The Pin Factory Blog

Upon observing gloomy reports of the UK economic growth figures last month (and with seemingly never-ending eurozone woes), panic has spreadthrough Westminster. The Conservatives are getting anxious and cannot seem to wait until their long term growth plan starts yielding its first results. The government wants to see higher growth immediately, as its popularity is decreasing at approximately the same rate as unemployment levels are increasing.

In times of slow growth, rising unemployment, no signs of recovery and record low consumer and investor confidence comes an idea that is supposed to alter the financial sector by decreasing the role of banks in the economic recovery and leaving it up to the government to kick start lending – not via fiscal stimulus, but something very similar and yet very unconventional – credit easing.

Credit easing implies the government buying corporate bonds from small and medium-sized businesses and therefore providing them with enough money to start investing and hiring again. It is supposed to be a swift way to deliver credit to businesses and start up economic growth in the short run until the long run stabilization reforms start to yield their expected effects. The idea comes as somewhat revolutionary for the system where the government wishes to create a market for loans and bonds of small and medium-sized businesses (SMBs) thereby removing the dependency of the SMBs on the banks.

Since George Osborne, who made the proposal, hasn’t yet found a way to enforce it, several ideas emerge on how this is supposed to be done; (i) buying loans and bonds directly from the SMBs by a government agency; (ii) buying SMB loans from the banks (either by the government or by private investors via government subsidies), securitizing them and selling them off to private investors; (iii) buying the banks’ corporate bonds and thereby reducing their funding costs and creating an incentive for banks to increase lending; (iv) offer a government guarantee on SMB loans increasing confidence for the banks to increase lending to the SMBs.

The first proposal implies a simple fiscal stimulus to certain businesses who found themselves in problems and need recapitalization. The problem arising, among many others, is adverse selection. There is no way for a government bureaucrat to possess enough information to determine which companies should get the necessary funding and which companies will have the strength to invest it in potentially prosperous projects.

With rising uncertainty surrounding the world economy, it is questionable why would the firms start increasing production and start hiring again if they anticipate more contraction in the future and higher taxes due to unsustainable deficit and debt levels. It is more likely that both businesses and consumers use this money to pay off their debts rather than increase hiring or production. The stimulus in the form of bond purchases can only result in a type of social transfer from the government to politically prominent firms that found themselves in trouble.

The second proposal has similar implications to the quantitative easing policy, where someone is supposed to artificially clean the riskier loans off the banks’ balance sheets. There is an additional clause to securitize these risky loans and sell them off as “safe” assets. The government will be the middleman that pools the securities together and gives them a government guarantee giving the security a high rating. These sorts of securities will soon enough become a desirable asset and their demand will increase. An increasing demand will yield more and more securities and more and more credit to businesses – an effect that is in theory a good one.

However, due to an increasing demand for these low risk securities it is very likely that the banks will start to decrease lending standards and offer loans to high-risk business projects. Knowing the typical regulatory train of thoughts, I dare to say the regulators will encourage banks and other institutions to fill up their assets with these securities in order to re-capitalise themselves and become safer (see Basel I and II and the recourse rule).

Needless to say, this will create an artificial demand for business loans which could lead to an even more dangerous bubble than the mortgage loan bubble as it’s eventual burst will impact the businesses directly. Creating an asset bubble to bring an economy out of a recession proved to be disastrous so far (remember Fed in 2001). Let’s not repeat the same mistake for Britain.

In conclusion, credit easing will undermine the government’s credibility in trying to pursue a long term credible growth path, the very basis upon which their austerity plan can work. By committing to balancing the budget in order to keep its deficit cut promise, the Treasury will send signals to investors that the growth plan is credible and that the government isn’t looking for short-term fixes but rather a long-run stabilization path. Even though the European debt market will influence the UK recovery substantially, more uncertainty and more asset bubbles isn’t a proper incentive for growth and it never will be.

Research released last week suggested that people in Wales, Northern Ireland and Scotland should follow an ‘English’ diet to reduce levels of obesity. Fair enough, but unfortunately they also recommended imposing this diet by taxing fatty foods.

Fatty food has an inelastic demand curve i.e. price has little impact on demand. What will happen is people will redistribute their income away from other areas of consumption – clothing, housing etc and towards the, now more costly, fatty foods that they enjoy or they may simply spend less on food which means they'll cut out any healthier elements of their diets. But they'll still eat fatty foods so they'll be poorer, but still fat. Just like those smokers who still smoke.

The state would also be sending out mutually contradictory signals. On the one hand it would be attempting to increase the private cost of consuming fatty foods by raising their price. On the other hand it is effectively encouraging consumption of fatty foods by socialising the health costs of doing so via the NHS. A healthcare system free at the point of delivery is a very poor mechanism for incentivising healthy diets. An insurance-based system would be far more effective in this regard as it could incentivise healthy eating and weight-loss via reduced insurance costs.

The other problem here is that the researchers have failed to ask themselves why the English diet (I can see plenty of English people shovelling fat into their mouths, but still, on average) is healthier than elsewhere in the UK? Clearly this is not because we have taxes on fatty foods but because we are wealthier.

Within England, diets tend to be better in the wealthy South East than the poorer North East. There is a ‘robust’ correlation between absolute levels of wealth and health outcomes. Making people poorer by taxing them more is not going to make them wealthy and thus is it likely to reduce their overall health outcomes as well as having little or no direct impact. I can’t even see ‘Spiritlevel’ types supporting this kind of action; such taxes would fall more heavily on the poorest thereby increasing inequality.

Of course the root of the problem is that these regions of the UK have Soviet (actually higher than Soviet) levels of state intervention which is impoverishing them. The way to deal with obesity here is not to make them poorer by increasing tax rates and further intervention, but to make them richer by decreasing rates of tax and decreasing intervention i.e. completely the opposite to what the very sinister-sounding 'Health Promotion Research Group' propose.

‘Sin’ taxes do not merely fail in their objectives, they have serious unintended downsides as the trade in smuggled alcohol and tobacco demonstrates. I look forward in trepidation to the day that there is a serious outbreak of food poisoning because someone has smuggled a lorry-load of dodgy frozen burgers into the country in order to avoid the ‘fat tax’.

Dr Linda Yueh – author, Oxford economics don and economics correspondent for Bloomberg TV – is optimistic about the future of the world. After all a third of the world's population is gradually being lifted out of poverty and into the middle classes. It's a coming 'golden age', she told the Aberdeen Asset Management conference in London's Savoy Hotel.

Quite right. The rich countries of the West might have suffered a knock – and the smaller developing countries who depend on their aid and trade too – but the larger countries, like China and India, are still growing. Pity about the West, right enough: things are nowhere near as bad as the 1930s Depression, but there are still a lot of countries in a lot of debt. When debt rises above 90% of GDP, a country finds it hard to grow under that burden.

It's markets, of course, that keep countries (relatively) solvent. Politicians would gladly raid the next generation's pockets as much as they could in order to pay for today's spending. It's markets that bring them up against economic reality. If you and I can borrow cheaper than a whole government, there must be something seriously wrong with that government. Once a country's interest rates hit 6.5%, it's usually only a couple of weeks later that they hit 7.0% and then the country has to appeal for a bailout. Italy's debt is 120% of GDP and its rate has just gone through the 6.5% barrier. Watch this space.

On the basis of past slumps, Dr Yueh reckons it takes about seven years for income to return to its pre-crisis levels. So we have a way to go. And meanwhile, India, China and the rest are surging upwards. Of course, the US remains the world's largest economy, its people earn ten times as much as the Chinese, and Americans are incredibly resilient and innovative. There is, as Adam Smith put it, a great deal of ruin in a nation. But the balance is changing. Still, says Dr Yueh, it's not just a good thing that large parts of the global population are finally rising out of poverty. A world with several super-rich countries in it might be a much more stable place than a world with only one, and provide more opportunities for smaller developing countries to trade and grow. You might expect her to say that, of course. But it's right.

The Telegraph reports that rubber bullets, or baton rounds, may be used against student protesters at the upcoming march. Rubber bullets have never been used in Great Britain (though they have been used in Northern Ireland), and have only been "pre-approved" once, during the London riots this summer. Deploying them now is a worrying step towards a dangerous “shoot first, ask questions later” approach to riot control, and should be reversed.

Despite widespread public perception of them as relatively harmless method of crowd control, rubber bullets are extremely dangerous. In a study of 90 patients suffering from injuries from their use in Northern Ireland, one person died and 17 were permanently disabled or disfigured. Over 35 years of their use in Northern Ireland, they have killed 17 people. Rubber bullets can be lethal to those they are fired upon.

Perhaps such force was needed at times in Northern Ireland. But it's obvious that student protesters won't present the same level of danger to civilians and police officers as riots at the height of the Troubles. Previous student protests have turned ugly, but not on a wide scale. The types of clashes that took place would not have been avoided by rubber bullets.

The police say that the bullets will only be used as a last resort. Yet they have not defined the circumstances under which they would be used, nor have they explained why they are needed now. What is so dangerous about these students that they require unprecedented police force to be controlled?

I doubt that the police will actually use their bullets against the students; to do so would be a PR disaster for them and the government. (If they did, incidentally, it would be politically lethal for the government.) The real danger is the slippery slope that arming the police with rubber bullets sets us on. If they are armed this time, they’ll be armed next time, and again and again. The police use of rubber bullets will become an ever more common occurrence. We're already seeing this – after a history of not using rubber bullets against marches, they have been approved twice in the last few months. Their deployment and, eventually, use will become a commonplace if not blocked by the government.

There is no need for the police to be armed with such dangerous weapons against a bunch of marching students, and to do so would set yet another dangerous precedent that empowers the police to be violent against protesters. We should jealously guard Britain's traditionally unarmed police from trigger-happy politicians and commissioners. 

Information in the economy is widely dispersed among a huge amount of consumers and businesses, which possess local information that enables them to set prices and determine quantities of goods and services to be bought and sold. The market price, aggregating billions of choices and decisions every single day, is the best way to express real value. No central regulatory body can do a better job, simply because they cannot physically posses all the necessary information.

The same line of reasoning is applied in the financial market. The complex matrix of information and market participants is somewhat smaller in the financial market and rather global (as the decisions and financial products are run globally) but they are far more complex than regular goods and services and are thus far more difficult to control and have oversight on. Even if the regulators fully understand the complex derivatives and quadrupled securitized loans they cannot process how market participants will react and sometimes cannot even see the obvious consequences of their own actions.

The current financial crisis is the best example of this. By steering banks into buying MBSs (Mortgage Backed Securities), they were creating an artificial demand for these securities and henceforth an artificial demand for more mortgages which led banks into lowering their lending standards in order to create more and more AAA-rated MBSs.

The regulators need to understand the consequences their actions may incur on those being regulated, and should be able to anticipate their reactions, but have failed to do so repeatedly. They will fail again, as their desire for finding new safe assets may end up creating another asset bubble. There were some suggestions that new safe assets should be debt of businesses backed up by government guarantees (in order to have an AAA rating) and re-packaged into new types of securities.

Others have proposed to do the same with eurozone peripheral sovereign debt – have highly solvent nations pull the debt into securities, back them up the usual way and sell them on the market, thereby creating new, huge, safe bonds and resolve the sovereign debt crisis in one blow. Some banks have already started to issue covered bonds (debt made up of high quality mortgages and loans) backed up by collateral and secured by bank’s other assets in the event of bankruptcy. No matter what the new safe assets look like, by exaggerating their use and forcing banks to recapitalize with these assets can only lead to another asset price boom, higher debt burdens (as these safe securities are in fact debt-tied securities) and consequently another recession.

As far as the impact on the current recovery, an increase of bank capital-asset ratios, even if announced at a future date (in the Basel III case this is 2019), due to negative future expectations, will work towards the decrease of lending, unprofitable business lines for banks that will drive costs for bank customers, and finally shift the businesses to seek support on high investment projects with the so-called “shadow banking system” – hedge funds, money market funds, SIVs, and investment funds. Furthermore, even if we disregard expectations of future contraction by the banks which may lead them to contract today, the European Commission (EC) plans to institute the 9% capital standard as soon as possible to prevent financial contagion from a Greek default, making the reaction on the lending market immediate.

The paradox of the regulatory oversight body arises in the following – by striving to make the system stable, they end up increasing the systemic risk and fuelling artificial demand that can lead to an asset bubble. By creating incentives to invest in certain types of assets, the regulators send false signals about the demand for these assets and hence distort its prices. The effects of their actions are usually counterproductive and the reason this is so is because they think they posses enough data and information to control the market economy and the behaviour of market participants.

Never was this possible before and has always proved to have disastrous consequences, since the market will always have more information than a few individuals, defined by the term asymmetry of information. The regulators call upon the asymmetry of information in their desire to overcome it, but they paradoxically become its victims.

Yet another solar panel has sprung up on a roof in my street. I wonder how anyone who wants to improve the environment could contemplate disfiguring their elegant Edwardian house with one of those.

The answer, of course, is that people only pollute their visual environment like this because there is money in it. Or specifically, because there is a subsidy in it. Middle-class householders who can afford the £10,000 or so to install solar panels get a hand-out, called the 'feed-in tariff', of 43.3p for each kilowatt hour (kWh) they generate, plus a further 3.1p for each kWh fed back into the National Grid. That gives each household that installs the kit an average income of £1,190 a year. A much better return, you have to agree, than putting your £10,000 in the bank, or anywhere else for that matter.

There are even companies who make a business out of it: you can basically rent out your roof to them in return for free electricity, while they pocket the rest of the subsidy. It is no wonder that so many people have despoiled the very places they live in.

Naturally, it is the rest of us who have to pay. Not just the environmental cost of being assaulted by rooftop eyesores. But hard cash too. The gamut of green levies (which also bring you wind turbines atop every scenic hillside) adds an average £42 to our electricity bills, with gas customers paying an additional £25 (plus £13 more towards the EU Emissions Trading Scheme). It means we are paying nearly £100 a year extra for the energy we use.

But there is some sign of relief. The government has pledged to cap our hidden solar panel tax, so it is having to cut the subsidy it pays out too. The average payback for a solar household is reckoned to fall from £1,190 a year to £640 a year – definitely not such a good investment for solar subsidy farmers. Let's hope that spares our local environment any more damage.

I’ve put off writing about the Occupy movement until now. It wasn't clear to me what Occupy Wall Street and Occupy London Stock Exchange wanted to achieve. Indeed, it still isn’t. But I’ve seen more and more articles like this, which claim that their problem is with governmental corporatism, which are worth considering. (I'm not particularly convinced by that article's take on economics, but it's just an example.) If this is correct, then the Occupy movement is more sympathetic that many have given it credit for being. Sadly, I don't think this is the case.

What do people mean when they say corporatism? The term is widely used but doesn’t seem to have a common definition. I and many other free marketeers use it to describe government collusion with big business; whether through direct cash transfers like bank bailouts, trade protection for industry like agricultural tariffs, indirect subsidies like taxpayer-funded roads or limited liability laws (as distinct from limited liability contracts, which are OK because they only apply to contract parties), or artificial barriers to entry like licensure. In this view, for example, Tesco is seen ambivalently, benefiting in some ways (unpriced roads, say, or agricultural subsidies) and suffering in others (such as import tariffs).

But this is not what many other people mean by the word. By corporatism, many mean a system in which large corporations exist, in their view wielding too much “market power”, such as the ability to sell below cost price to undercut rivals or to put pressure on suppliers to reduce their asking price. In this view, Tesco is a bad thing because of its size alone, irrespective of whether that size comes from the state. And, typically, they are comfortable with using the state to cut a large firm down to size.

This distinction is important: libertarians who are encouraged by the Occupy movement’s rhetorical opposition to corporatism should be wary of people using the same word to mean two different things. If you are opposed to corporations being sponsored by the state, I’m probably your ally.  If you want the state to stop big corporations from existing at all, I’m probably not.

The Occupy protest’s focus on Wall Street and, especially, the London Stock Exchange make me think that they are in the latter camp of anti-corporatists. Yes, Wall Street is home to bailed-out banks, but Occupy Wall Street hasn’t focused on the banks – they have targeted the financial sector in general, which is certainly not all (or even mostly) a creature of the state. Occupy London Stock Exchange’s focus has been even broader; the target has been publicly-listed companies, most of which are hardly recipients of government privilege at all.

The Occupiers are not anti-government, they are anti-wealth. Their slogan, “we are the 99%”, highlights this. The only way this distinction between the bottom 99% and the top 1% makes sense is if it is about money, not state-granted privilege.

Many Occupiers would probably say that they are OK with people who have really earned their money by making people’s lives better. But what meaningful definition have they settled on for this? Did Wilt Chamberlain deserve his millions, earned by taking a small amount of money from thousands of willing spectators? Does Wayne Rooney? Many Occupiers could answer yes to both questions. But what significant difference is there between Rooney and, say, the CEO of Royal Dutch Shell, or some other highly-paid CEO? If they’ve been paid the money willingly by shareholders, they deserve the money just as much as a sportsman who has been given money by thousands of spectators.

Most of the top 1% of income earners (or wealth owners) have made their money through market mechanisms, by selling something that people want. In fact, the biggest recipients of state largesse are usually the voting middle classes, who take from both the rich and the poor. I suppose “we are the bottom 60% and the top 2%” doesn’t have the same ring to it, but if the Occupiers were really against state largesse rather than the wealthy themselves, it would be a truer slogan.

Alas, despite the optimism of many libertarians, I don’t think there is much that is liberal about the Occupy movement’s aims. Whatever superficial resemblance to aspects of the free market cause there is in the Occupiers’ rhetoric is just that: superficial.

If the Occupy movement focuses on what it could achieve, it might realize that government is the only institution that will listen to it. If that happens, there might be some common cause with free marketeers – a broad-based anti-bank bailout campaign is long overdue in this country, for instance. But as long as Occupiers insist on bleating about “the 1%” and targeting legitimate private firms as if they are criminal bodies, I’m not optimistic. 

Do you have an old biscuit tin where you stash left over cash from foreign trips? You may want to check it for any Greek euros. Yes, there are such things. Physical euro notes are issued by national central banks and the notes are pretty much identical across the zone except for the serial number. Those numbers on notes issued by the Greek central bank start with Y.

The Greek saga continues to twist and turn with each passing day. However, the most significant development this past week was the unprecedented statement by France’s Nicolas Sarkozy and Germany’s Angela Merkel that any Greek referendum on Greece’s bailout package will be considered a referendum on continued membership in the euro club.

This is a seismic shift in attitude. Those committed to maintaining the eurozone have never countenanced the slightest discussion of a possible exit from the euro. Even now, they’re warning of all manner of catastrophe if that were to happen and point to the huge complexity of such a move - as if carrying on with the status quo is free of potential catastrophe and complexity. In particular, they’re doing everything they can to make sure there is no Greek referendum. They have bitter memories of the inconvenience from listening to the people.

Now that Merkel and Sarkozy have finally made an exit from the euro an official option, we wish all parties godspeed to do what needs to be done. Back in February, The ASI featured a five-point plan for Ireland to leave the euro. It was quick (overnight) and dirty but quite doable for Greece today. Sure, it would be messy and costly but so is staying in the euro.

In anticipation of this, it might be smart to exchange those euro notes issued by Greece. One of the ASI’s five points calls for Greece to keep current euro notes in circulation but calling them Greek euros when the serial number designates them as such. They’d start at a 1:1 exchange rate with the real exchange rate soon set by market forces, starting in the black market - a very big one in Greece.

A large benefit of this switch to a Greek euro would be the continued functionality of ATM’s and other machines. Losers would include tourists stuck with the old notes but this is a relatively small number holding a relatively small amount of spare change. Big losers would be criminals and tax evaders doing business in cash. We shed no tears for them.

So check those crumpled old notes and toddle on down to your local bureau de change. While you’re at it, here’s other codes you may want to check for: Ireland (T), Italy (S), Portugal (M) and Spain (V).

One of the amusements I delight in about the environmental movement is that they're generals, always fighting the last war. We've still got doomongers warning about population when we already know the answer to that. Indeed, are implementing the answer to it. Population, birth rates, fall when places get rich (not least because rich places have more for women to do than endlessly pump out more babies) and as the world is getting rich we've solved that problem. We've similarly got doomongers telling us all that minerals are about to run out: without noting that we're recycling ever more of them and in many places co0nsumption of virgin material is falling as we replace it with recycled (the iron industry being an obvious example).

One that is similarly popular is that we're just simply using too much stuff, that on a limited planet we can't all just keep having more. But it appears that peak stuff has already been and gone:

In 2001, Goodall says, the UK's consumption of paper and cardboard finally started to decline. This was followed, in 2002, by a fall in our use of primary energy: the raw heat and power generated by all fossil fuels and other energy sources. The following year, 2003, saw the start of a decline in the amount of household waste (including recycling) generated by each person in the country – a downward trend that before long could also be observed in the commercial and construction waste sectors.

In 2004, our purchases of new cars started to fall – as did our consumption of water. The next year, 2005, saw our household energy consumption starting to slump (notwithstanding an uptick last year due to the cold winter). And in 2006 we seem to have got bored with roads and railways, with a decline in the average distance traveled on private and public transport. All of this while GDP – and population – went up.

The secret to this is that GDP is the "value of all goods and services produced". And we can, as we have been, increase GDP by increasing the value added rather than the quantity of goods and services. There's actually no great secret here at all: it's exactly what we would expect to happen in fact, if raw materials get more expensive (as those who insist they are running out would say they are) then we'll use less of them.

And note, no one planned this, insisted upon it, regulated for it or imposed it. Just happened quite naturally as the market response to higher raw material prices. As we've seen the quite natural market response to greater wealth being fewer children, prices encouraging recycling of metals and all the rest.

Great things markets, aren't they? If only more environmentalists would realize that they are the method of getting what we all desire, that cleaner, greener, richer, world.

You remember how back in 2006 everyone was getting poisoned by all those nasty chemicals that industry was using? Sure you do, millions falling over every month. And how Margot Wallstrom was able to push through the REACH legislation? To make sure that we were all safe and that only chemicals that had been properly tested were available for use? Glory be, aren't we lucky little boys and girls, eh?

The thing is though, there's a bill to be paid for this. In my email this morning I got this: 

In continuation to our earlier communication regarding this letter of access (LOA) cost for Sodium Iodide (EC no: 231-679-3) please be informed that the LOA cost calculated is 8500 Euros (for the 100 to 1000 tons per annum tonnage band); considering the present response in the SIEF.

Now, if I'm honest, a payment of € 8,500 to make sure that sodium iodide is safe to use doesn't seem like all that much.

Except that's not actually what this payment is. It's not one payment for someone to go through the scientific literature and say, well, yes, this appears to be safe. It's not even a payment for anyone to do any experiments. It's not even one payment.

Every single importer, manufacturer and or user (if you're a user and the manufacturer has done this you don't need to, but if you're a user and the manufacturer has not done this you do need to) has to pay this fee. This is after all of the importers, manufacturers and users have got together and agreed to share the costs. This is the cost each, not the total cost.

No! Wait! There's more! Every single chemical combination has to go through this process. OK, you don't have to deal with O and a couple of others but just about any possible combination of elements must go through this process. Given that there's 72 elements that we normally worry about (the radioactives and a few of the gases we tend not to) the number of possible combinations is 72! Which is, umm, 6.123445837688612e+103 or, at my level of maths, gazillions. Possibly even umpty elebenty billions.

So every single importer, manurfacturer and or user of a chemical combination has to, even after they band together to share the costs, pay this sort of sum for each and every chemical combination that can possibly be used in a complex economy of 500 million people and some billions of different products.

I suppose you could just about, possibly, make the case that this is worth it to make sure that we're not all poisoned in our beds. Maybe. But this isn't the cost of doing the testing or anything. No one is actually doing any work for all of this money.

This is the cost of filing the paperwork.

No, really, this is the fee that must be paid to the European Chemicals Agency just for the joy of having them look over the paperwork. We're not getting anything for this other than a bunch of bureaucrats in Helsinki reading a few .pdfs.

As I say, thank goodness for the European Union, Margot Wallstrom and REACH. Just think of the idiocies we would have spent all this moolah on if we'd had a choice. No one actually wanted to cure cancer, poverty or HIV anyway, did they?