Sunday, 29 November 2015

Why economists fail at foreign

One thing I've noticed about economic types over the past few years is that they really struggle to get their head around the interactions across the world. I've been trying to put my finger on why that is for a while now and I think I might have it. It's because they seem to be trained to operate from a single viewpoint. A single mental framework in which all the questions are asked and answered. And that mental framework is this.

Every analysis I've ever read from economic types seems to follows this mental model. It is always from the viewpoint of a particular country and the Rest of the World is abstracted to a single lump that is casually mentioned in passing. The lines are hard and rigid and follow the political boundaries of the country in question absolutely and without variation. The RoW is able to take action like a Deus Ex Machina without any effect on anywhere other than the Country in question.

It is precisely the same sort of mental trap as the 'government borrows' model. It leads to a particular type of behaviour, a particular set of analyses, and a particular set of conclusions - all incorrect.

So we end up with every country's financial system set up as though it was a net exporting nation, and loads of discussions about fixed exchange rate ideas as solutions to the issues this causes. It's like asking Lewis Hamilton to use dry tyres for a wet race and then the race engineer suggesting that the only solution to his predictable issues is that he slows down. Only to then to say he should have slowed down more when the car inevitably aquaplanes into the nearest crash barrier.

To get anywhere you have to shift viewpoint.
A currency zone world
Here the taegeuk represents the entire world and the colours each represent a different currency zone.  Currency zones consist of assets grouped by they primary denomination. The primary denomination is essentially the currency denomination in which the income/costs turns up. That's generally the same denomination as the primary capital value listing, but not always. Some assets have no primary denomination because they pay no income - Bitcoin for example. (Gold and other commodities tend to have an ongoing storage cost, and so effectively have negative income in a currency zone). 

So currency zones are conceptually separated by income flows and the stock of assets follows from that.

The dotted lines are the political boundaries of countries. The viewpoint is a view of a free capital floating currency world where the boundaries of countries are distinctly secondary - almost to the point of being irrelevant. You'll note that the currency zone division is by asset, not by entity. An entity can be in multiple currency zones and can have multiple physical domiciles with no necessary correlation between the two. 

Like all pictures it is a massive simplification of reality. Only three currency zones is unrealistic and there are unfortunate inverse relationships in the segment sizes (for example, red is the primary reserve currency in this model because the segment is the smallest. Chances are that segment is the most powerful country). 

The picture is akin to a mainstream economics - static, two dimensional and with no depth. So like mainstream economics use it only in toy situations where there is no risk of damage to real people. 

A more realistic visualisation would be dynamic, alive and moving.  The colours would shimmer and ripple as entities moved in and out of the zones - causing the zones to shrink and grow.  It would be multi-dimensional to represent the many more currencies and countries that there are. You would be able to zoom in and out and twirl the model around you. And it would have agents in there so you can understand how their motivations feedback into the aggregate and then back into altering their motivations.

But even the toy is useful in the way that it changes your thinking. For example
  • It's pretty clear that every entity in every country has the choice of ordering their goods and services from any of the countries and therefore has a choice of competitive supplier.
  • If a supplier chooses not to accept a particular colour of currency, then it has to have alternatives orders in one of the other colours or the supplier's sales shrink - and so does the world economy (the diameter of the taegeuk)
  • Growth in exports overall grows with world income (as the taegeuk increases in diameter), so if you're planning on growing faster than that then you're beggaring a neighbour somewhere.  
  • The whole focus on 'balance of payments' goes away because you're focussed upon assets and income flows, not the physical location of entities within rigid borders. In any case for anybody to have a deficit there has to be a surplus somewhere. It's all automatically balanced under the 'fair exchange is no robbery' principle. The surplus and the deficit arise at the same time and if they don't then neither can exist - as the transaction would simply fail due to lack of the right sort of money somewhere along the chain.  Attempts to reduce surpluses or deficits cause damaging feedback effects on all sides that will be resisted by the entities involved - particularly if there are economic policies in place. 
Just by linking the countries and the currencies in a simple mutual feedback model and by switching the viewpoint to a world view rather than a country view you get greater insight into what is going on.

So the next time you hear bizarrely one-sided ideas about how economic areas interact,  you'll know why.

They are just looking for a RoW. 

Sunday, 15 November 2015

Job Guarantee - Jobs For the People

In the normal job selection process, first a job is created and then the matching system looks for people to match to that job. Once you get to the margins you end up with jobs that cannot be filled and people that cannot get jobs.

You have a matching problem.

That can only be resolved a little bit via training, job redesign, sanctions, etc. and you always end up with a list of vacancies and a list of people who want a job.


The job guarantee is different.

You take the person as they are and you find/build a job for them as they are.

You are guaranteeing a match because you are helping the person to become employed as a function of the programme. Coming up with jobs is part of the process.

Think of a bespoke suit made specifically to fit from a selection of templates, rather than trying to squeeze into an off the peg affair.

The result is that the list of people who want a job becomes empty. That is the key difference that makes a Job Guarantee a Job Guarantee.

Standard employment, workfare schemes, and even normal public sector employment can only provide people for the jobs.

It takes a Job Guarantee to provide Jobs for the People.

Thursday, 1 October 2015

UK Private Debt Levels - Q2 2015

Here are the private debt ratios from the Q2 2015 data are as follows:
Relative deleveraging is ongoing, but the trend is for corporates to deleverage and households to slowly ramp up debt. Total debt is still hovering around the £6.5tn mark where it has been for a year now.

Will this turn into a house of (credit) cards?

Source: Office of National Statistics. Private sector debt based on tables NLBC, NKZA, NNQC, NNRE, NNXM, NNWK, NLSY, NLUA, NJCS and NJBQ (Lending and securities per sector, not seasonally adjusted) scaled by BKTL (Gross domestic product at market prices, not seasonally adjusted). Data and calculations are available online

UK Sectoral Balances - Q2 2015

At long last the data from Q2 2015 is out. All the data streams have been adjusted to comply with the new national accounts standards, so the specific data will have changed again. The trends stay roughly the same though. The Household sector continues to net borrow and the corporate sector continues to net save - somewhat similar to ten years ago. The five sector chart shows the household/corporate distinction much more clearly. We'll see next quarter whether the household debt continues to grow as required to get the 'surplus' the government is insanely obsessed about, and if the pattern of corporate sector saving and household sector indebtedness continues to follow the previous pattern.

Source: Office of National Statistics, tables RPYH, RQAJ, RQBN, RQBV, RPYN, RPZT, RQCH, DJDS (Seasonally adjusted Net Lending/Borrowing per sector plus residual error) and YBHA (Gross domestic product at market prices, seasonally adjusted). Data and calculations are available online

Saturday, 19 September 2015


This week the current governor of the Bank of England, Mark Carney, was questioned about the impact of Corbynomics on the economy by the Treasury Select Committee. He said:
The issue would be imperilling potentially the achievement of price stability. The consequence of that of course would be inflationary
Which I think crossed a line he shouldn't have - since that is a deliberate political statement.

Corbynomics is about creating more investment in the economy by simply spending the money on infrastructure and refusing to pay out corporate welfare in the form of interest to those who choose to save in the private sector. That has been signposted five years in advance of any potential start, would be subject to parliamentary debate and approval anyway, and would take a little while to get going. If that isn't 'signalling' and 'setting expectations' then nothing is.

If a Corbyn government is elected it would be the Bank of England's job, under the current arrangements, to ensure there was space in the economy to handle whatever spending the government decided to undertake. It can do that, theoretically, by assessing the output gap and adjusting interest rates accordingly.

So if there is any inflation from the government spending it would be entirely down to Carney & Co. failing to do their job properly.

That means the quote above is either a statement of incompetence, in which case the Governor should be sacked right now, or it is, in reality, a statement in support of the political philosophy of the current government and the set of people the Governor belongs to and represents - the bankers.

That single political philosophy has, with the election of Corbyn, finally given way to a real alternative. Comparing the two is instructive.

The incumbent philosophy should be familiar to everybody.

  • A central bank ensures there is sufficient borrowing in the economy to maintain 'aggregate demand' at 'full employment' where 'full employment' is defined as a few million people out of work give or take a few million more. 
  • The central bank is supposedly independent, but is really politically homogenous. 
  • Activity is based entirely upon the private sector, under roughly free market rules, operating exclusively and having access to all the resources of society.
  • In this model the government is just another actor in proceedings that has to carve out its space 'competitively' with everybody else by taxing, spending and borrowing. 
  • The push is for ever smaller government with the state constantly deferring to private interests and binding its own hands ever tighter. 
  • If anybody is left behind it is their fault, not the fault of a system incapable of maintaining real full employment - where everybody has a job and an income. 

The result of this philosophy is all around us - vast inequality, massive private debt burdens, wage shares on the floor, insufficient investment, productivity trashed, and millions of people without a living income to sustain them. And of course eight years after a collapse we're still not back on our feet. It simply doesn't work for the majority.

The new philosophy is very different.

  • the state, as representative of us all, takes the resources necessary to create the critical public infrastructure and basic functions - all those that are a natural monopoly or are best treated as a natural monopoly, plus whatever is required to fulfil the critical public purpose of the people who elect them (a health service, education, etc). 
  • the private sector is then allowed to play with the rest of the resources as it sees fit.
  • the state then takes what the private sector decides it doesn't want to use and deploys them sensibly for the 'nice to have' public purpose.
Within this philosophy the free market private sector is bookended by the public sector and sensibly contained - like any good nuclear reactor should be. Here the public sector gets first dibs at the resources of society and maintains the structures necessary for the private sector to operate at optimal efficiency and maximum output (for example, removing the need for 'jobs' in the private sector allows it to press on with automation). 

Correctly configured this philosophy actually creates a private sector that is larger than the original structure because, of course, it can maintain more of the population at a higher level of economic activity. However what it does do is remove political power from bankers and corporate leaders and we've known for decades they don't like that idea.

So once you see the difference in world view, Carney's comments become clear. He doesn't believe it is his job to trim back the private sector and makes space for government investment. And that is a political position based upon belief.

This interference is why the central bank must be moved further back under political control - to make it crystal clear it is operating under a particular philosophy. The central bank should operate like the Department of Work and Pensions - taking decisions independently, but under direction from a minister of the government. Otherwise you end up with an unelected individual in charge who doesn't, or can't, understand a change in political philosophy. In other words the central bank director should change when the government does.

The consequence of that is the central bank governor either has to be a minister in the government, or the governor reports directly to and receives directions from a minister. That doesn't necessarily mean that the minister sets interest rates, delegation on technical matters is fine, but it does mean that the minister sets the philosophy under which the bank operates.

The whole political idea behind moving the central bank away from politicians is to embed a particular philosophy into the economy and to then defeat any alternatives that might come up. We have seen that with the deplorable actions of the ECB in Greece, declaring banks solvent on the one hand and refusing liquidity on the other solely to bring down an elected government. And now we are seeing the same rumblings in the UK with a deliberately political and provocative statement from the Governor of the Bank of England against regime change. Something that if said by any other Civil Servant would probably lead to them being fired.

Central banks are run by people, and those people are just as corrupt, just as embedded in class viewpoints, and just as political as all the other politicians. Those feting central bankers as latter day Solomons really need to rethink their position. All individuals suffer from the same human failings. Democracy is how we mediate those failings.

Now we have TIARA - There Is A Real Alternative - the vested interests are coming out into the open, declaring their intentions and shoring up their defences.

And that highlights where the incumbent philosophy has embedded itself and which institutions need to change so they can cope when there are changes in philosophy via the political process.

Ultimately those institutions must accept change, or be made to change, because, at long last, it's TIARA time.

Tuesday, 15 September 2015

Corbynomics and the Current Budget Balance

One of the propositions put forward in the Corbynomics documents and subsequent discussions is the elderly Keynesian idea of balancing the current budget and letting the capital budget float. The suggestion is that it is more politically acceptable for the government to be seen investing in hard and solid Fixed Capital Formation rather than create money to undertake frivolous consumption activities such as education, training, R&D or elderly care.

The Keynes idea appears to come from a time before the Beveridge style welfare state was implemented and certainly before that evolved into a spending side auto-stabiliser system, but that 'fact change' doesn't appear to have dulled enthusiasm for the concept.

So I thought I'd dig into the numbers to show what it is all about and point out the issues.

The numbers come from the Public Sector Finance report from the UK's Office of National Statistics.

For the financial year 2014/15 the current budget deficit stood at £48,876mn. So that is the amount you have to generate from somewhere to get it to zero.

However before we do that it is useful to understand how you get that figure. What actually is the current budget deficit?

It is defined as:
Net Current Expenditure + Interest Paid + Depreciation - Current Receipts
so using the figures from 2014/15 (In £ mns) you get:
634,317 + 47,222 + 37,306 - 669,969 
To get the current budget deficit to zero you have to conduct extra investment spending - which then gets taxed away at the tax take percentage (which is 1 - the saving percentage) creating the extra tax receipts to cover the current budget deficit. Effectively you move the deficit from the current budget to the capital budget.

There are a couple of things to note from this calculation.

The first is that the depreciation figure is a transfer from the capital budget and adds to the current deficit. The more investment you do, the bigger the depreciation figure gets which then means you have to do ever more investment spending every year to cover the growing current deficit.

The second is the interest paid figure which similarly adds to the current deficit. The more investment spending you do at interest the bigger this figure gets. The higher interest rate you pay the bigger this figure gets. And the bigger the figure gets,  the more investment spending you have to do in subsequent years to clear the current deficit.

You can already see that there are two unfortunate positive feedback loops inherent within the calculations.

Net investment spending (Gross spending less depreciation) for 2014/15 was £30,328mn. If you express receipts as a percentage of total expenditure you find the tax take is 89.4%. So for every £100 spent, £89.40 came back as tax and £10.60 was held as financial savings.

The tax take percentage varies as the tax side auto stabilisers allow people to save. In the post crash era where people are generally saving it has been as low as 82%.

So to clear the current budget deficit at a conservative tax take of 80% you'd need to make £61,095mn of extra investment spending (i.e. the capital net spend needs to be three times what it currently is). That will vary up and down depending upon the actions of the automatic stabilisers. In 2009/2010 you would have needed £107,684mn of investment spending.

There is of course lots of talk within Corbynomics of closing tax gaps, changing rates and the like. All of that is largely distributional. If you take tax off one person, they can't then spend it with somebody else and you potentially deprive somebody of an income. Only where you defer or offset saving behaviour, somehow, is there an impact on the total tax take percentage. Really you're relying on the old balanced budget multiplier to work its magic - which likely isn't that effective in an open net importing economy like the UK.

There is, of course, no need to balance any budget, and doing so violates 'Lerner's Law'. The wisdom in Lerner's statement is already apparent given the brouhaha over People's QE. All that is down to the complexity of trying to present a simple overdraft or guarantee in flowery language. The mainstream have misinterpreted it and are now engaged in a campaign of misinformation. The lack of simplicity makes that difficult to counter.

Besides the complexity issues, balancing the current budget has clear issues.

  • you are limited to fixed capital formation and capital transfers. So you can build universities and hospitals, but you can't staff them.
  • eventually you run out of stuff to build. This leads to the old Labour problem of building roads to nowhere just to keep 'investment' going. 
  • you neglect items because of the current budget restriction. The only effective investment a government can make is in its people. But that is all current spend and is therefore difficult to do. 
  • you have to raise taxes to make the books balance. Nobody likes tax rises. Raising taxes is far more unpopular than explaining that budget balances are not really significant. It seems strange to take a political hit on taxation when you don't need to
  • Fixed capital investment targets a small section of the country's supply chain. Only a small section of the population is engaged in building things. The UK is 80% service based and people are trained for services. So you are quickly going to run into supply side capacity constraints, and potentially start to limit other capital development in the private economy.
  • the action of the auto-stabilisers pulls the current budget out of balance as a matter of design. If the economy contracts social security payments go up and tax take declines. You then have to do more investment spending to counter that. Yes there is more slack at that point, but is it the right sort of slack. Is the supply fungible enough?
  • the more investment, the more depreciation and interest paid. That leads to a positive feedback spiral between the current budget deficit and the level of required investment (and is another reason why Gilt Issues are harmful)

Overall it seems a strange political choice, when you can easily get away from adjusting taxes and allow yourself more freedom to improve direct services (the National Education Service for example) with a functional finance approach.  Simply explain that government is creating money so banks don't have to lend it. Government is stepping in so that ordinary people can save more and borrow less while at the same time ensuring everybody the private sector doesn't wish to hire has a job and an income. 

Surely the only people that would object to that are bankers and their economist lackeys.

Source: Office of National Statistics. Figures from Public Sector finance sequences: ANBT (Total Current Receipts), ANLO (Interest Paid), ANLT (Total Current Expenditure), ANNZ (Depreciation), ANMU (Current Budget Deficit), and ANNW (Net Investment). Data and calculations are available online

Thursday, 3 September 2015

Gilt Issues Considered Harmful

The title of this blog is a riff on the famous 1968 letter to the editor by the late Edsger W. Dijkstra called 'Goto Statements Considered Harmful'. That started the debate within computing to eliminate 'spaghetti code' (funnily enough often written in FORTRAN) and take the long slow road to using advanced 'high level' techniques. It led to the proof that goto statements were never required in programs, and the extensive mathematical work to provide the basis of higher level tools and techniques that I use every day in my work.

The paper contains the following quote:
... our intellectual powers are rather gathered to master static relations and that our powers to visualize processes evolving in time are relatively poorly developed. For that reason we should do (as wise programmers aware of our limitations) our utmost best to shorten the conceptual gap between the static program and the dynamic process, to make the correspondence between the program (spread out in text space) and the process (spread out in time) as trivial as possible
The parallel with economists and the economy should be clear to anyone observing their intellectual approach to the subject.

And secondly the letter sparked a whole series of papers and articles entitled 'X considered harmful' for a whole plethora of X. I am proud to continue the tradition and introduce the seminal work of Dijkstra and his colleagues to a wider audience.

What are Gilts?

Gilts are HM Treasury securities, like the Treasury securities of the USA. They represent liabilities of the National Loan Fund and are issued by the state. 

Functionally they are a form of guaranteed income bond - like the other savings certificates issued by National Savings. In fact in the not too distant past you could purchase Gilts via National Savings as an alternative to the products National Savings issued itself.

But there is one key difference. National Savings Income Bonds can only be bought by individuals, there is a fixed holding limit and they are non-negotiable (i.e. they can't be transferred - only sold back to National Savings or held until maturity), whereas Gilts can be held be any entity national or international, in any quantity and traded in a marketplace.

Once you understand that Gilts, like Savings Bonds, attract regular income and are a government annuity paid by the state to the holder of the Gilt, then you have to start assessing it like any other recipient of a government benefits - tax credits, state pension, disability benefit, housing benefit.

In other words what is the public purpose of providing the Gilt holder with a state income?

Who holds Gilts?

The Debt Management Office, a department of HM Treasury, issues Gilts and the produce a quarterly review of the Gilt Market. The Aug 2015 issue analyses the first quarter, and describes the holding distribution as this:

As you can see from the distribution, and even excluding the nominal holding by the Bank of England, very few Gilts are held directly by Households. The vast majority is held by financial intermediaries and overseas entities.

What is the public purpose of having these middlemen in the process? What is the public purpose of paying a state income to overseas entities? What is the public purpose of the trading market?

Gilts suppress Asset prices

Because Gilts pay an income and are negotiable, they add to the total income available to the private sector, which means - naturally - that the price of other income producing assets is less.

When the Bank of England withdrew Gilts from the market via QE, leaving in place the alternative Bank Reserves, the price of other assets went up.

So because more income is paid on Gilts than on the alternative Bank reserves, the price of private assets is lower than it otherwise would be.

Gilts suppress Spending

Income from Gilts ends up in the hands of a lot of entities that are unlikely to spend it - particularly overseas entities - so there is less demand than there should be given the level of government expenditure.

The actual result is likely to be similar to a tax cut for the wealthy - a greater increase in financial wealth saved by them. 

Gilts are just liabilities of the State.

QE did a swap of Gilts for Bank Reserves, to very little effect in the real economy. As it notes in the Whole of Government Accounts

Consolidating Quantitative Easing does not significantly reduce the overall liabilities of government but it does reduce the number reported as government borrowing. Once intra-government transactions are eliminated, the scheme represents an exchange of gilts (liabilities of the National Loans Fund) for central bank reserves (liabilities of the Bank of England).
Why pay a higher interest rate, or a term premium when you don't need to? 

Gilts back Private Pensions

The main contention made to support Gilts is that they manage the risk profile of private pension firms. And it is true that they do. In fact Indexed-Linked Gilts were introduced in 1981 by the Thatcher government specifically to do just that. The rationale behind them is a triumph of monetarism.

Of course what that tells you straightaway is that the private pension industry is incapable of managing the risk profile of pensions on its own within the private sector. It requires permanent government assistance to do so. The question then is what is the purpose of the private pension industry if it can't deliver the outcome that is required?

A simple pension savings plan at National Savings, along the lines of the Guaranteed Income Bonds and Indexed Linked Savings Certificates, would solve the problem permanently, would be limited to individuals, and would allow them to manage their risk profile as they approach retirement (they would sell out of risky assets and transfer the money to National Savings).

Since it would be only available to individuals and there is no need to pay middlemen, it is clearly far more efficient than the current Gilt issuing system.

Gilt Issues Considered Harmful

I agree with the conclusions reached by Bill Mitchell and Warren Mosler. Read Bill's post on public debt for a more detailed critique.
Most of the arguments made in favour of sustaining public debt issuance can be reduced to special pleading by an industry sector for public assistance in the form of risk-free government bonds for investors as well as opportunities for trading profits, commissions, management fees, and consulting service and research fees. [...] 
The operation of public debt markets absorb a diversity of real resources deployable elsewhere. [...] The opportunity costs in terms of the labour employed directly and indirectly in the public debt ‘industry’ are both real and large.
The ‘cottage industry firms’ that characterise the public debt industry use resources for public debt issuance, trading, financial engineering, sales, management, systems technology, accounting, legal, and other related support functions.
These activities engage some of the brightest graduates from our educational system and the high salaries on offer lure them away from other areas such as scientific and social research, medicine, and engineering. 
On balance, public debt markets appear to serve minor functions at best and the interest rate support can be achieved simply via the central bank maintaining current support rate policy without negative financial consequences. 
The public debt markets add less value to national prosperity than their opportunity costs. A proper cost-benefit analysis would conclude that the market should be terminated.