What is currency?

Posted by Christie Malry on September 1, 2012 at 11:59 am

Those of you that have children will be used to questions that can't be answered. You know, things like "Why is grass green?" Attempts to respond with "Because of chlorophyll" will be met with further, impossible questions such as "Yes, but why is it green? Why not purple? Why not yellow with pink spots?" And so on. And as soon as they shut up about one question, they're on to another. "Daddy, why do spiders have eight legs? Why do we have two legs, two eyes and two ears but only one nose and one heart? Why do we have some words with two or more meanings when there are lots of gibberish words that aren't already used?"

And today, d1 asked a question that I struggled to answer. "Daddy, why are there different currencies in the world?"

I suspect that in order to answer this properly, I need to be able to explain to her coherently what currency is. And I'm simply not articulate enough with economics to be able to give her a good answer.

So, does anyone care to answer these questions in a way that a clever 10 year old could understand? Why are there different currencies in the world? And what are currencies anyway?

Shocking inflation revisionism from Eoin

Posted by Christie Malry on August 21, 2012 at 10:37 pm

This is totally shocking revisionism from Eoin:

The problem for the UK is that under George Osborne, wage growth has languished badly whilst inflation has gripped the economy. In previous economic slow downs we could often expect the GDP slump to be accompanied by a fall in inflation or a slowing down in the growth of prices. Under Tory rule, however, the Bank of England has consistently over-estimated the speeds at which inflation would fall. The levels of inflation are no accident. 20% VAT levels added 0.7% to inflation throughout 2011, and in 2012 growing instability in Europe as well as increasing petrol costs have led to increased prices across several sectors due to higher transport and manufacturing costs. To put it short, government policy has a direct impact on the levels of inflation. George Osborne chooses to let this problem continue.

Let's just remind ourselves of what happened before 2010:

OK, so we can possibly cut Gordon Brown some slack during the financial crisis itself, from 2008. But you can see that he was content for inflation to run above its 2% target from 2005 onwards, a full three years before the crisis. The Bank of England's failure to get a grip on inflation is a long-running saga.

I'm as happy as the next man to put the boot into Osborne for failing to deal with the economy. But to pretend that all the trouble started in May 2010 is a blatant lie. The inflation-led approach to the economy was a deliberate policy started by Gordon Brown and allowed to continue by Osborne, not something that Osborne created himself merely to wreck the economy and kill poor people.

Ritchie plumbs new depths

Posted by Christie Malry on August 20, 2012 at 10:05 pm

In which he uses a BMJ paper on suicides and unemployment to bash the Tories. As if making political capital out of other people's misery wasn't grubby enough, he fails to notice that the paper considers data to 2010, covering the period during which Labour were in government. Doh!

The final word on the impact of tax on employment

Posted by Christie Malry on August 20, 2012 at 9:48 pm

The Treasury is considering the introduction of "mini-jobs", which allow people to take on work without paying tax or national insurance, in a bid to boost employment.

So there you have it. Even the Government thinks that tax destroys employment. So just think how much more employment there might be if taxes were lowered.

Government preference for SMEs

Posted by Christie Malry on July 12, 2012 at 10:51 pm

NYU tax professor Daniel Shaviro asks a good question: what's so special about SME's anyway?

"Small business" sounds good rhetorically, whether you are trying to put a misleading face on support for the top 0.1%, like the Republicans, or simply trying for a more generally faux-populist tone, like the Democrats.  Tax breaks for "big business" certainly don't sound as wholesome.  But there is no particular reason to favor one part of the business sector over another, or to give businesses a tax incentive to stay small  And even without the rhetorical edge, "small business" often has an advantage over "big business" in mustering political support in Congress, due to the advantages of being decentralized and hence in lots of members' districts, where the "small business" leaders often are prominent local personages and important campaign contributors.

Instinctively, we like the idea of helping the "little guy". But might government action actually be more effective if targeted at larger businesses?

Universal pensions insurance is a bad idea

Posted by Christie Malry on July 9, 2012 at 9:25 pm

The Telegraph reports that pensions minister Steve Webb wants to encourage the private sector to produce a system of insurance for defined contribution pension plans:

Ministers fear that unless they can guarantee that pensioners’ money is safe, they will be deterred from saving. The average Briton saves almost £300 a month in a workplace pension, comprising both personal and employer contributions as well as tax relief from the Government.

Experts propose that workers pay a levy on contributions of 0.75 per cent, about £30 a year on average.

The policy, provided by private insurance companies, would guarantee savers that their pension pot on retirement is worth at least the combined value of their contributions, their employers’ contributions and the tax relief they have received over their working lives.

Well, of course, the devil lies in the detail. But, as presented, this is a bad idea:

  1. The insurance policy puts a floor under the value of a pension fund, but it doesn't put a ceiling over it. So the rational policy, were you to purchase this insurance, would be to buy the riskiest assets possible. You'd know that your fund cannot fall below its purchase price, but you'd be maximising your potential upside.
  2. Given that investors are likely to react in this way, I'm sceptical that the private sector could supply the insurance at the price quoted. If it can't, or if a scheme fails, government will find themselves under great pressure to make up the difference using taxpayers' money.
  3. Webb also fails to recognise that capital loss is merely one small part of trust in pensions. If he were to consider my bucket model of pensions, he'd realise that interest rates in retirement and mortality (which drive annuity prices) and inflation are just as, if not more, important. A saver might find himself having to save much much more, merely because annuity prices are low or because government failed to keep a lid on inflation. This is a big reason why people don't have trust in pensions.
  4. Many pension providers already help pension savers to protect against falling asset prices by encouraging savers to move their assets into safer categories as they near retirement.

We'll have to see where the final scheme ends up, if this ever gets implemented. But it's half-baked. If Webb really wants to transform private defined contribution pensions saving, he'd be better off incentivising employers to pay similar sorts of pensions to their employees in defined contribution schemes as they do to their employees in defined benefit schemes. That's the real issue here. 

The cost of PFI

Posted by Christie Malry on July 8, 2012 at 9:22 pm

I know Worstall has already dealt with this somewhat. But his website has fallen over again, so I'll cover a piece I don't think he addressed.

The Guardian is very excited about how PFI will cost £300bn.

As you might expect, they have adopted the usual statistical obfuscation of quoting the entire cost over many years, in this case decades.

In addition, as Worstall points out, the usual suspects have compared this cost to the capital outlay required to purchase the assets outright. But PFI includes service costs in addition, so any fair comparison would need to separate the capital outlay from these costs in order to make the comparison like-for-like.

And to really estimate how much PFI is costing us, you'd need to compare the PFI contract cost to the sum of:

  1. the capital outlay we would have spent; plus
  2. interest we would have had to spend; plus
  3. the ongoing costs of providing the services that we would have spent but which are now covered by PFI.

It's possible, indeed likely (given that a primary motivation wasn't cost saving but to massage the nation's balance sheet), that PFI will still come out as more expensive. But if you're going to put the boot into PFI, please at least do so on a reasonable basis. Otherwise you just look and sound ridiculous.

Zipcar creates cars out of thin air!

Posted by Christie Malry on June 10, 2012 at 12:22 pm

Zipcar creates cars out of thin air! No, really.

People might think that when they sign up for Zipcar, that a car is bought with their name on it. It isn't.

Instead what Zipcar does is a conjuring trick. They agree to provide you with a car when you want it. But at the point at which you sign up, they don't go out and buy another car. They merely create an account for you. Note that there are no cars involved in this process at all. It's just an accounting trick. Nothing more.

All that matters is that they can provide cars to those who need them when they need them.

Zipcar will charge you for the benefit of having opened an account for you. Even though there is no car as such, even thought you think there is. Because you can drive a car as if you really did own it. 

Of course, they need some cars. That's necessary to ensure that those who do want to drive can do so.

And of course they can't repeat this trick forever because if they did people would realise that there was no substance behind the promise they made to you when you agreed to sign up to their service. That promise is that the car that's notionally "yours" can be driven by other people, and it's a promise that is only as good as their own efficiency. If they're unable to supply cars to people when they need one, confidence in their service will suffer.

But that's the confidence part of the trick. So long as people believe that Zipcar will provide them with a car, they don't actually need a car. They can just pretend they own one. When people don't have that confidence, they will find that they do need a car. The risk is that companies like Zipcar will bring in too many members for the number of cars that they have.


Well, by now you'll probably have seen through what I'm doing here. People instinctively understand what companies like Zipcar are trying to do. But when the company is providing money, not cars, people throw their comprehension out of the window.

Banks aren't doing anything magical or mysterious. They merely take money from people who don't currently need it and lend it to those who do, thereby stimulating the economy. They act as an essential intermediary between these two people, ensuring that the borrower repays and that the 'lender' can actually access his/her money if needs be.

This notion that banks create money out of nothing is bona fide idiocy of the highest order.

History lesson for Ritchie

Posted by Christie Malry on May 30, 2012 at 11:09 pm

Source: Paul Krugman, here.

As he says, not good, but hardly unprecedented right now.

And no cause to panic, at all.

One question, Ritchie.

Where's the world war that would justify increasing our debt above its long term equilibrium position?

Using a bucket to model pensions

Posted by Christie Malry on May 30, 2012 at 10:14 pm

Today, doctors voted to strike over changes that are being made to their pension plans. Having been surprised to see clearly intelligent people talk complete gibberish about pensions, it's obvious that a simple guide to pensions is needed. So here it is.

Pensions are like a bucket.

The idea is to fill the bucket with water (representing money) while you're working. And then you empty the bucket when you retire. Easy, isn't it?

Well, it would be, but this situation requires a lot of judgements:

Filling the bucket

You have to decide:

  • How much water to add to the bucket each year;
  • How many years you'll add water to the bucket; and
  • (ok, this doesn't quite fit) The level of investment growth over the period up to retirement.

Emptying the bucket

You have to decide:

  • How much water you'll take out the bucket each year;
  • How many years you'll take water out of the bucket; and
  • (ok, this doesn't quite fit either) Interest rates in retirement (because pension pots are turned into safe income streams). 

There's a hole in my bucket

Inflation is a cancer that will eat into your pension both up to and during retirement. So you have to decide:

  • How big is the hole in the bottom of your bucket (representing inflation).

So how does all this work?

The relationship between these items is fairly self-explanatory. Putting in more water every year, putting in water for more years and obtaining high levels of investment growth will lead to a lot of water in the bucket. Desiring a high pension for a lot of years while interest rates are low will require a bucket with lots of water in it. An emptyish bucket requires either a low pension or a shorter period of retirement.

The logic underpinning the bucket is inescapable.

But this doesn't apply to me because I've got a defined benefit pension plan

Yes, the bucket does apply to you. Even if you have a defined benefit pension plan. It's just that different variables are held constant compared to your unfortunate brethren on defined contribution plans.

Those on defined contribution plans typically have "number of years in" fixed. They then have "asset returns", "inflation", "number of years out" and "interest rates" as independent variables. If those variables conspire against them, as they have in recent years, then if they don't want "water out" to suffer, they must increase "water in". As most employers don't increase their level of contribution, employees must increase their pension savings unilaterally, or accept a lower pension in retirement.

Those on defined benefit plans typically have "number of years in", "inflation" and "water out" fixed. They have "asset returns", "number of years out" and "interest rates" as independent variables. If those variables conspire against them, as they have in recent years, then "water in" must be increased substantially to compensate. The difference to defined contribution plans is that the responsibility to increase contribution levels usually rests with the employer, not the employee.

OK, so defined benefit plans don't actually have a bucket with each employee's name on it. They have one big bucket, into which current employees and employers pay and from which pensioners are paid. But it's a helpful discipline to think of there being separate buckets. Those supporting the doctors strike like to argue that the current scheme is "in surplus" because there is more being paid into the scheme than is being paid out. Thinking about it in bucket terms shows this argument to be a load of nonsense. The excess of contributions over pensions in payment tells us nothing about the long term viability of the scheme, which can be determined only by considering the other variables in the equation.

So, are the doctors right to strike? 

I don't intend to answer that question here. But a proper answer to the question requires you to consider just how much it costs to provide a doctor with the promised level of pension, given assumptions over mortality and inflation. Is the current employee contribution to this cost fair, or should the employee be asked to contribute more for a longer period of time to make it fairer?

Any answer that doesn't consider this angle simply doesn't answer the question at all.