Adam Smith Institute

One of the perks of this wonk land stuff is being sent books before their publication date so that we terribly important people can tell you what to think about them before you read them. As with the upcoming "Power and Plenty" which bills itself as an economic history of the past thousand years. I found it fascinating and it'll provide me with all sorts of wondrous arguments to deploy in times to come, some of which I'll sketch out in the next few days here (no, don't worry, I'm not going to try a comprehensive review of such a complex book in a blog post).

One of the things I like about it is the way that little factoids pop up which explain, make clear in a simple manner, quite complex situations. At one point we're told that the Mongols commanded the services of 50% of the world's horses. At a time when the animal was both the transport to the battlefield and the tank equivalent once there this rather explains some of their success, doesn't it? Another is

...the number of operative hours to process 100 lb of cotton was over 50,000 for spinning by hand in India. In England it was cut to only 2,000 by the 1779 invention of Crompton's mule, and fell to 300 by 1795 and 135 by 1825, compared with 40 in 1972.... 

That after two centuries only 0.1% or less of the man hours are required to do the same thing as before rather explains why our cupboards are filled with a multiplicity of clothes while our forefathers had, if they were lucky, two outfits, daily and Sunday best.

The excellent point is also made that such technological advance really rather required international trade: without it, the domestic market would quickly have become flooded and the economies of scale would never have appeared. 

Paul Krugman makes a point about the US mortgage market :

The WSJ reports that homeowners whose mortgages are bigger than their houses are worth are starting to walk away from their houses, even if they could afford the mortgage payments.

This will have some Brits, those with memories of the early 90s and negative equity, rather scratching their heads, for you can't walk away here. If you owe more than the house is worth and it is sold, or foreclosed upon, you still owe the bank that gap. This is something that is generally not true in the US: most mortgages are non-recourse (and thus Jingle Mail: posting the keys back to the bank and loading up the pick up truck). That is, they are secured against solely the property, there is no recourse to the general income of the borrower nor other of their assets (this is subject to a number of qualifications, it depends State by State and usually is only true for primary mortgages).

What this means in the grander scheme of things is that what happened to consumer spending in the UK in those 90s is not a good guide to what might happen to it in the US in the coming year or two as the bubble unravels. Similarly, given that it is the lender that has to eat such losses in the US, nor is what happened to the banks here. We can also take this a stage further and point out that whatever happens in the US in the coming year or two will not be a good guide to what might happen here if there is a large fall in house prices.

I agree this is a slightly geeky point but watch out for those commentators who fail to grasp it: the differences in the mortgage contracts are sufficiently large that the effects of negative equity upon consumer spending (and thus the wider economy) could be wildly different. 

According to reports in yesterday's Financial Times, the government are finally going to heed our advice and put the Tote (the state-owned betting company) up for auction. As we have consistently argued, from our influential 2004 report At Odds With Taxpayers to the present day, this is the only fair and straightforward method of finding out what the Tote is actually worth, and getting good value on the sale for UK taxpayers.

The government's original plan was to simply sell the Tote to the racing industry and the Tote's management at a knockdown price - "for the good of racing". However, the ASI challenged the government through a formal complaint to the European Commission's Competition Directorate, which twice ruled that the government's backroom deal with the racing industry would constitute an illegal use of state aid.

In any case, the racing industry and the Tote's management have only managed to muster £330 million, well short of the £400 million valuation placed on the Tote by PWC, the accountancy firm.

However, if the Treasury now goes ahead and auctions off the Tote, the price realised may be north of £500 million, according to our City sources. That is good news for UK taxpayers, and good news for racing too - since the government plans to give something back for 'the good of racing'.

However, it is worth remembering that horse racing as a sport and business has never been more prosperous. It would be far better to put the revenue raised towards cutting some taxes and maintaining some sports grounds, so that British kids can get some more exercise.

The Prime Minister still likes to crow over making the Bank of England independent when he was chancellor. He is keen to take credit for every success, but when the fan gets clogged his McCavity alter ego is assumed. In any case, recent occurrences have shown the Bank's independence to be purely cosmetic: they are culpable when inflation targets are missed, but when they try to avoid moral hazard by not bailing out Northern Rock, the Treasury takes over.

What the Northern Rock debacle has illustrated is the weakness of Brown's tripartite system of financial regulation (divide and rule) where the boundaries are blurred and the Treasury maintains close control. This kind of regulation is a feature of the government's approach to everything from the NHS to quangos – and it doesn't work. Everyone who is anyone in the City knew Northern Rock was in trouble months before it collapsed through the most normal of banking failures: borrowing short and lending long. Why did the situation get so out of hand?

Another failing was highlighted by the Bank of England's decision not to inject liquidity into the markets over the summer, as the European Central Bank and the US Federal Reserve chose to. As James Harding put it in The Times:

Was this because it was not sufficiently in touch with the financial markets? Was it because the Financial Services Authority knew what was needed but, under Gordon Brown’s model of tripartite regulation, did not have the authority to make it happen? Was it because the Bank is mandated to meet inflation targets but, unlike the Fed, does not have an equal responsibility for nurturing growth?

Will Hutton makes a good point here :

The state and market are in a symbiotic relationship of mutual need. Regulation delivers public good. And private markets and corporations are the better because of it.

We now need a social-democratic Keynesian government.

...an activist US government took over Continental Illinois bank in the Eighties.

The situation was in fact eeriely similar. A bank with few retail deposits decides to expand by tapping the wholesale markets to borrow short and lend long. When those markets worry about the quality of lending, those wholesale funds can no longer be rolled over and the bank faces a liquidity crunch. Sound familiar yet? What do the authorities do? Well, first, they guarantee all deposits: yes, all, disregarding the previous statutory limits on deposit insurance. They extend assistance through the Fed's discount window. They guarantee to provide any liquidity needs Continental might have. (This is sounding, well, more recent, isn't it?) Then they fiddle around for a couple of months seeing whether anyone would like to take over the bank. That doesn't work, so then, well, do they nationalise it? In a sense I suppose, for the next part was that the Fed bought a chunk of the bank's bad loans ($4.5 billion) and then invested $1 billion in capital by purchasing preferred stock.

This gave them 80 percent of the equity and the bank survived, being taken over a decade later by another bank. With, for some time, continued liquidity support. 

No, I don't know whether this is the best solution for Northern Rock or not. I just rather like pointing out that Will Hutton is telling us all that we must be more socially democratic, more Keynesian, must follow the Continental Illinois path: when what we've been following for the past few months is exactly that Continental Illinois path, the one pioneered by the decidedly monetarist and free market America of the 1980s.

Given that the majority of my income is denominated in US dollars I'm not all that wildy excited about the fact that it is fast approaching toilet paper in value. However, it is in fact what is necessary. I mean, when you've got Paul Krugman insisting that it's not George Bush's fault, something must be going on.

    I blame Bush for a lot of things, but the declining dollar isn’t one of them.

The US is running a large trade deficit and the only two ways to balance it are either a recession or for the dollar to fall. Guess which is preferable? However, I was most taken by an argument floating under the surface here at Capitalists@Work.

Roughly speaking, the $, £, € and yen (and many other currencies I can't find the symbol for) trade in free markets. Sure, there's a bit of fiddling with interest rates, the occasional thumb on the scales from central banks, but broadly speaking relative values are determined in the market.

However, a number of important currencies (China for one, HK etc) have their values pegged to that of the dollar. For those free floating currencies, we would expect (with some errors and over-shooting) values to reflect comparative values: as indeed the markets currently are doing. Those pegged ones though, they create a larger problem. It might be that to get them to break those fixed values, that the dollar must be driven down below its real value, in order to get those governments to change their minds.

So the result of the market rigging, which is widely agreed has over valued the dollar recently, will be to enforce a period of undervaluation of it.

Not really what those riggers really wanted now, is it?