The numbers associated with the current financial crisis are getting mind-boggling.
Bonuses in the millions (for failing)
Losses in the billions
Bailouts in the trillions
Liabilities in the quadrillions
and so on and so on...
It's both surreal and unreal. So it's time to think of a way to get back to reality. But what could we use?
Currencies are hard to measure at present as we are all hell-bent on debasing the damned things. What is the alternative?
Ah, yes! The faithful ironing board!
In a past professional life I used to make ironing boards for a living (I also used to make tea for a living, but that's another story...). Not glamorous, but on reflection, I'm actually very proud of it. Millions of people now use something 'real' that I had a big influence in developing.
It's 'real' - unlike most of the nonsense going on in the economy at present.
For simplicity sake, going forwards I'll refer to an ironing board as being:
1 IB sells for £10 (for now)
1 IB generates about £2 of profit
So if you make 1000 ironing boards, it should generate £10,000 of sales and £2,000 of profit. On an average day a factory of about 50+ people would make 1500-2000 ironing boards. Quite a bit of effort to generate only £3-4k of profit.
Why bother when Governments and banks can just print billions?? That's the problem that our country faces currently.
So when bankers say they 'deserve' millions in bonuses and billions in bailouts, think how many ironing boards that equates to...
Tuesday, 10 February 2009
Thursday, 5 February 2009
Paul Volcker - The Solution?
Who and where will the solutions to the current economic problems come from?
A starting assumption: The UK might as well be the 51st state of the USA. A brief analysis of the last 40-odd years of interest rate and inflation patterns show a strong correlation between the two (much stronger than most of Europe).
If we accept that the above holds to a reasonable degree, then we need to take a close look at the US for leads of where we are going and where solutions may lie.
There aren't many policymakers in either the UK or US that inspire me with confidence at present. One notable exception is a bloke called Paul Volcker.
Paul who??
Paul Volcker was chairman of the Federal Reserve (US central bank) between 1979 and 1987. His relevance today can be summed up by saying that he is a 'friend of sound money', which is something that many of today's 'free money' generation will find weird. After all, what's wrong with abolishing taxation and just printing the money to fund a bottomless pit bailout programme and stimulus package?
The reason I think it matters is that long-term 'sound money' is the most likely solution to our current problems. As a society, we don't realise it yet - it's too early in the downturn - but history tells us that at some point funny money must be replaced by sound money to heal the economy. We can't carry on funding society with printed money - sorry to disappoint fans of all the stimuli packages!
This is someone who has been there and done it in an economic crisis; taking tough decisions that his predecesors were too afraid to. Google the guy - he talks sense in straightforward language, unlike the constant riddles from his successor at the Fed, the 'sage' Sir Alan Greenspan. Here's an example from today:
Quote:
Some banks are not only "too big to fail," Mr. Volcker said. Some are "too big to exist."
Dead right; and the further we get into this mess the more he will be proved correct...
Volcker has been pulled in by Obama to head up a new economic advisory panel - which is an encouraging sign. But his 'sound money' views don't fit with many in Washington at present, so there seems to a lot of delaying going on. Let's hope he is consulted sooner rather than later.
When things get really messy (maybe a few years away yet) at some point we'll get desperate and then you can expect that Paul Volcker (or someone similar) will get wheeled out to come up with the solution.
In the meantime, the Daily Mash is probably closer to the truth than most mainstream economists at present!
A starting assumption: The UK might as well be the 51st state of the USA. A brief analysis of the last 40-odd years of interest rate and inflation patterns show a strong correlation between the two (much stronger than most of Europe).
If we accept that the above holds to a reasonable degree, then we need to take a close look at the US for leads of where we are going and where solutions may lie.
There aren't many policymakers in either the UK or US that inspire me with confidence at present. One notable exception is a bloke called Paul Volcker.
Paul who??
Paul Volcker was chairman of the Federal Reserve (US central bank) between 1979 and 1987. His relevance today can be summed up by saying that he is a 'friend of sound money', which is something that many of today's 'free money' generation will find weird. After all, what's wrong with abolishing taxation and just printing the money to fund a bottomless pit bailout programme and stimulus package?
The reason I think it matters is that long-term 'sound money' is the most likely solution to our current problems. As a society, we don't realise it yet - it's too early in the downturn - but history tells us that at some point funny money must be replaced by sound money to heal the economy. We can't carry on funding society with printed money - sorry to disappoint fans of all the stimuli packages!
This is someone who has been there and done it in an economic crisis; taking tough decisions that his predecesors were too afraid to. Google the guy - he talks sense in straightforward language, unlike the constant riddles from his successor at the Fed, the 'sage' Sir Alan Greenspan. Here's an example from today:
Quote:
Some banks are not only "too big to fail," Mr. Volcker said. Some are "too big to exist."
Dead right; and the further we get into this mess the more he will be proved correct...
Volcker has been pulled in by Obama to head up a new economic advisory panel - which is an encouraging sign. But his 'sound money' views don't fit with many in Washington at present, so there seems to a lot of delaying going on. Let's hope he is consulted sooner rather than later.
When things get really messy (maybe a few years away yet) at some point we'll get desperate and then you can expect that Paul Volcker (or someone similar) will get wheeled out to come up with the solution.
In the meantime, the Daily Mash is probably closer to the truth than most mainstream economists at present!
Gordon Brown does the Hoovering
A few months ago, I dug out Edward Chancellor's (very good) book on speculative bubbles and read the chapter on the Great Depression of the 1930's. The aim was to see what mistakes our current leaders were likely to copy from that period.
The one thing that leapt out was the similarity between Gordon Brown and US president Herbert Hoover. Both were finance ministers during the boom and were seen as the steady hand during those times. But they both took over around the time of the bust starting and it was all downhill from there.
Brown constantly blames "global problems" rather than his own government for helping contribute to the conditions for the crash. Again, this rhymes perfectly with Hoover. Whilst it worked initially, it eventually backfired badly on Hoover.
Over time, Hoover became associated more and more with the problem, as measures became increasingly desperate, rather than the solution. Although still early in the current cycle, Brown is showing all the signs of going down the same route. People already laugh at the suggestion of him being still an iron leader with prudence as his middle name. A couple of years ago, you'd have been branded a bitter loonie for suggesting that. How times change.
My feeling is that until all the people involved (Brown included) recognise that there was a fundamental problem with the financial system (and people's role in it) prior to the credit crunch then we can't move into the healing stage for the economy. The UK is still a million miles from taking the bitter medicine needed (balancing/reversing our various deficits) and until we recognise it makes no sense to 'return to 2007' then our problems will continue to get worse. But that would require real leadership.
Hoover got booted out in the elections of 1933 and was replaced by 'New Deal' Roosevelt.
Much as Brown likes to think of himself as the new Roosevelt, the signs suggest he'll go down in history as the new Hoover. Definitely not a Dyson...
The one thing that leapt out was the similarity between Gordon Brown and US president Herbert Hoover. Both were finance ministers during the boom and were seen as the steady hand during those times. But they both took over around the time of the bust starting and it was all downhill from there.
Brown constantly blames "global problems" rather than his own government for helping contribute to the conditions for the crash. Again, this rhymes perfectly with Hoover. Whilst it worked initially, it eventually backfired badly on Hoover.
Over time, Hoover became associated more and more with the problem, as measures became increasingly desperate, rather than the solution. Although still early in the current cycle, Brown is showing all the signs of going down the same route. People already laugh at the suggestion of him being still an iron leader with prudence as his middle name. A couple of years ago, you'd have been branded a bitter loonie for suggesting that. How times change.
My feeling is that until all the people involved (Brown included) recognise that there was a fundamental problem with the financial system (and people's role in it) prior to the credit crunch then we can't move into the healing stage for the economy. The UK is still a million miles from taking the bitter medicine needed (balancing/reversing our various deficits) and until we recognise it makes no sense to 'return to 2007' then our problems will continue to get worse. But that would require real leadership.
Hoover got booted out in the elections of 1933 and was replaced by 'New Deal' Roosevelt.
Much as Brown likes to think of himself as the new Roosevelt, the signs suggest he'll go down in history as the new Hoover. Definitely not a Dyson...
Monday, 26 January 2009
A Good Bank?
We had a good news story last week in the form of our old friend Northern Rock being in much better shape than expected and now being worthy of yet another infusion of cash. Although lacking both taste and judgement, the 10% staff bonus story concerns me less than the £10bn infusion package.
I mean, WTF? So it makes sense to reward the most reckless UK lender with a package to allow it to outcompete viable businesses and undertake yet more malinvestment? How about rewarding more responsible institutions (e.g. Nationwide / Cooperative / etc) that deserve to survive? Nah, far better to force them out of business and let Northern Rock survive. World gone mad...
I've held the view from the start that Northern Rock should have gone to the wall as it was painfully obvious even in 2006 that it would be the first bank to fail with its' suicidal business model. Hence it would be wasted ammo needed for bigger problems downstream. But that's not a popular position to hold.
The problem with everything associated with Northern Rock is the notion of moral hazard. Namely, the responsibility for managing risk. If bad decisions have no consequences, such as being left to collapse when your whole business model falls over, then it leads to more and more bad decisions.
Now, having bailed out most of the UK banking sector, a queue of begging bowls is forming with many major employers (particularly foreign owned) ready to blackmail the government to get their share of the cash that the bond market is just dying to throw at UK PLC over the next few months for 0% return*.
It's unfortunate that the good banks and businesses that deserve help the most will be at the back of this queue, so probably won't see the money. Is this really the best way to heal the economy?
* - bold section is ironic!
I mean, WTF? So it makes sense to reward the most reckless UK lender with a package to allow it to outcompete viable businesses and undertake yet more malinvestment? How about rewarding more responsible institutions (e.g. Nationwide / Cooperative / etc) that deserve to survive? Nah, far better to force them out of business and let Northern Rock survive. World gone mad...
I've held the view from the start that Northern Rock should have gone to the wall as it was painfully obvious even in 2006 that it would be the first bank to fail with its' suicidal business model. Hence it would be wasted ammo needed for bigger problems downstream. But that's not a popular position to hold.
The problem with everything associated with Northern Rock is the notion of moral hazard. Namely, the responsibility for managing risk. If bad decisions have no consequences, such as being left to collapse when your whole business model falls over, then it leads to more and more bad decisions.
Now, having bailed out most of the UK banking sector, a queue of begging bowls is forming with many major employers (particularly foreign owned) ready to blackmail the government to get their share of the cash that the bond market is just dying to throw at UK PLC over the next few months for 0% return*.
It's unfortunate that the good banks and businesses that deserve help the most will be at the back of this queue, so probably won't see the money. Is this really the best way to heal the economy?
* - bold section is ironic!
The Madness of Crowds
BBC Economics editor Stephanie Flanders started off her own editor's blog last week by suggesting that the current problems were a "bolt from the blue" and that no-one had predicted the recession we are in. This was met with a torrent of comments from people pointing out that many 'punters' saw the problems coming from a mile off yet the 'professionals' did not. Quite right too....
This opens up a can of worms relating to how crowd behaviour skews performance in a number of professions. 3 pertinent examples spring to mind: Journalists, Economists and Fund Managers. In these cases, it is seen as being less risky to 'fail with the crowd' than risk being 'proved right alone'. There's a famous quote by Keynes: "the market can stay irrational longer than you can stay solvent". Namely, you could be right in the long-term but the irrational behaviour would get you the sack before that happens!
So why bother listening to these people or investing with them????
Errrmmmm..... Pass.
In the case of fund managers, there have been a number of studies exploring the returns from tracker funds (automated funds for things like the FTSE 100). In most cases they provide better than average returns than funds with active managers. Between extra charges and listening to daily noise, the active managers end up doing worse than if they had done nothing!
Madness...
This opens up a can of worms relating to how crowd behaviour skews performance in a number of professions. 3 pertinent examples spring to mind: Journalists, Economists and Fund Managers. In these cases, it is seen as being less risky to 'fail with the crowd' than risk being 'proved right alone'. There's a famous quote by Keynes: "the market can stay irrational longer than you can stay solvent". Namely, you could be right in the long-term but the irrational behaviour would get you the sack before that happens!
So why bother listening to these people or investing with them????
Errrmmmm..... Pass.
In the case of fund managers, there have been a number of studies exploring the returns from tracker funds (automated funds for things like the FTSE 100). In most cases they provide better than average returns than funds with active managers. Between extra charges and listening to daily noise, the active managers end up doing worse than if they had done nothing!
Madness...
Friday, 23 January 2009
Housing Part 1
The housing market. The UK's favourite pastime. Until recently...
For the last 5-10 years it has been hard to find anyone over 25 who did not hold an opinion (or expertise) on housing. Even now, it's not uncommon to believe that rising house prices go hand in hand with a healthy economy. Like boom goes with bust?
For a subject matter that many people understand, the intricacies can be quite complicated. Things like:
The current cycle is a biggie! Using the Halifax data, the ratio peaked around 5.8 in mid-2007. That was 30-40% over the trend value (i.e. 30-40% overpriced).
It's currently (Dec 08) around 4.4, so is still 10-20% overpriced.
But note that prices overshoot on the down slope as well as the up. So house prices could well fall further...
If we assume that house prices bottoming out is key to putting a floor under the current problems (bank losses, repossessions, etc) then either prices need to fall quickly (deflation?) or wages rise quickly (inflation?).
This brings us to another key concept to master: 'nominal' and 'real' house prices. Nominal is the face value of the house at any point (e.g. £200k now and £200k 2 years later are the same nominally) whilst real house prices take account of inflation (so with 2 years of 10% inflation, the above example would have lost almost 20% and only be worth about £162k in equivalent terms). A lot of people don't 'get' real house prices - and our politicians know that!
If the politicians get their way and run the printing presses at full speed, nominal house prices could rise sooner than we think. But they would not 'real'-ly be going up in value...
For the last 5-10 years it has been hard to find anyone over 25 who did not hold an opinion (or expertise) on housing. Even now, it's not uncommon to believe that rising house prices go hand in hand with a healthy economy. Like boom goes with bust?
For a subject matter that many people understand, the intricacies can be quite complicated. Things like:
- What is a 'fair' average price?
- Have trends changed in recent years?
- Do granite worktops in kitchens add more value to a house than having 10 bathrooms?
- Is it linked to the current financial crisis? (obvious question!)
- How did high house prices contribute to our problems?
- What should 'normal' lending criterion be?
- What is a sustainable level of lending for the economy?
- If prices are too high, how can we tell when they are good value again?
- etc etc - the list is endless.
Here's my take on the key question:
What is a fair average price and how can we tell if housing is overpriced or underpriced?
Traditionally, house prices have a good correlation with earnings, so a good measure is the average price:earnings ratio. Namely:
Average Price / Average Earnings
The trend for the last 25 years (plus my 'best guess' of the next 3 years) is shown on the graph below.
Before the mid-70's, this ratio had a trend between 3 and 3.5 but more recently it has moved up closer to 4. Since the 1980's another theme has been that the ratio has fluctuated more - indicating more extreme boom and busts.
For the ratio to go up, either house prices have to rise or average earnings has to fall.
For the ratio to go down, either house prices have to fall or average earnings rise (inflation???).
The current cycle is a biggie! Using the Halifax data, the ratio peaked around 5.8 in mid-2007. That was 30-40% over the trend value (i.e. 30-40% overpriced).
It's currently (Dec 08) around 4.4, so is still 10-20% overpriced.
But note that prices overshoot on the down slope as well as the up. So house prices could well fall further...
If we assume that house prices bottoming out is key to putting a floor under the current problems (bank losses, repossessions, etc) then either prices need to fall quickly (deflation?) or wages rise quickly (inflation?).
This brings us to another key concept to master: 'nominal' and 'real' house prices. Nominal is the face value of the house at any point (e.g. £200k now and £200k 2 years later are the same nominally) whilst real house prices take account of inflation (so with 2 years of 10% inflation, the above example would have lost almost 20% and only be worth about £162k in equivalent terms). A lot of people don't 'get' real house prices - and our politicians know that!
If the politicians get their way and run the printing presses at full speed, nominal house prices could rise sooner than we think. But they would not 'real'-ly be going up in value...
The Blame Game
I was listening to a phone-in on the radio the other day. It was discussing whether the 'UK was finished?' This was in response to Jim Rogers suggesting last week that the UK financial industry as a powerhouse was finished.
Shock! Horror! One after another the callers were angry. Jim Rogers was to blame for the fall in sterling. What a nasty man - after all he ran the highly successful Quantum fund with that evil George Soros fella who forced us out of the ERM in 1992. It must be his fault...
I'd beg to differ. Having tracked Rogers' commentary of the problems that have been developing over the past few years (and read a couple of his books), he saw this coming years ago and has not jumped on the bankwagon recently like many lemming economists.
He's a free-thinking individual who is not afraid of airing unpopular views on economic policy. His advise on what the Federal Reserve chief (US central bank - the Fed) Ben Bernanke should do? "Abolish and Fed and then tender his resignation". You wouldn't get the Times' idiotic duo of Anatole Kaletsky and David Smith suggesting that...
When he says the UK is going to struggle due to running out of oil and the financial collapse, I struggle to see a flaw in his logic. But that would be too close to the truth for many of the current crop of politicians. So we might as well blame him for all our ills. It's easier than taking heed and doing something positive about it!
Rogers' expertise is in commodities and is a strong advocate of agriculture in the mid to long term. His suggestion for how to utilise the finance geeks who caused a lot of the problems we now face:
Shock! Horror! One after another the callers were angry. Jim Rogers was to blame for the fall in sterling. What a nasty man - after all he ran the highly successful Quantum fund with that evil George Soros fella who forced us out of the ERM in 1992. It must be his fault...
I'd beg to differ. Having tracked Rogers' commentary of the problems that have been developing over the past few years (and read a couple of his books), he saw this coming years ago and has not jumped on the bankwagon recently like many lemming economists.
He's a free-thinking individual who is not afraid of airing unpopular views on economic policy. His advise on what the Federal Reserve chief (US central bank - the Fed) Ben Bernanke should do? "Abolish and Fed and then tender his resignation". You wouldn't get the Times' idiotic duo of Anatole Kaletsky and David Smith suggesting that...
When he says the UK is going to struggle due to running out of oil and the financial collapse, I struggle to see a flaw in his logic. But that would be too close to the truth for many of the current crop of politicians. So we might as well blame him for all our ills. It's easier than taking heed and doing something positive about it!
Rogers' expertise is in commodities and is a strong advocate of agriculture in the mid to long term. His suggestion for how to utilise the finance geeks who caused a lot of the problems we now face:
"Bankers should learn to drive tractors"
At least we could blame them if the harvest were to fail...
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