The Index of Economic Freedom

I had big plans to write a post this morning about the oil price. But then my host server decided to have a lie-in. A long one.

So that oil price post is on hold until Monday, and in the interim, I thought that this infographic might be interesting, following on from yesterday’s post:

Happy weekend!

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

Businesses? Not Free Markets, actually.

In the world of economics out there in the academic ether, there are lots of Big Ideas about the economy and the way it works. But I listened to an FT Alphaville podcast earlier this week that declared that we’re done with the Big Ideas now, and economists are henceforth going to be winning Nobel prizes for the work that they do on topics that are the economic equivalent of studying the flora in the digestive system of a particular sub-species of starfish, as found in the coastal waters off the north side of an archipelago belonging to an obscure Pacific island.

I’m not clever or informed enough to know whether that prediction is reasonable.

But there are some Big Contradictions that we don’t seem to have settled yet. Mainly, between:

  • Free and unfettered markets (farewell regulation); and
  • Welfare states (state intervention)

In practice, you get a bit of a mix – but because the free markets fans will see almost any state regulation as being too much regulation, the ideological argument is still very much alive.

I guess that the unspoken rule is that the argument is a bit like Evolution versus Creationism: where all the real scientists know Evolution/Free-Markets to be true and empirically evident, while the Creationist/State-Interventionist cretins are misguided, wishful and unenlightened. Oh, and they’ve caused more bloodshed over the millennia than anyone else*.
*Which has always struck me as a spurious argument in the case of religion. Stalin and Mao managed quite fine as atheistic villains. I feel like we should be declaring that the quest for power and its retention has caused more bloodshed than anything else – and religion was the ultimate power tool back when religion was a given. Today, we’ll just as willingly go to war over an ideal and/or political philosophy. Which in effect counts for much the same thing.

But I’m just not convinced that it’s as simple as that.

Mainly because: when was the last time that your life actually reflected a free market ideal?

As children, we grow up under (hopefully) benevolent dictators in the form of parents. You get bad dictators, of course. But we’re yet to dispense with parenthood as a means to raising children. Although, I guess, you could wait for the free market forces to feed the baby. It’ll probably die – but in the mind of free market economists, that’s just collateral damage. Eventually, the need to propagate will encourage the parents to care for a child at some point, always assuming that they’re rationally self-interested and, you know, not lazy, crazy or stupid.

Then we went to school, where you basically found yourself regulated by a welfare state. You could break the rules, and sometimes there would be repercussions. But for the most part, the school was interested in getting you educated – and that formed a large motivation for the rules. It didn’t always work, because one size never fits all. And sometimes, the practicalities of policing meant that some rules were stricter than they needed to be. But it was all a process.

Finally, you started working, where you discovered that the world is very much a selection of fiefdoms, monarchs and communist states; in which the boss is the autocratic ruler, and all the underlings live in fear and hope to curry favour. In some corporations, working hard meant higher rewards. In other corporations, it doesn’t matter how hard you work relative to your colleague, you all pull out the same paycheck on the 25th.

Perhaps the only real form of free market exists socially. You get to pick and choose your lovers, provided that they also pick you. But inevitably, we end up institutionalising our romantic relationships and turning them into socialist states where everything is shared and regulations exist* with punitive consequences for violating them**.
*Fidelity, buddy.
**Divorce and alimony

The point is, on a smaller scale, we don’t live in a world of free markets. We live in a world filled with corporations (kingdoms) and family units (socialist dictatorships).

The free market hypothesis for political economy is that we just let the corporations (in particular) run around unfettered and do whatever they want. Because, ultimately, what’s good for the kingdom is what’s good for the subjects, and what’s good for the subjects will be longterm survival of the species (so we’ll suddenly end up taking care of the environment and allocating resources efficiently and getting less unequal).

Does that sound remotely plausible?

History has rarely ever demonstrated that what’s good for the kingdom is what’s good for the subjects. More like: what’s good for the kingdom is what’s good for the king. And no matter the size of the kingdom, most monarchs get to their positions in the search for power – and if they want power, they’ll go to war; and with enough war, you get empires; and what was once a free-for-all is back at Hail, Caesar. Or Hail, Mr Koch and Mr Koch. Or Hail, Mr Ma.

Perhaps it’s just me.

But I think that the Big Ideas in economics still ignore the practical reality of being social beings with a need for hierarchy and pecking orders (mostly, the desire to be higher up in both).

Also, I don’t really care about starfish.

In the meantime, here’s a slightly derisive comic on some of the free market pitfalls (email subscribers, if you can’t see this, then here’s the link).

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

Graphic Novels and Social Security

I am a big fan of the January holiday. It’s the only time of the year that I don’t sit down to write a daily post (instead, you get a whole lot of pre-prepared posts – most of which get rushed into the scheduling during the first two weeks of December). But it gives me a chance to see and do things that I don’t normally have time for. And this January, my big plan was to discover the graphic novel.

I’m not entirely sure why.

Actually – that’s a lie. I blame the team at Pop Culture Happy Hour, who completely transformed my internal narrative from:

“Comics are about superheroes that I really don’t care about and why would I read that when I could be reading real books?”

to

“These are works of art. Real art. And you get non-fiction and indie-fiction and all manner of genre that don’t have anything to do with the Marvel universe or Japanese Manga.”

The other big benefit is that picture books align much better with our internal mental digestion. After all, when we read words, the mental process looks a lot like:

  1. Read words
  2. Try to form mental image of what is going on
  3. Read more words
  4. Assess against mental image of what is going on
  5. Tweak as necessary
  6. Start again if mental image doesn’t hold together
  7. Store in the memory bank

Comic books tend to do this:

  1. Look at image
  2. Read words to understand image
  3. Store in the memory bank

So what happens (I find) is that you’re able to absorb information/ideas/theories with both ease and speed.

Which isn’t really all that useful when you’re reading about Batman. But it’s particularly helpful when someone comes along and writes a non-fiction history of Economics.

Here it is:

To be frank, it’s a book that deserves the adjective “monumental”. I often try to condense economic concepts into illustration. And lemme tell you – it’s far easier to write than it is to illustrate (mainly because, when writing, it’s easy to take all kinds of knowledge for granted). And to see it done on this scale is masterful.

And if you’d like some proof, then I think that you should spend 3 minutes this morning going to this page: Economix explains what is going on with Social Security. It’s 16 pages of comic. And here is the first page:

See how quick that was to read? Finish the rest in the next 3 minutes here.

See how quick that was to read? Finish the rest in the next 3 minutes by clicking here.

I’m not saying that I agree with him about Social Security. But I do love getting so much information in a nutshell.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

Germany: History has more lessons than just inflation #GreekElections

Dear Germany

I know that you’re a bit concerned about Alexis Tsipras and his election win in Greece. There’s lots of rhetoric floating around about all the debt that Greece won’t be paying under his stewardship, and that doesn’t sit well with (mostly) yourselves. The other members of the Eurozone as well – but especially yourselves.

And I know that it would be nice if the Greeks collectively agreed with you about your inflation fears. After all, they too had a hyperinflation. Awkwardly enough, they experienced it while they were under your occupation (totes awks – but still). But regardless, it would be nice if they had remembered the lesson as well as you have, amirite?

Except, I worry that you too haven’t learned some lessons here.

So first off, no one is denying that the Weimar Republic left you with a legacy of hyperinflation. Even though much of that hyperinflation was caused by the Weimar Government trying to pay back impossibly huge debts imposed upon you by the Treaty of Versailles, as the direct consequence of the war waged by a Kaiser that you subsequently rejected.

That said, this seems to have made you most wary of rampant money creation and not at all wary of the costs involved in external insistence on crippling debt, however justified.

But I also want to point out that the Weimar Republic left you with a second legacy. A legacy of austerity under the Brüning government between 1930 and 1932. When Chancellor Brüning decided that he should cut back on everything in order to pay down the reparations debt. Here’s a quote from the Economist:

…all classes lost out when Brüning’s government reacted to a projected fiscal deficit and gold outflows in 1930 with deflationary policies. The resulting economic tailspin hurt most groups in German society. Unemployment surged among both the working and middle classes. Businessmen went bankrupt. Civil servants were either laid off or had their wages repeatedly slashed. Creditors lost their savings and debtors had their homes repossessed when the banking system collapsed in 1931. The experience of deflation made Hitler’s promises to conquer unemployment and stabilise prices by any means necessary attractive to a wide range of groups in German society, making it into a mass political movement across Germany for the first ever time in the early-1930s. The rest, as they say, is history.

It’s the trouble with austerity – it creates the conditions for very anti-austerity parties to come to power. Parties with no clear economic agenda other that “not this”. Parties led by Hitlers.

At this point in time, you need to be more concerned with the second lesson.

After all, when a radical leftist Prime Minister decides to visit the tombs of war heros on the day of his inauguration, having formed a coalition government with a radical right-wing party, having just been swept to power on a stream of anti-austerity rage, how do you think things will end?

No one is advocating hyperinflation in the Eurozone. 

But you need to soften your austerity stance here and try something else.

After all, austerity isn’t working.

And you should know this better than anyone.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

Batman, Expectations, and QE?

Meet Batman:

Just joking. This is Batman:

His name is Daniel Kish, he’s blind, and he gets around using echolocation. Here he is teaching it:

I realise that this may sound like a bit of old news. Daniel Kish has been appearing in feature segments of believe-it-or-not style documentaries for years. But recently, he was the baseline for an episode of my newest favourite podcast: NPR’s Invisibilia. The episode dropped on Friday, and you can download it (like, for free!!) here.

Daniel’s Story

In summary:

  1. When he was a toddler, he had both his eyes removed after a cancer scare.
  2. Instead of abandoning him to a home for the blind, his mother allowed him to climb trees and go to a public school and really just be normal.
  3. It seems that if you leave blind toddlers to their own devices, they naturally start to click with their tongues and learn to navigate their world using human echolocation.
  4. The public schooling system told Daniel’s mother that he needed to stop clicking, because it was socially “unacceptable” (or something along those lines).
  5. His mother refused.
  6. Daniel learned to ride a bike (supposedly impossible).
  7. Media were amazed.
  8. Daniel had an epiphany when he came into contact with other blind people – realising that they are basically constricted by the way that they are treated. People expect them to need help, so they get helped, and they never really need to learn the coping mechanisms (such as echolocation) that would allow them to navigate the world more independently.
  9. Daniel becomes a kind of activist against the Organisations for the Blind that instil dependence in the very people that they are meant to help.
  10. Daniel starts teaching echolocation to young blind children.
  11. Neuroscientists perform tests on the brains of echolocators, and realise that the visual areas of the brain that are normally dormant in the blind are, instead, blazing hubs of activity.
  12. The good news: the blind can see.
  13. Caveat: if they’re allowed to.

Here is the TED Talk:

The take-home message from all this is, I guess, that expectations shape reality. It’s the same old message that has launched many thousands of self-help books and programs.

But I wanted to share this because it feels more scientific and demonstrable than just the philosophical ramblings of The Secret. This is the real deal. The kind of story that ends with blind people literally being able to see. In the way that we see. After all, when you come down to it, eyes are just an opening for light-absorbing neurones to transmit a series of electric pulses to a processing unit in your brain that translates all that activity into a perception of space and the placement of objects within it. Why not do that with sound?

Sure, you may not get colour, and all the benefits that come with that (like reading, and night-skies, and so on). And you may struggle with the transparent (a window is a solid object, after all). But what you lose on the roundabout…you gain in being able to see in the dark.

So the moral of the story is: if you expect the blind to be helpless in their disability, then you tend to create the conditions for that to be true.

Expectations are powerful things.

And this Power of Expectation…

Is exactly what the ECB, the Bank of Japan and the Fed are relying on when they launch programs of Quantitative Easing.

For all the theoretical arguments and the assertions of portfolio-rebalancing effects (see here), QE is really just a way for a Central Bank to persuade an economy of people to believe that the boom times are just around the corner.

And the hope is that, if they’re aggressive enough:

  • consumers will start to spend their money instead of saving it, because they expect inflation (even if the real problem is more that consumers are neither spending nor saving owing to their not-being employed); and
  • firms will start to hire workers in expectation of all this renewed consumption (thereby giving the means to the workers to consume); and
  • banks will start to lend to these firms in expectation of all the improved returns based on all the renewed consumption (even though banks are biased in favour of historical data as a basis for their lending practice, which is not helpful when the historical data of firms is all very doom-and-gloom).

The problem, of course, is that:

  • consumers need jobs (and job security) before they start spending again;
  • firm-owners are naturally skeptical, and want to see signs of recovery before they’ll throw themselves back into debt; and
  • bankers are naturally averse to losses on their loans (bad for bonuses!), and want some evidence of better returns before they’ll extend them.

It’s why Keynes was such a fan of fiscal intervention – because that tends to start more logically by giving the consumers the means to consume, rather than starting from behind. It also tends to shape reality with reality.

You see, unfortunately, part of the power of expectations is that they’re powerfully difficult to change once they’re entrenched. It’s why Mr Kish is an activist against the Organisations of the Blind, rather than their champion.

That said, miracles do happen. After all, Daniel is blind, and he’s leading the blind, and he rides a bike.

So there’s plenty of hope.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

Mario Draghi gives the Eurozone QE. And look at Denmark, dancing.

In case you missed the full announcement, here’s the link: Mr Draghi gets caught in a broken lift, arrives late, and  announces Quantitative Easing for the Eurozone.

Here is the key paragraph:

[The Governing Council of the ECB] decided to launch an expanded asset purchase programme, encompassing the existing purchase programmes for asset-backed securities and covered bonds. Under this expanded programme, the combined monthly purchases of public and private sector securities will amount to €60 billion. They are intended to be carried out until end-September 2016 and will in any case be conducted until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term. In March 2015 the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary market. The purchases of securities issued by euro area governments and agencies will be based on the Eurosystem NCBs’ shares in the ECB’s capital key. Some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme.

And this is the other key paragraph:

As regards the additional asset purchases, the Governing Council retains control over all the design features of the programme and the ECB will coordinate the purchases, thereby safeguarding the singleness of the Eurosystem’s monetary policy. The Eurosystem will make use of decentralised implementation to mobilise its resources. With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (which will be 12% of the additional asset purchases, and which will be purchased by NCBs) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases. This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing.

So let me give you those two paragraphs again, this time with the important parts highlighted in red:

[The Governing Council of the ECB] decided to launch an expanded asset purchase programme, encompassing the existing purchase programmes for asset-backed securities and covered bonds. Under this expanded programme, the combined monthly purchases of public and private sector securities will amount to €60 billion. They are intended to be carried out until end-September 2016 and will in any case be conducted until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term. In March 2015 the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary market. The purchases of securities issued by euro area governments and agencies will be based on the Eurosystem NCBs’ shares in the ECB’s capital key. Some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme.

As regards the additional asset purchases, the Governing Council retains control over all the design features of the programme and the ECB will coordinate the purchases, thereby safeguarding the singleness of the Eurosystem’s monetary policy. The Eurosystem will make use of decentralised implementation to mobilise its resources. With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (which will be 12% of the additional asset purchases, and which will be purchased by NCBs) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases. This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing.

What that means:

  1. No, journalists, this QE program is not “bigger than expected”. It’s exactly what was expected. The ECB was already buying up €10 billion worth of asset-backed securities and covered bonds each month. Come March, it will be buying an extra €50 billion per month of investment-grade government bonds (and some debt from euro-area public agencies – whoever they are, because I’m not sure who they are, and google was unhelpful). Which is about what the consensus was expecting.
  2. Buying “investment-grade” securities technically means that Greece and Cyprus are locked out of the QE program.
  3. But if you read the detail of the technical press release that came out later yesterday (see here), it seems that “investment-grade” securities also includes “non-investment grade” securities (those of Greece and Cyprus), provided that they play by the rules. If not, “during reviews in the context of financial assistance programmes for a euro area Member State, eligibility would be suspended and would resume only in the event of a positive outcome of the review” #sneaky #AlexisTsiprasWatchOut
  4. That said, the allocation of the monthly €50 billion between the member states will be based on the proportional shares held by the individual National Central Banks in the European Central Bank. So:
    Thanks the ECB

    Thanks the ECB. And in case you’re wondering how it is that the total is not 100% – it’s because the other 30% of the shares in the ECB are held by Central Banks whose countries are not full members of the Eurozone (like the Bank of England, etc).

    Meaning that Cyprus was never going to feature that strongly, seeing as they hold only 0.15% of the shares.

  5. Also, Germany will be getting the largest portion of the stimulus – which is a bit ironic seeing as they’re not really the ones that so desperately need it.
  6. “Decentralised implementation” means that the ECB won’t be buying directly – it’ll be making their purchases through the Central Banks of the member states. Many people think that this is a Bad Thing because it shows Eurozone Disunity and Lack of Commitment, but that was really just a question of the risk-sharing (because if the risk was shared equally by everyone, then this would just be a practical way to get the buying done).
  7. On the risk-sharing front, 20% of all asset purchases will be equally shared, and the rest will be for the account of the individual National Central Banks. That is: “We’re 20% in this together; and 80% each to his/her own; unless there’s a crisis and you need a bailout because you can’t print money, in which case, we’re all 100% German European.”

In Related News

After the announcement, Denmark had to cut its interest rates for the second time in three days.

According to Bloomberg:

“Denmark sent hedge funds and other speculators a clear message yesterday, daring them to test the full force of its monetary arsenal at their own peril.”

According to the Danish National Bank:

“We have plenty of kroner. We have the necessary tools in terms of interest-rate changes and interventions and we have a sufficient supply of Danish kroner.”

According to me:

“Yes, but you had to cut your interest rates twice in three days. That sends its own clear message. And it sounds a lot like Abba singing S.O.S.”

We shall see. But for my money, the Danish krone will need to free-float. And soon.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.

Eurozone Quantitative Easing: The Man on the Street (?) Summary

Today, the world is expecting Mario Draghi to announce a formal round of Quantitative Easing in the Eurozone. And I say “formal” because actually, it’s already been sort of happening through the ECB’s purchases of “peripheral bonds”*.
*That is: buying the government debt of the peripheral Eurozone countries, like Cyprus, Greece, Italy, Portugal, etc. These bond purchases were “sterilised”, meaning that every purchase had to be matched by a removal of equal liquidity from the system. But from what I understand, in practice this just meant that normal banks would briefly have higher reserve requirements with the ECB (ie. they were required to keep more money in their bank accounts at the ECB) – and given that they were already holding some excess reserves (because they weren’t lending as much as the ECB would have liked), the impact was not really that important.

Given that the ECB is announcing this process many years after the Fed, and the Bank of England, and the Bank of Japan, I feel like there are two obvious questions:

  1. Why the delay?
  2. Will it work if they’re so late to the party?

If you’re wondering how QE works, I do have an earlier post on this (check it out here), but here is the basic summary that I lifted off this excellent article at the New York Times*:
*It really is excellent – I’ve read a stack of Euro QE articles, and I liked this one best.

Why The Delay?

The big reason that everyone throws around when asked this question is “Germany” and “the Bundesbank” and all those German fears of hyperinflation. And to an extent, I guess that’s true.

But I’d bet that another big reason is that we still don’t know if QE works. Almost every article I’ve read describes the various rounds of QE in the United States as having been “largely successful”. To which I’ll say:

  1. ?
  2. On what basis?
  3. They did it for six years, and then they ended it. The US economy recovered a bit, which economies are bound to do with enough time anyway. And six years is quite a long time. I’m just not sure that you can say “The proof that QE worked is by thinking about what could have been had QE not happened”. That is not proof. That is speculation.
  4. Japan has been trying it for decades with near no success.
  5. All that QE really accomplished was a spike in asset prices.
  6. Almost none of the impact was felt by consumers. Who are the folks responsible for greasing the economic machine.
  7. And while some might argue that the spike in asset prices has to converge on consumption spending over time – I’m just not convinced that’s always the case, especially in situations where the top 1% own almost half of everything (see here and here).

Anyway. The point is, the political will seems to be tending toward allowing some more extreme action to be taken. And I’m sure that Mario Draghi is at the point of trying almost anything.

But will it work?

In the end, I think we’re almost certain to conclude that it will. Mainly because the commentary will end up saying “Imagine what would have happened had they not.”

But that aside, on the face of it, there are some rather glaring issues:

The “How” is a big one

There are no eurobonds for the ECB to buy (unlike the US treasuries that the Fed was mopping up). The ECB is going to engage in the equivalent of the Fed buying up the bonds of individual States.

So does the ECB buy up the bonds of the states that most need stimulation (like Greece, Cyprus, Portugal), which would deeply displease the Germans? Does it buy up the bonds by proportion of Gross National Debt, in which case, Italy and Germany would get the largest stimulus? Does it buy it by proportion of GDP, when again, Germany would get the largest injection of liquidity?

Many people are making an issue out of whether the ECB does the actual bond-buying, or whether it delegates out the bond-buying process to the various national Central Banks – but in my mind, that’s just semantics for the benefits of the Germans (“See? You’re not buying the debt directly..”). Ultimately, it amounts to much the same thing.

The bigger issue is how they divvy up the actual bond-buying.

Then where will all this extra liquidity go?

Regardless of how they do it, that extra liquidity will flow into the market – and past experience would suggest that the money will flow straight into financial assets and alternative currencies and carry-trades offshore. Possibly also into some commodities – which would certainly be a bit of welcome relief for those markets.

But the flow of money into alternative currencies is almost certainly why (in my mind) the Swiss abandoned the euro peg. And if you want my vote, I’d be throwing money into the Danish krone – because I’m just not convinced that they’re ready for what defending that exchange rate will entail. Especially if (when?) the Wall Street FX traders spin their leverage into Denmark.

The Big Question

The real hope is that the spike in asset prices and the drop in bond yields will encourage European firms to take advantage of the cheap capital and launch themselves into consumer sales.

And this would hopefully have a spiral effect – expansion creates jobs, which creates consumption, which validates the expansion, and so the recovery kickstarts.

To be honest, I feel like this ignores the reality of real-life business. Most businesses don’t launch expansion programs in order to create demand for their products. They expand in response to higher demand.

Which is why you need the fiscal stimulus first. Otherwise, you’re asking the horse to push the cart.

Unfortunately, German austerity…

But enough of the gloom

QE is actually really good news for investors! Especially if you’re the smaller investor on a street that’s not quite Wall Street who will actually consume a bit more if your general wealth goes up.

Because if today goes as expected, asset price spike ahoy.

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.