionable as to whether they can do this, without some explicit guarantees from their EU brethren.
As much as this is all very gloomy, the big issue I am looking to understand is why the yield on government bonds in "strong" countries is continuing to lower itself when the liabilities side of their collective balance sheets is growing and worsening at a pace of knots. In December the yield on 3 month Treasury Bills (i.e. short term US govt. debt) actually dipped below 0%, meaning that investors were actually willfully losing money to invest, but doing so on the basis that the speed of their loss would be slower than on any other store of value they could think of. In the future I would say that there is a great likelihood that as these same governments tried to stave off deflation, they will look at policy actions that could be hyper-inflationary further down the road. If government debts become so large, one easy way to reduce their cost is to pay bond investors with money the government has printed. In some cases this may be the only policy action that is left available to avoid default.
The fact that yields on government debt in "strong" countries are so low, is a consequence of how bad the world investment community views alternative asset classes. A taxi driver once said to my Dad as he jumped in a taxi to head to the airport in Las Vegas,
"How did you do?"
...to which Dad said: "O, I'm not really a gambler"
and the taxidriver said:
"Yep, I hear you. The best you can do is to lose slowly"
That seems to be the manner of thinking of those jumping headfirst into the apparent safety of the worlds government bond markets. But even the non-gamblers may be wrong.
Also in the past week, investors chose not to take up all the debt on offer at a German Bund auction, leaving nearly €2bn of debt unsold. Across the board the price of insuring government debt is rising: it costs more to insure against US and UK government default with a credit default swap (an insurance policy against default) than against the collapse of McDonald's, the fast-food chain. This quirky situation is one of the easiest demonstrations of how the efficient markets theory that underlies our economic policy-making can be quite daft; any country with a central bank can always service its debt by printing money, and as of yet cheeseburgers albeit good value, aren't legal tender.
To be clear, however, investors have not sated their appetite for debt backed by strong governments. The "failed auction" was partly a quirk of the German bond sale process. Rather than holding a reverse auction for debts, it fixes a price. If debt is left unsold, it will try again on another day. It was certainly not good news, but is not a reason to panic. France, Spain and Ireland all held auctions after the Germans and these passed without incident (oversubscribed in some cases) while there was strong demand for Commerzbank's German-state-backed debt. Lenders still want large quantities of safe, liquid assets.
The municipal bond market in the US has not held up quite so well, and may well be a leading indicator of where some national governments may be heading. Rising bond expenses are forcing municipalities to postpone projects, with estimates that the backlog of offerings to fund public works has grown to more than $120 billion. Examples of project postponements are a growing subject category in local newspapers across the US (and around the world). The school district in Fort Bragg, California, a town of 6,600 located 170 miles north of San Francisco on the Pacific coast, put off construction at its high school and delayed a solar-power project after shelving a $7 million bond sale when interest rates jumped following the collapse of Lehman Brothers in September.
Worryingly the state of California, which if separated from the US would still be the 5th biggest economy in the world, saw its credit rating downgraded again last month (to A-). It now has the joint lowest credit rating of all of the US states, tied for that unenviable position with Louisiana, which more than 3 years later is still recovering from the devastation that was Hurricane Katrina. California's state shortfall will reach a record $41.8 billion over the next 19 months, and the State Controller has said the state could run out of cash within weeks. Consequently they may begin delaying tax refunds, student grants and vendor payments by the start of February if lawmakers do not resolve the States fiscal problems by then. Arnold Schwarzenegger has proposed to borrow $23.3 billion via the municipal bond markets to cover immediate liabilities, but the sense is that it would be impossible for the markets to clear that quantity of debt in any short time frame at any reasonable price.
The next stop for California, should the bond markets fail them directly, is not likely to be bankruptcy. They will almost certainly be tacked onto the growing list of targets for Federal level bailouts - Barack Obama is proposing that the Federal Reserve and the US Treasury Department together design a "funding backstop" for state and municipal debt that is similar to the Fed's program for commercial paper. "This new facility should be designed to protect taxpayer resources while ensuring that state and local governments can continue to provide vital services to their residents." said Obama. As a consequence the attractive yields on existing municipal bonds traded in the market should be a compelling alternative to US Treasuries, which as investors have been globally taking flight to their relative safety have seen yields drop precipitously. Nonetheless, given that California has a problem that is not isolated, and the US municipal bond market is close to $2trillion in size, it's disturbing to think how much could be tacked onto the overall US Federal bailout package, and the overall amount that will need to be raised via the bond markets to cover these liabilities.
To restate this; the UK is the worlds 5th largest economy (with GDP in 2008 at around $2.8trillion). California, if not part of the US would be the 5th biggest economy. Although it's not a comparison of like-for-like, as California does contribute to national tax revenue in the US, it is a scary proposition that an economy the size of the UKs cannot fund itself directly, and its liabilities are going to be assumed at a national level.
The US has a financing requirement in the next 12 months of $2trillion, based on current estimates. I think that figure will realistically be higher, as they grow the number and scale of their "funding backstops" to corporations (GM/Ford etc), to agencies (Fannie Mae, Freddie Mac), and to a growing number of municipal authorities (California, New York etc.). The $3trillion funding tag for sovereign borrowers globally this year, is in my view more likely to be closer to just the US portion of the funding requirement. Globally the real number could be substantially higher.
At current yields on benchmark government bonds in the "strong" nations of the world (US, Japan, Germany, France, UK etc.) the current cost of funding available is strikingly attractive. The US 10yr Treasury is trading at a yield of well under 2.5%, 10yr UK Gilts are yielding little over 3%, and likewise 10yr German Bunds, so borrowing costs at a Federal level are perfectly affordable. Given the asset price erosion across the board - stocks, real estate, corporate bonds etc. - it is understandable that there has been a "flight to safety" into government backed assets. However, given the scale of funding that is a requirement globally over the coming years, there must be a saturation point for investors. The ever growing list of liabilities being assumed by these governments will need to be accounted for in terms of either much higher yields or a complete unwillingness or even inability to invest.
In the Eurozone, there are similar situations where at a Federal level (i.e. from Brussels) there may be calls for bailouts of some of the peripheral, and even not-so-peripheral states. Already Italy and Greece, who were largely scale funders through the international bond markets are struggling to tap the markets at either reasonable rates, or at all. They may find that the value of their EU membership is greater than was previously thought if the likes of Germany, France and the UK play the role of providing similar "funding backstops" to those being proposed in the US. Perhaps more worrying about the European situation is that Italy and Greece, unlike California don't seem to be producing companies like Silicon Valley can in California, the Apples of the world; so tax revenues that would be used to pay off future liabilities will not be as forthcoming. For example the protracted process of privatising Alitalia will cost the Italian taxpayer more than Euros 3bn in written-off debt. The number of layoffs across the country in December was up 528% on last year, with the central provinces of Lazio and Abruzzo the worst affected; everything from steel to textiles is showing signs of weakness. In Greece, recent riots and proposed union strikes are commensurate with exponential rises in government bond yields. Greece has to rollover debt in 2009 that is greater than 20% of 2008 GDP, and the credit insurance market is pricing in a default probability of close to 20% over the next 5 years. It's highly questionable as to whether they can do this, without some explicit guarantees from their EU brethren.
As much as this is all very gloomy, the big issue I am looking to understand is why the yield on government bonds in "strong" countries is continuing to lower itself when the liabilities side of their collective balance sheets is growing and worsening at a pace of knots. In December the yield on 3 month Treasury Bills (i.e. short term US govt. debt) actually dipped below 0%, meaning that investors were actually willfully losing money to invest, but doing so on the basis that the speed of their loss would be slower than on any other store of value they could think of. In the future I would say that there is a great likelihood that as these same governments tried to stave off deflation, they will look at policy actions that could be hyper-inflationary further down the road. If government debts become so large, one easy way to reduce their cost is to pay bond investors with money the government has printed. In some cases this may be the only policy action that is left available to avoid default.
The fact that yields on government debt in "strong" countries are so low, is a consequence of how bad the world investment community views alternative asset classes. A taxi driver once said to my Dad as he jumped in a taxi to head to the airport in Las Vegas,
"How did you do?"
...to which Dad said: "O, I'm not really a gambler"
and the taxidriver said:
"Yep, I hear you. The best you can do is to lose slowly"
That seems to be the manner of thinking of those jumping headfirst into the apparent safety of the worlds government bond markets. But even the non-gamblers may be wrong.
Sunday, 4 January 2009
Why the Swedish are to blame for the credit crunch
The explanations for the current financial situation are wide ranging, but none so far seemed to have blamed the Swedish. So here goes.
Up until the formation of the Swedish Riksbank in 1656 the concept of what now is called "fractional reserve banking" didn't really exist. Most banking that had taken place up until that point was done where any loans were matched 1-for-1 against a metallic reserve (gold, silver etc.) whose price was typically pretty constant or fixed. The Spanish Conquistadors for example had pillaged and looted their way through the Inca Empire in the 16th century because precious metal was the only way in their minds to expand economically. The Spanish monarchy were the main beneficiaries of the conquests, but the way the gold and silver "money" was spent provided the entire continent with a stimulus. Precious metal had become the store of value, and the Spanish "pieces of eight" coins were the world's first reserve currency. As such, it allowed the Spanish to finance its empire building, it's wars in Europe and it's trade flows between Europe and Asia. Nevertheless, as an empire they were still limited by the amount of precious metal they could plunder; in modern banking terminology - the "money supply" could only grow as fast as they could plunder gold and silver.
The Swedish Riksbank a century or so later had figured that they could overcome this issue. They realised that they didn't really need gold or silver as "collateral" to match 100% against any deposits they had. They could profitably lend money that had been left on deposit, and since it was highly unlikely that depositors would ask for their deposits back en masse, only a fraction of the deposits would need to be left on reserve at any one time. This was the first large scale attempt of any bank to introduce the concept of credit creation.
Other banks followed over time, but even by the late 18th century many banks were still yet to transition to fractional reserving that made the Riksbank successful. By way of example, the Amsterdam Exchange Bank by 1760 still had close to a 100% ratio between its deposits and reserves of precious metal. In that year they had deposits of 19 million florins versus metallic reserves of 16 million. Any modern bank would call this ludicrous inefficiency, as they were missing out on a large quantum of lending and earning opportunities, but as is oft ignored, commensurately more liquidity risk (the risk that all of the depositors come looking for their funds at once - a bank "run"). Say for example that the Riksbank operated a 10% reserve policy, and received a deposit of 100 from the central bank. They would place 10 on reserve with the central bank, and lend on 90 to the Volksbank. The Volksbank also operated a 10% reserve ratio so they reserved 9 and lent out 81 to the Peoples Bank. After 3 rounds of lending the money supply has reached 271.
Two of the core definitions of modern monetary theory are covered above. M0 (known as the monetary base), is equal to the total liabilities of the central bank, that is, cash plus the reserves of private sector banks on deposit at the central bank, and M1(known as narrow money) which is equal to cash in circulation plus deposits at private sector banks. Prior to the Riksbanks move into the unchartered territory of fractional reserve banking, the difference between M0 and M1 would have been almost nil. In the example above, M0 is 100 and M1 is 271.
The point here is that with the spread through the Western world of fractional reserve banking the very nature of money changed in a profoundly important way. Now money represented the sum total of specific liabilities (deposits and reserves) incurred by banks. The newly established concept of credit, was quite simply the total of banks' loans. Some of this money might still consist of precious metal, though a rising proportion of that would be held in the central bank's vault (no longer in the UKs case, as Gordon Brown sold most of the UKs gold a few years ago at a terrible price versus where the market is today), but most of it would be made up of those banknotes and coins that made up legal tender along with the invisible money that existed only in deposit account records.
Was this progress? In many senses, of course this was progress. Credit creation has been essential in the process of capital formation, which drives entrepreneurship, creates jobs, and has been responsible for pulling literally billions of people out of poverty the world over. Good risk taking achieves the positive aspects to credit creation outlined above. Bad risk taking on the other hand will make it more likely the borrowers will go bankrupt, and consequently that a bank cannot make new loans, or that depositors will worry that there isn't enough in the kitty to pay them back, and might induce a bank run. In the US in 2007 98% of bankruptcy filings were classified as "non-business" (i.e. personal/ consumer debt). The principal driver of bankruptcy therefore was not failed attempts at entrepreneurship but personal indebtedness, not backed by corporate endeavour, but by hope. In 2007 US consumer debt hit $2.5trillion. In 1959 average mortgage debt was 54% of personal income and by 2007 it was 140%. That is not necessarily a bad thing, but it just makes any liquidity shocks that much more painful.
In the 1946 film It's a Wonderful Life, which has become Christmas-time staple viewing, we are led to feel a great deal of sympathy for the plight of George Bailey (Jimmy Stewart) as he tries to sustain the Building & Loan Association that he has taken over from his dead father. The loans made to the local working class are critical to the local economy, whom the Baileys treat with a greater respect and dignity than their competition. The film is set from 1928 onwards, so the fractional reserve system is universal at this point. At various points through the story-line, George Bailey is close to seeing his bank collapse, firstly through a bank run and secondly through a sizeable misplaced deposit, which I'm sure the Daily Mail wouldn't have been too sympathetic towards. In the end he is saved from committing suicide by Clarence, his guardian angel, as God thinks that George essentially is a good man with the right attitude towards people and life. The blasphemous alternative take on George Bailey's situation is that he was undercapitalised and too careless to operate under the fractional reserve system, though it would spoil what is such a magical film.
Since the Swedes embarked on their revolutionary banking model in 1656 the inescapable reality seems to be that breaking the link between money creation and a precious metal anchor has led to an unprecedented monetary expansion - with a credit boom the likes of which the world has never seen. The pace of the expansion has increased exponentially in the past 20 years, with technological innovations that have made global markets instantaneously accessible. At the same time the capital reserves (or "adequacy") of banks in the developed world has been steadily declining. In Europe bank capital is now equivalent to less than 10% of assets, compared with around 25% at the beginning of the twentieth century. Today banking assets (loans + deposits) in the world's major economies are equivalent to around 150% of those countries combined GDP. This figure doesn't take into consideration "the shadow banking system", whereby many banks assets aren't recorded on balance sheet, but they may become liabilities at some distressed point (like now) in the future. According to the Bank for International Settlements, total international banking assets (loans + deposits) were equivalent to around $30 trillion, which is roughly 63% of world GDP. $30 trillion was also the total value "credit crunched" off world stock markets this year. And all of this is the fault of the ambitious Swedish, circa 1656. Well at the very least that gives us someone to add to the list of who's to blame.
Up until the formation of the Swedish Riksbank in 1656 the concept of what now is called "fractional reserve banking" didn't really exist. Most banking that had taken place up until that point was done where any loans were matched 1-for-1 against a metallic reserve (gold, silver etc.) whose price was typically pretty constant or fixed. The Spanish Conquistadors for example had pillaged and looted their way through the Inca Empire in the 16th century because precious metal was the only way in their minds to expand economically. The Spanish monarchy were the main beneficiaries of the conquests, but the way the gold and silver "money" was spent provided the entire continent with a stimulus. Precious metal had become the store of value, and the Spanish "pieces of eight" coins were the world's first reserve currency. As such, it allowed the Spanish to finance its empire building, it's wars in Europe and it's trade flows between Europe and Asia. Nevertheless, as an empire they were still limited by the amount of precious metal they could plunder; in modern banking terminology - the "money supply" could only grow as fast as they could plunder gold and silver.
The Swedish Riksbank a century or so later had figured that they could overcome this issue. They realised that they didn't really need gold or silver as "collateral" to match 100% against any deposits they had. They could profitably lend money that had been left on deposit, and since it was highly unlikely that depositors would ask for their deposits back en masse, only a fraction of the deposits would need to be left on reserve at any one time. This was the first large scale attempt of any bank to introduce the concept of credit creation.
Other banks followed over time, but even by the late 18th century many banks were still yet to transition to fractional reserving that made the Riksbank successful. By way of example, the Amsterdam Exchange Bank by 1760 still had close to a 100% ratio between its deposits and reserves of precious metal. In that year they had deposits of 19 million florins versus metallic reserves of 16 million. Any modern bank would call this ludicrous inefficiency, as they were missing out on a large quantum of lending and earning opportunities, but as is oft ignored, commensurately more liquidity risk (the risk that all of the depositors come looking for their funds at once - a bank "run"). Say for example that the Riksbank operated a 10% reserve policy, and received a deposit of 100 from the central bank. They would place 10 on reserve with the central bank, and lend on 90 to the Volksbank. The Volksbank also operated a 10% reserve ratio so they reserved 9 and lent out 81 to the Peoples Bank. After 3 rounds of lending the money supply has reached 271.
Two of the core definitions of modern monetary theory are covered above. M0 (known as the monetary base), is equal to the total liabilities of the central bank, that is, cash plus the reserves of private sector banks on deposit at the central bank, and M1(known as narrow money) which is equal to cash in circulation plus deposits at private sector banks. Prior to the Riksbanks move into the unchartered territory of fractional reserve banking, the difference between M0 and M1 would have been almost nil. In the example above, M0 is 100 and M1 is 271.
The point here is that with the spread through the Western world of fractional reserve banking the very nature of money changed in a profoundly important way. Now money represented the sum total of specific liabilities (deposits and reserves) incurred by banks. The newly established concept of credit, was quite simply the total of banks' loans. Some of this money might still consist of precious metal, though a rising proportion of that would be held in the central bank's vault (no longer in the UKs case, as Gordon Brown sold most of the UKs gold a few years ago at a terrible price versus where the market is today), but most of it would be made up of those banknotes and coins that made up legal tender along with the invisible money that existed only in deposit account records.
Was this progress? In many senses, of course this was progress. Credit creation has been essential in the process of capital formation, which drives entrepreneurship, creates jobs, and has been responsible for pulling literally billions of people out of poverty the world over. Good risk taking achieves the positive aspects to credit creation outlined above. Bad risk taking on the other hand will make it more likely the borrowers will go bankrupt, and consequently that a bank cannot make new loans, or that depositors will worry that there isn't enough in the kitty to pay them back, and might induce a bank run. In the US in 2007 98% of bankruptcy filings were classified as "non-business" (i.e. personal/ consumer debt). The principal driver of bankruptcy therefore was not failed attempts at entrepreneurship but personal indebtedness, not backed by corporate endeavour, but by hope. In 2007 US consumer debt hit $2.5trillion. In 1959 average mortgage debt was 54% of personal income and by 2007 it was 140%. That is not necessarily a bad thing, but it just makes any liquidity shocks that much more painful.
In the 1946 film It's a Wonderful Life, which has become Christmas-time staple viewing, we are led to feel a great deal of sympathy for the plight of George Bailey (Jimmy Stewart) as he tries to sustain the Building & Loan Association that he has taken over from his dead father. The loans made to the local working class are critical to the local economy, whom the Baileys treat with a greater respect and dignity than their competition. The film is set from 1928 onwards, so the fractional reserve system is universal at this point. At various points through the story-line, George Bailey is close to seeing his bank collapse, firstly through a bank run and secondly through a sizeable misplaced deposit, which I'm sure the Daily Mail wouldn't have been too sympathetic towards. In the end he is saved from committing suicide by Clarence, his guardian angel, as God thinks that George essentially is a good man with the right attitude towards people and life. The blasphemous alternative take on George Bailey's situation is that he was undercapitalised and too careless to operate under the fractional reserve system, though it would spoil what is such a magical film.
Since the Swedes embarked on their revolutionary banking model in 1656 the inescapable reality seems to be that breaking the link between money creation and a precious metal anchor has led to an unprecedented monetary expansion - with a credit boom the likes of which the world has never seen. The pace of the expansion has increased exponentially in the past 20 years, with technological innovations that have made global markets instantaneously accessible. At the same time the capital reserves (or "adequacy") of banks in the developed world has been steadily declining. In Europe bank capital is now equivalent to less than 10% of assets, compared with around 25% at the beginning of the twentieth century. Today banking assets (loans + deposits) in the world's major economies are equivalent to around 150% of those countries combined GDP. This figure doesn't take into consideration "the shadow banking system", whereby many banks assets aren't recorded on balance sheet, but they may become liabilities at some distressed point (like now) in the future. According to the Bank for International Settlements, total international banking assets (loans + deposits) were equivalent to around $30 trillion, which is roughly 63% of world GDP. $30 trillion was also the total value "credit crunched" off world stock markets this year. And all of this is the fault of the ambitious Swedish, circa 1656. Well at the very least that gives us someone to add to the list of who's to blame.
Monday, 29 December 2008
Job Posting: Well paid opportunity for real business people
The past year has been tough for small businesses, particularly in the UK. The dramatic fall in the value of sterling, the increased cost of borrowing and the reluctance of banks to lend to SMEs (small and medium sized enterprises) have all hit firms hard. There are three million family-run businesses in the UK, employing 9.5million people and contributing to more than 30 per cent of GDP and with many facing a white knuckle ride into 2009 there has been an understandable focus on how to ensure the survival of this part of the economy. If unemployment is to be kept to somewhat manageable levels next year this is seen as a key area to target. Small businesses cannot protect themselves from clients, suppliers and bankers in the same way that big companies can, so the speed with which they can run into difficulties when sailing through the current storm is very much heightened.
The British Chambers of Commerce has warned that many small firms will struggle to survive in the coming months, with access to finance and cash flow likely to be major issues. BCC Policy Adviser Steve Hughes says: 'The Government's stimulus failed to help smaller businesses. Many will be forced to lay off staff and in some cases businesses will go to the wall. We must do all we can to help small firms survive, not only because they will get us out of this downturn but because the businesses we lose will never return". One certain opportunity that will come as a consequence is that anyone who is good at running real business is going to become a valuable commodity. If you can manage your way through this and keep people employed the government is likely to be very much "on your side".
Private equity companies, I believe, have a great opportunity in this area. They will quickly need to transfer their focus away from the financial engineering approach of the past five years to a focus on sales growth and productivity gains; i.e. doing something "real". The true secret of private equity performance in the past five years was recapitalisations and pass the parcel secondary buyouts which led to ever more leveraged companies, and unbelievable returns during the good times. Now that the world has turned, there has to be real value added - which is much harder work. Nonetheless, given the likely purchase prices that will be available for the next rounds of private equity deals, the opportunity for those willing to do the hard yards is potentially very high. Many of these opportunities will come as over-levered companies fall by the way side, and government will be keen to help if part of the focus is on keeping people employed.
In the last few weeks and months, a raft of well known high street retailers in the UK have been taken into administration, Woolworths, Zavvi, Adams Kids and Whittards to name a few. Many more will undoubtedly follow early in the New Year after they tally up the numbers for what must have been extremely difficult trading times over the all important Christmas period. 30-50% discounts were not hard to find, even early on in the season, and the impact on the margins of these retailers will become clear soon enough. The ability of government to look at more bail-out type packages to support those who are next to fall off the cliff has got to be increasingly limited. Other non-financial solutions are being desperately looked at, in order for it to be as easy as possible for companies that are big employers to remain in business and keep paying wages.
Many of the companies that will fail, will do so because their balance sheet leverage increased over the past 10 years and as a consequence their sensitivity to margin erosion is acute. This tale is applicable to many more high street names - Boots, MFI, Countrywide, Hilton, Gala Coral, EMI for example. As these leveraged companies come to refinance their original loans (taken in the good times at low interest rates), banks will either choose not to refinance at all, or will do so at incredibly penal credit costs. 2009 will see plenty of covenant breaches on the loans that backed these highly levered deals, which will lead to banks embarking on restructuring programs that will see existing private equity investors diluted out of sight. At this point in time most of the debt that exists from the LBOs mentioned above trades in the market at yields that reflect that the private equity holders investments are worthless, and that these companies are technically insolvent. The insolvency expert Begbies Traynor has predicted that at least 15 national retail chains will go bust in the UK by mid January.
That is where we are heading, but the above commentary can be read in any newspaper so is not particularly revelationary. What is more compelling, and optimistic is that out of all this, there will be some really great opportunities for real business people to pick up the pieces. And these pieces will likely come at very low cost.
A private equity company (that one of the readers of this blog works for), was responsible for purchasing Whittards (the speciality tea and coffee maker) out of pre-packaged administration in the last couple of weeks. Whittards employs 950 people in 130 different stores across the UK. It generated close to £50mm worth of revenues last year, having been purchased by the now beleaguered Icelandic retail group, Baugur, for over £20mm 3 years ago. The sale price out of the "pre-packaged" administration process this time was believed to be less than £1mm. Presumably given Baugurs troubles, they were forced sellers as they would not have had the money to have put into the business at this point in time to get it back on track. I don't know the ins-and-outs of whether Whittards can be turned into a viable business, but if it can then the upside to the investors on their small purchase price could be huge. They are in effect buying a cheap call-option; not quite free, but close.
There will be plenty of opportunities of this nature that start to rise up from the ashes in 2009. I would suspect that there will be other non-private equity participants looking to enter the fray; consultancy firms who earn fees for fixing ailing business should probably look into this area. They have the right people in place to oversee the real business change that will lead ailing companies back onto the right track - so why not see the upside through ownership? I expect to see more fund raising taking place of this nature. Pre-packaged bankruptcies, where obligations to past creditors are close to nil, could well be the territory where the seeds for a broader economic recovery are grown. Governments will certainly be on the side of anyone who is willing to try to keep people employed in the process, especially if they don't have to spend any more taxpayers money. What is for sure is that there certainly won't be much sympathy for creditor complaints that have arisen out of the excesses of the past.
The British Chambers of Commerce has warned that many small firms will struggle to survive in the coming months, with access to finance and cash flow likely to be major issues. BCC Policy Adviser Steve Hughes says: 'The Government's stimulus failed to help smaller businesses. Many will be forced to lay off staff and in some cases businesses will go to the wall. We must do all we can to help small firms survive, not only because they will get us out of this downturn but because the businesses we lose will never return". One certain opportunity that will come as a consequence is that anyone who is good at running real business is going to become a valuable commodity. If you can manage your way through this and keep people employed the government is likely to be very much "on your side".
Private equity companies, I believe, have a great opportunity in this area. They will quickly need to transfer their focus away from the financial engineering approach of the past five years to a focus on sales growth and productivity gains; i.e. doing something "real". The true secret of private equity performance in the past five years was recapitalisations and pass the parcel secondary buyouts which led to ever more leveraged companies, and unbelievable returns during the good times. Now that the world has turned, there has to be real value added - which is much harder work. Nonetheless, given the likely purchase prices that will be available for the next rounds of private equity deals, the opportunity for those willing to do the hard yards is potentially very high. Many of these opportunities will come as over-levered companies fall by the way side, and government will be keen to help if part of the focus is on keeping people employed.
In the last few weeks and months, a raft of well known high street retailers in the UK have been taken into administration, Woolworths, Zavvi, Adams Kids and Whittards to name a few. Many more will undoubtedly follow early in the New Year after they tally up the numbers for what must have been extremely difficult trading times over the all important Christmas period. 30-50% discounts were not hard to find, even early on in the season, and the impact on the margins of these retailers will become clear soon enough. The ability of government to look at more bail-out type packages to support those who are next to fall off the cliff has got to be increasingly limited. Other non-financial solutions are being desperately looked at, in order for it to be as easy as possible for companies that are big employers to remain in business and keep paying wages.
Many of the companies that will fail, will do so because their balance sheet leverage increased over the past 10 years and as a consequence their sensitivity to margin erosion is acute. This tale is applicable to many more high street names - Boots, MFI, Countrywide, Hilton, Gala Coral, EMI for example. As these leveraged companies come to refinance their original loans (taken in the good times at low interest rates), banks will either choose not to refinance at all, or will do so at incredibly penal credit costs. 2009 will see plenty of covenant breaches on the loans that backed these highly levered deals, which will lead to banks embarking on restructuring programs that will see existing private equity investors diluted out of sight. At this point in time most of the debt that exists from the LBOs mentioned above trades in the market at yields that reflect that the private equity holders investments are worthless, and that these companies are technically insolvent. The insolvency expert Begbies Traynor has predicted that at least 15 national retail chains will go bust in the UK by mid January.
That is where we are heading, but the above commentary can be read in any newspaper so is not particularly revelationary. What is more compelling, and optimistic is that out of all this, there will be some really great opportunities for real business people to pick up the pieces. And these pieces will likely come at very low cost.
A private equity company (that one of the readers of this blog works for), was responsible for purchasing Whittards (the speciality tea and coffee maker) out of pre-packaged administration in the last couple of weeks. Whittards employs 950 people in 130 different stores across the UK. It generated close to £50mm worth of revenues last year, having been purchased by the now beleaguered Icelandic retail group, Baugur, for over £20mm 3 years ago. The sale price out of the "pre-packaged" administration process this time was believed to be less than £1mm. Presumably given Baugurs troubles, they were forced sellers as they would not have had the money to have put into the business at this point in time to get it back on track. I don't know the ins-and-outs of whether Whittards can be turned into a viable business, but if it can then the upside to the investors on their small purchase price could be huge. They are in effect buying a cheap call-option; not quite free, but close.
There will be plenty of opportunities of this nature that start to rise up from the ashes in 2009. I would suspect that there will be other non-private equity participants looking to enter the fray; consultancy firms who earn fees for fixing ailing business should probably look into this area. They have the right people in place to oversee the real business change that will lead ailing companies back onto the right track - so why not see the upside through ownership? I expect to see more fund raising taking place of this nature. Pre-packaged bankruptcies, where obligations to past creditors are close to nil, could well be the territory where the seeds for a broader economic recovery are grown. Governments will certainly be on the side of anyone who is willing to try to keep people employed in the process, especially if they don't have to spend any more taxpayers money. What is for sure is that there certainly won't be much sympathy for creditor complaints that have arisen out of the excesses of the past.
Monday, 22 December 2008
Status Anxiety
"Were an alien to pick up our news channels, it would conclude that human civilisation depended on the production of cheap plastic tat." This would be the outsiders view of our existence according to Tim Harford, in his book "The Logic of Life". For my money, he probably goes a bit far in discrediting our ability to produce useful things, but the importance of the consumer to economic growth during the last 25 years, particularly in the UK and the US, has been very clear.
In a simplified story-line, China has been the global producer of last resort, and the US has been the consumer of last resort. This plentiful arrangement had worked quite nicely for both parties up until recently. China funded a decent chunk of the credit that US consumers fed-on, and in return the US purchased the "tat" and not-so-tat stuff that was made in China, creating jobs, prosperity and a very large current account surplus in China. This surplus was then recycled into more US government and consumer debt, and more "tat" was bought to fill the houses that were rising in value so nicely in places like California and Florida. Then a wheel fell off the wagon.
Now, attempts to fix the broken wagon have almost been fully exhausted; the Federal Reserve has reduced interest rates to 0% and we have been through a variety of various asset purchase plans and bail-out plans. The only remaining tool left in the bag is to start printing money - which didn't work quite so well for the Weimar Republic in Germany in the early 1930s. Hyperinflation, and the Nazi party followed in short order.
Within the US and the UK, the solutions being proposed to "get things back on track" seem to be aimed at recreating a more sustainable version of the spend, borrow, work philosophy that successfully drove up economic growth over the past quarter of a century, and that also led to the current implosion. After the initial stage of the overall crisis, which started as a banking crisis, we have gone through several stages of thinking within what is termed the "real economy", that have led us in a downward spiral:
1) Pessimism. Fueled by news commentary on the plight of the financial system, which led to:
2) Lower planned spending;
3) More pessimism from banks, because of this lower planned spending. As a consequence, banks started to lend less;
4) Lower spending because of less consumer credit;
5) Lower earnings for companies because we are buying less of their stuff;
6) Less credit available to companies because their earnings are falling;
7) Companies can't get credit, so lower inventories/ stock or companies can't refinance debts so they either sell assets or default;
8) Banks need to lend less because the are taking writedowns against past loans to these failing companies;
9) Layoffs/ recession etc. etc.
It looks like in the short-run, there is a serious dependence on consumption to keep this legal "Madoff" scheme going ("Ponzi" is so last year). In the run up to Christmas, which the British theologian Don Cupitt referred to as "the Disneyfication of Christianity", we are reminded on news channels of how absolutely critical it is for our shopkeepers lives that we get out and spend this year.
In the longer term, perhaps there are more choices, and we could go about things in a different way. A completely counterintuitive approach might be that we collectively accept a lower average income and take more leisure time, doing things that don't involve consumer spending. It's interesting to note that the typical British man earns roughly twice what his father did at the same age, on an inflation adjusted basis. When today's children are in their forties and fifties, perhaps they will opt to use their increased prosperity to work less and take more leisure time. Instead of being twice as rich as their parents, they may opt to start their weekend on Wednesday afternoon. In theory this would be possible, as we are rich enough already. A survey done 10 years ago by a couple of US economists (Solnick and Hemenway) found that many Harvard students would rather have an income of $50,000 in a world where most people were poorer than an income of $100,000 in a world where most people were richer. Perhaps that survey says something about those Harvard graduates, but the point is played out across society. There is no rational economic logic to this behaviour.
To continue the theme of Harford's "The Logic of Life", he identifies this sort of behaviour with what he calls "status anxiety". The desire that "status anxiety" produces is almost insatiable because it is largely relative - the better someone else is doing, then the better you need to be doing. Perhaps in China, the opposite happens to what happens in the US; status comes not from having a yacht, but from having produced the most stuff and having saved the most. It is what George Soros would call a reflexive process; i.e. it is a self-reinforcing process, and becomes the bias of a society or culture. Neither route is necessarily right.
On a personal level, I would like to retain the choice to work longer, for more ability to consume or to work less for more free time, and to take the trade off decision at a personal level.
One worry is that the current response to the excesses of past consumerism, might make this trade off more difficult for us all. Current government bail-outs that are aimed at reinvigorating our consumer orientated economies will in effect be placing the motherload of a credit card bill onto future generations, which may limit those choices. Taxes will need to go up at some point in the future.
The erosion of tax revenues will only be made up by longer working lives, or more successful, innovative companies. If there is a collective move away from 'consumerism', towards working less and taking more leisure time we will see plenty of defaulting governments in 15-20 years time as the burden of today's debts are unmet by the desire of the next generation to sustain the approach our generation so eagerly lapped up.
As many people around the world are facing up to their relatively tough economic situations, there is evidence that a significant number are looking to reconsider their work/life balance - either through their own choosing, or through an enforced situation...i.e. they have been laid off. For many in this camp, the lucky ones who were closely involved in the gold-rush of the last 25 years, or those who've worked long enough to have achieved the standard of living their parents had at a considerably earlier age, there are real choices.
The flexibility to opt for a simpler more frugal existence is there for the taking, albeit that many people would say this is too difficult a change to contemplate; private school fees, 2 cars, golf club membership can't be given up. The alternatives are substantial; perhaps working in the 'day job' from monday to wednesday afternoon (by which time you will be at your parents income level) and then spending thursday and friday working on charity projects, sporting endeavours, or whatever else flicks our collective switches.
The burden of financial responsibility for the problems that the work, spend, borrow philosophy advocated over the past 25 years, is being shifted onto the next generation, who will not have been the beneficiaries of the 'good times', but will be picking up the tab. Is it fair, given that they may want to move down the route towards a more holistic lifestyle, that they should be burdened with an even greater responsibility for tax revenue generation than ever before?
It's a difficult time to be making policy decisions, but the law of unintended consequences may mean that widespread economic bailouts just reinforce the behaviour patterns that got us into this mess. As difficult as it is to swallow for many people and many businesses, it is important that sufficient pain is felt by the system in the short-to-medium term so that we are really forced to consider what approach we choose to collectively take for the long term.
In a simplified story-line, China has been the global producer of last resort, and the US has been the consumer of last resort. This plentiful arrangement had worked quite nicely for both parties up until recently. China funded a decent chunk of the credit that US consumers fed-on, and in return the US purchased the "tat" and not-so-tat stuff that was made in China, creating jobs, prosperity and a very large current account surplus in China. This surplus was then recycled into more US government and consumer debt, and more "tat" was bought to fill the houses that were rising in value so nicely in places like California and Florida. Then a wheel fell off the wagon.
Now, attempts to fix the broken wagon have almost been fully exhausted; the Federal Reserve has reduced interest rates to 0% and we have been through a variety of various asset purchase plans and bail-out plans. The only remaining tool left in the bag is to start printing money - which didn't work quite so well for the Weimar Republic in Germany in the early 1930s. Hyperinflation, and the Nazi party followed in short order.
Within the US and the UK, the solutions being proposed to "get things back on track" seem to be aimed at recreating a more sustainable version of the spend, borrow, work philosophy that successfully drove up economic growth over the past quarter of a century, and that also led to the current implosion. After the initial stage of the overall crisis, which started as a banking crisis, we have gone through several stages of thinking within what is termed the "real economy", that have led us in a downward spiral:
1) Pessimism. Fueled by news commentary on the plight of the financial system, which led to:
2) Lower planned spending;
3) More pessimism from banks, because of this lower planned spending. As a consequence, banks started to lend less;
4) Lower spending because of less consumer credit;
5) Lower earnings for companies because we are buying less of their stuff;
6) Less credit available to companies because their earnings are falling;
7) Companies can't get credit, so lower inventories/ stock or companies can't refinance debts so they either sell assets or default;
8) Banks need to lend less because the are taking writedowns against past loans to these failing companies;
9) Layoffs/ recession etc. etc.
It looks like in the short-run, there is a serious dependence on consumption to keep this legal "Madoff" scheme going ("Ponzi" is so last year). In the run up to Christmas, which the British theologian Don Cupitt referred to as "the Disneyfication of Christianity", we are reminded on news channels of how absolutely critical it is for our shopkeepers lives that we get out and spend this year.
In the longer term, perhaps there are more choices, and we could go about things in a different way. A completely counterintuitive approach might be that we collectively accept a lower average income and take more leisure time, doing things that don't involve consumer spending. It's interesting to note that the typical British man earns roughly twice what his father did at the same age, on an inflation adjusted basis. When today's children are in their forties and fifties, perhaps they will opt to use their increased prosperity to work less and take more leisure time. Instead of being twice as rich as their parents, they may opt to start their weekend on Wednesday afternoon. In theory this would be possible, as we are rich enough already. A survey done 10 years ago by a couple of US economists (Solnick and Hemenway) found that many Harvard students would rather have an income of $50,000 in a world where most people were poorer than an income of $100,000 in a world where most people were richer. Perhaps that survey says something about those Harvard graduates, but the point is played out across society. There is no rational economic logic to this behaviour.
To continue the theme of Harford's "The Logic of Life", he identifies this sort of behaviour with what he calls "status anxiety". The desire that "status anxiety" produces is almost insatiable because it is largely relative - the better someone else is doing, then the better you need to be doing. Perhaps in China, the opposite happens to what happens in the US; status comes not from having a yacht, but from having produced the most stuff and having saved the most. It is what George Soros would call a reflexive process; i.e. it is a self-reinforcing process, and becomes the bias of a society or culture. Neither route is necessarily right.
On a personal level, I would like to retain the choice to work longer, for more ability to consume or to work less for more free time, and to take the trade off decision at a personal level.
One worry is that the current response to the excesses of past consumerism, might make this trade off more difficult for us all. Current government bail-outs that are aimed at reinvigorating our consumer orientated economies will in effect be placing the motherload of a credit card bill onto future generations, which may limit those choices. Taxes will need to go up at some point in the future.
The erosion of tax revenues will only be made up by longer working lives, or more successful, innovative companies. If there is a collective move away from 'consumerism', towards working less and taking more leisure time we will see plenty of defaulting governments in 15-20 years time as the burden of today's debts are unmet by the desire of the next generation to sustain the approach our generation so eagerly lapped up.
As many people around the world are facing up to their relatively tough economic situations, there is evidence that a significant number are looking to reconsider their work/life balance - either through their own choosing, or through an enforced situation...i.e. they have been laid off. For many in this camp, the lucky ones who were closely involved in the gold-rush of the last 25 years, or those who've worked long enough to have achieved the standard of living their parents had at a considerably earlier age, there are real choices.
The flexibility to opt for a simpler more frugal existence is there for the taking, albeit that many people would say this is too difficult a change to contemplate; private school fees, 2 cars, golf club membership can't be given up. The alternatives are substantial; perhaps working in the 'day job' from monday to wednesday afternoon (by which time you will be at your parents income level) and then spending thursday and friday working on charity projects, sporting endeavours, or whatever else flicks our collective switches.
The burden of financial responsibility for the problems that the work, spend, borrow philosophy advocated over the past 25 years, is being shifted onto the next generation, who will not have been the beneficiaries of the 'good times', but will be picking up the tab. Is it fair, given that they may want to move down the route towards a more holistic lifestyle, that they should be burdened with an even greater responsibility for tax revenue generation than ever before?
It's a difficult time to be making policy decisions, but the law of unintended consequences may mean that widespread economic bailouts just reinforce the behaviour patterns that got us into this mess. As difficult as it is to swallow for many people and many businesses, it is important that sufficient pain is felt by the system in the short-to-medium term so that we are really forced to consider what approach we choose to collectively take for the long term.
Sunday, 14 December 2008
The Long View...
One of the most striking aspects of some of the grandest cathedrals in Europe is that these buildings tended to take an incredibly long time to complete. Notre Dame in Paris was started in 1163 and finished 1345, St. Peter's in Rome was started in 1506 and completed in 1626 (a bit of a rush job, that one), and Barcelona's Sagrada Familia - started in 1882 and still under construction. On the subject of the long construction period of the Sagrada Familia, Antoni Gaudi (the original architect) was reported to have commented that "...my client is not in a hurry". The agreeable client, God in this case, makes this "long view" a bit more viable.
What strikes me about these undertakings is that those who devoted their working lives to these magnificent, all encompassing, projects would likely in many cases never actually see the fruition of their work. Presumably the divine connection that they were attributing to their work, may have been sufficient compensation. Many of an atheistic persuasion would say that they were deluded. Personally, though, I'm glad that they did, whatever of their reasons. Those individuals involved in these projects will have had greater legacies attributable to them than most of the projects people concern themselves with in their working lives. The trade-off is that with mortgage payments to be met, banks tend not to accept 'godliness' as an acceptable form of credit, so most of us are pushed down the route of a form of pragmatic short-termism.
Recently, I had the opportunity to take a insiders tour of the Sagrada Familia, with the current leading architect and construction engineer on the project. The passion that was on display for their work was pretty awe inspiring - to be honest i was fairly jealous about feeling as engrossed in an undertaking as these guys did. I also set to thinking as to where else in the world, and what sort of other projects exist that encompass this "long view" mentality. What becomes clear is that the notion of what the term "long-term" means in the developed world is shorter than it used to be. There are cultural consistencies - the Japanese when asked for a nominal figure in years as to what the "long-term" means always give a longer time period than people from the US, but in both cases that figure is less than it was 25 years ago. There are plenty of good reasons for this - the acceleration of technology, the short-horizon perspective of market-drive economics, the next-election perspective of democracies, or the basic requirement for personal multi-tasking. All of these are on the increase.
Nevertheless, on the search for projects that encompass the long view, my brother (who was also on the Sagrada Familia tour) highlighted a group based in the US, called the Long Now Foundation. Their website advertises that they hope to "provide a counterpoint to today's 'faster/cheaper' mindset and promote 'slower/better' thinking. We hope to creatively foster responsibility in the framework of the next 10,000 years." Pretty heady stuff. The term "Long Now" was apparently coined by one of the founders of the foundation, Brian Eno (the former U2 producer), who upon moving from the UK to New York "found that here and now meant this room and this five minutes as opposed to the larger here and now he was used to back in England". The point of their foundation is to explore whatever may be helpful for thinking, understanding, and acting over very long periods of time.
The initial project that the Long Now Foundation decided to embark upon was the construction of a 10,000 year clock. The idea for this was borne out of an observation by a computer scientist called Danny Hillis, who helped form the Foundation.
"When I was a child, people used to talk about what would happen by the year 2000. For the next thirty years they kept talking about what would happen by the year 2000, and now no one mentions a future date at all. The future has been shrinking by one year per year for my entire life. I think it is time for us to start a long-term project that gets people thinking past the mental barrier of an ever-shortening future. I would like to propose a large (think Stonehenge) mechanical clock, powered by seasonal temperature changes. It ticks once a year, bongs once a century, and the cuckoo comes out every millenium."
A brilliant idea. The complexity of trying to design something of this nature is where the concept becomes really interesting. Once you start to think of the logistics and planning that would be required, especially in the knowledge that you need to get things right at the outset, because making big changes even in the early years of the project (the first thousand years or so) is going to be beyond your control. 10,000 years is roughly about as long as the history of human technology. There are very, very few pieces of technology that are that old, currently still in existence - basically a few fragments of pots. Geologically, though, 10,000 years is a drop in the ocean. When this group started thinking about building something that lasts that long, the real problem they established was not with decay and corrosion, or even with finding a sustainable power source. People are the real problem. If something becomes unimportant to people, it tends to get destroyed, or substituted. There are countless cathedrals that have not survived for these reasons.
The conclusion that was drawn by the foundation was that the only way to survive over the long run is to be made of materials large and worthless, like Stonehenge and the Pyramids, or to become lost. They point to the Dead Sea Scrolls, that managed to survive for a couple of thousand years because they were lost. Now they've been located and preserved in a museum, the sense is that they won't last as long again. The Pyramids and Stonehenge have survived close to 5000 years, but over time they have been periodically pillaged and looted and its not clear as to their original purpose.
The principles that directed the design of the clock were vast and complex. As a starting point, they considered the very basic idea of how to power it in a sustainable way. Options included atomic power (poor maintainability, transparency), chemical power (poor scalability) etc. (full list at http://www.longnow.org/projects/clock/principles). Other issues that were up for consideration were - how to create a source of timing, options for how to display time, what concept of time to display and where to house the clock to ensure survival. On this last question, given the failure of human constructions to have survived the test of time, they reverted to Nature. A mountain in the Great Basin National Park, Nevada, will house the clock on the basis of its remoteness (over 200miles from any city), and is a relatively inaccessible and inhospitable location.
Whether this project will survive the 10,000 year test of time, obviously remains for the future. It would be against the balance of probabilities if it did. What I find interesting in the design concepts that are raised by undertaking a project that is so forward looking is that there are so many variables to consider. Very basically, what the future looks like thousands of years forward, and what civilisation will look like at that time.
One of the criticisms of the endeavours of our current institutions; governments, companies, charities, agencies etc. is that they are constructed in ways that don't benefit from taking this design principle into their construction, and consequently find themselves in life-threatening difficulties when we have periods of relatively high stress. Much of this happens because these institutions are reactive as opposed to proactive about the direction they want to take themselves. What I mean by this is that a public company often runs itself on the basis that it needs to report on itself to stakeholders every 3 months. A proactive institution will have considered the long view design principles, not necessarily for 10,000 years, but over a longer period such that they are less surprised about the "once in a generation" shifts that occur. There is no guarantee that they will succeed in understanding the future context ahead of time, but considering it in the way the Long Now Foundation looked at the design issues the "Clock for the Long Now" encountered would certainly create a fighting chance during stressful periods, like now.
What strikes me about these undertakings is that those who devoted their working lives to these magnificent, all encompassing, projects would likely in many cases never actually see the fruition of their work. Presumably the divine connection that they were attributing to their work, may have been sufficient compensation. Many of an atheistic persuasion would say that they were deluded. Personally, though, I'm glad that they did, whatever of their reasons. Those individuals involved in these projects will have had greater legacies attributable to them than most of the projects people concern themselves with in their working lives. The trade-off is that with mortgage payments to be met, banks tend not to accept 'godliness' as an acceptable form of credit, so most of us are pushed down the route of a form of pragmatic short-termism.
Recently, I had the opportunity to take a insiders tour of the Sagrada Familia, with the current leading architect and construction engineer on the project. The passion that was on display for their work was pretty awe inspiring - to be honest i was fairly jealous about feeling as engrossed in an undertaking as these guys did. I also set to thinking as to where else in the world, and what sort of other projects exist that encompass this "long view" mentality. What becomes clear is that the notion of what the term "long-term" means in the developed world is shorter than it used to be. There are cultural consistencies - the Japanese when asked for a nominal figure in years as to what the "long-term" means always give a longer time period than people from the US, but in both cases that figure is less than it was 25 years ago. There are plenty of good reasons for this - the acceleration of technology, the short-horizon perspective of market-drive economics, the next-election perspective of democracies, or the basic requirement for personal multi-tasking. All of these are on the increase.
Nevertheless, on the search for projects that encompass the long view, my brother (who was also on the Sagrada Familia tour) highlighted a group based in the US, called the Long Now Foundation. Their website advertises that they hope to "provide a counterpoint to today's 'faster/cheaper' mindset and promote 'slower/better' thinking. We hope to creatively foster responsibility in the framework of the next 10,000 years." Pretty heady stuff. The term "Long Now" was apparently coined by one of the founders of the foundation, Brian Eno (the former U2 producer), who upon moving from the UK to New York "found that here and now meant this room and this five minutes as opposed to the larger here and now he was used to back in England". The point of their foundation is to explore whatever may be helpful for thinking, understanding, and acting over very long periods of time.
The initial project that the Long Now Foundation decided to embark upon was the construction of a 10,000 year clock. The idea for this was borne out of an observation by a computer scientist called Danny Hillis, who helped form the Foundation.
"When I was a child, people used to talk about what would happen by the year 2000. For the next thirty years they kept talking about what would happen by the year 2000, and now no one mentions a future date at all. The future has been shrinking by one year per year for my entire life. I think it is time for us to start a long-term project that gets people thinking past the mental barrier of an ever-shortening future. I would like to propose a large (think Stonehenge) mechanical clock, powered by seasonal temperature changes. It ticks once a year, bongs once a century, and the cuckoo comes out every millenium."
A brilliant idea. The complexity of trying to design something of this nature is where the concept becomes really interesting. Once you start to think of the logistics and planning that would be required, especially in the knowledge that you need to get things right at the outset, because making big changes even in the early years of the project (the first thousand years or so) is going to be beyond your control. 10,000 years is roughly about as long as the history of human technology. There are very, very few pieces of technology that are that old, currently still in existence - basically a few fragments of pots. Geologically, though, 10,000 years is a drop in the ocean. When this group started thinking about building something that lasts that long, the real problem they established was not with decay and corrosion, or even with finding a sustainable power source. People are the real problem. If something becomes unimportant to people, it tends to get destroyed, or substituted. There are countless cathedrals that have not survived for these reasons.
The conclusion that was drawn by the foundation was that the only way to survive over the long run is to be made of materials large and worthless, like Stonehenge and the Pyramids, or to become lost. They point to the Dead Sea Scrolls, that managed to survive for a couple of thousand years because they were lost. Now they've been located and preserved in a museum, the sense is that they won't last as long again. The Pyramids and Stonehenge have survived close to 5000 years, but over time they have been periodically pillaged and looted and its not clear as to their original purpose.
The principles that directed the design of the clock were vast and complex. As a starting point, they considered the very basic idea of how to power it in a sustainable way. Options included atomic power (poor maintainability, transparency), chemical power (poor scalability) etc. (full list at http://www.longnow.org/projects/clock/principles). Other issues that were up for consideration were - how to create a source of timing, options for how to display time, what concept of time to display and where to house the clock to ensure survival. On this last question, given the failure of human constructions to have survived the test of time, they reverted to Nature. A mountain in the Great Basin National Park, Nevada, will house the clock on the basis of its remoteness (over 200miles from any city), and is a relatively inaccessible and inhospitable location.
Whether this project will survive the 10,000 year test of time, obviously remains for the future. It would be against the balance of probabilities if it did. What I find interesting in the design concepts that are raised by undertaking a project that is so forward looking is that there are so many variables to consider. Very basically, what the future looks like thousands of years forward, and what civilisation will look like at that time.
One of the criticisms of the endeavours of our current institutions; governments, companies, charities, agencies etc. is that they are constructed in ways that don't benefit from taking this design principle into their construction, and consequently find themselves in life-threatening difficulties when we have periods of relatively high stress. Much of this happens because these institutions are reactive as opposed to proactive about the direction they want to take themselves. What I mean by this is that a public company often runs itself on the basis that it needs to report on itself to stakeholders every 3 months. A proactive institution will have considered the long view design principles, not necessarily for 10,000 years, but over a longer period such that they are less surprised about the "once in a generation" shifts that occur. There is no guarantee that they will succeed in understanding the future context ahead of time, but considering it in the way the Long Now Foundation looked at the design issues the "Clock for the Long Now" encountered would certainly create a fighting chance during stressful periods, like now.
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