Archive for the 'UK' Category

Digital currencies, including Bitcoin

Back in 2011, I wrote a post about Bitcoin.

In March 2013 I started employment at the Bank of England and this blog went into dormancy.

My view evolved somewhat since then. Interested readers might care to read two new articles in the Bank’s Quarterly Bulletin on digital currencies. I was a co-author on both of them.

That link also includes two videos (hosted on YouTube), one of which features my head talking awkwardly.

Monetary policy, fear of commitment and the power of infinity

This is a fascinating time to be thinking about monetary policy…

Like everybody else, central banks can do two things:  they can talk, or they can act.

Some people say that talk is cheap and, in any event, discretion implies bias.

Other people point out that things like central bankers’ concern for their reputation mean that it’s perfectly possible to promise today to implement history-dependent policy tomorrow. Some cheeky people like to point out that this amounts to saying that, when in a slump, a central bank should “credibly commit to being irresponsible” in the future.

In fact, some people argue (pdf) that, in my words, “all monetary policy is, fundamentally, about expectations of the future.”  But if that’s the case, why act at all? Why not just talk and stay away from being a distorting influence in the markets?

There are two reasons: First, since since talk is cheap, credibility requires that people know that you can and, if necessary, will act to back it up (talk softly and carry a big stick). Second, because if you can convince people with actions today, you don’t need to explicitly tell them what your policy rule will be tomorrow and central bankers love discretion because no rule can ever capture what to do in every situation and well, hey … a sense of mystery is sexy.

OMO stands for “Open Market Operation”. It’s how a central bank acts.  Some scallywags like to say that when a central bank talks, it’s an “Open Mouth Operation.” Where it gets fun (i.e. complicated) is that often a central bank’s action can be just a statement if the stick they’re carrying to back it up is big enough.

In regular times, a typical central bank action will be to announce an interest rate and a narrow band on either side of it. In theory, it could be any interest rate at all, but in practice they choose the interest rate for overnight loans between banks. They then commit to accepting in or lending out infinite amounts of money if the interest rate leaves that narrow band. Infinity is a very big stick indeed, so people go along with them.

So what should a central bank do when overnight interest rates are at (or close to) zero and the central bank doesn’t want to take them lower, but more stimulus is needed?

Woodford-ites say that you’ve got to commit, baby. Drop down to one knee, look up into the economy’s eye and give the speech of your life. Tell ’em what you promise to do tomorrow. Tell ’em that you’ll never cheat.  Pinky-swear it … and pray that they believe you.

Monetarists, on the other hand, cough politely and point out that the interest rate on overnight inter-bank loans is just a price and there are plenty of other prices out there. The choice of the overnight rate was an arbitrary one to start with, so arbitrarily pick another one!

Of course, the overnight rate wasn’t chosen arbitrarily. It was chosen because it’s the price that is the furthest away from the real economy and, generally speaking, central bankers hate the idea of being involved in the real economy almost as much as they love discretion. They watch it, of course. They’re obsessed by it. They’re guided by it and, by definition, they’re trying to influence it, but they don’t want to be directly involved. A cynic might say that they just don’t want to get their hands dirty, but a realist would point out that no matter the pain and joy involved in individual decisions in the economy, a cool head and an air of abstraction are needed for policy work and, in any event, a central banker is hardly an industrialist and is therefore entirely unqualified to make decisions at the coalface.

But as every single person knows, commitment is scary, even when you want it, so the whole monetarist thing is tempting. Quantitative Easing (QE) is a step along that monetarist approach, but the way it’s been done is different to the way that OMOs usually work. There has been no target price announced and while the quantities involved have been big (even huge), they have most definitely been finite. The result? Well, it’s impossible to really tell because we don’t know how bad things would have been without the QE. But it certainly doesn’t feel like a recovery.

Some transmission-mechanism plumbers think that the pipes are clogged (see also me).

Woodford-ites say that it’s because there’s no love, baby. Where’s the commitment?

Monetarists say that infinity is fundamentally different to just a really big number.

Market monetarists, on the other hand (yes, I’m sure you were wondering when I’d get to them), like to argue that the truth lies in between those last two. They say that it’s all about commitment (and without commitment it’s all worthless), but sometimes you need an infinitely big stick to convince people. They generally don’t get worked up about how close the central bank’s actions are to the real economy and they’re not particularly bothered with concrete steps.

So now we’ve got some really interesting stuff going on:

The Swiss National Bank (a year ago) announced a price and is continuing to deploy the power of infinity.

The European Central Bank has switched to infinity, but is not giving a price and is not giving any forward guidance.

The Federal Reserve has switched to infinity and is giving some forward guidance on their policy decision rule.

The Bank of England is trying to fix the plumbing.

It really is a fascinating time to be thinking about this stuff.

Monetary policy still works at the ZLB

In case anybody was wondering, monetary policy definitely still has an effect at the zero lower bound.  In the UK, the banks have unwittingly (and certainly unwillingly) been part of a demonstration of a so-called helicopter-drop of money.  In a country of 60 million people, by mid 2008 there were over 20 million Payment Production Insurance (PPI) policies in effect and that number was growing fast.  In early 2011, they were ruled to have been mis-sold (customers were deemed, in general, to have been pressured or deceived into buying insurance they didn’t need) and banks were ordered to offer compensation.  Wikipedia has a summary here. From a pair of articles in the FT ([1], [2]):

[Article 1] About £4.8bn had already been paid out by the end of May – effectively acting as “helicopter money” dropped into the hands of those people who may be among the most likely to spend it.

[Article 2] The independent Office for Budget Responsibility, relying on estimates that PPI refunds would deliver £6bn over the year, revised up its estimate of the growth rate of real disposable household income by 0.5 percentage points in March from its November figure … the amounts set aside for PPI redress by the five biggest banks have now soared to almost £9bn.

[Article 2] The FSA said it does not know the average payout per claimant. But some of the “complaints management” companies, which have been making aggressive pitches to help consumers get their money back, say these average £2,000 to £3,000 per applicant.

[Article 1] “When I heard I was going to get over £2,000 in compensation I hired builders to fix a long-overdue problem with the eaves in my roof and put the rest of the money towards a holiday to Greece in September,” said Elaine Overten, a retired nurse from Derbyshire, who received compensation for PPI payments made on her NatWest mortgage over 10 years.

I just love the little (and not remotely subtle) hint from the FT that monetary stimulus would help Greece out of their hole.

Anyway, the point is simple.  If you put money in people’s hands, especially if those people are “credit constrained,” they will spend it.  That was the point of my “Monetary policy for 10 year olds” post a while ago.  It remains the point today.  It will always be the point.

The problem, of course, is that while PPI compensation payouts are acting as a positive stimulus, the corresponding hit to the banks will be causing them to hold back in their lending and so provide a negative stimulus at the same time.  If I had to guess, I’d say that the net effect of PPI compensation is to provide a positive stimulus because of the broad distribution and, I assume, the fact that a large fraction of the recipients really are currently credit constrained.

A brief note to George Osborne

Hi, George.

No doubt your political advisers have mentioned this to you by now, but just in case they haven’t, I thought I’d drop you a line.  The UK press are a funny lot. They will insist on making hay out of the budget every year (and let’s be frank, you like the attention), but you can never really tell which bits they’re going to ignore and which bits they’re going to put in the spotlight.  Take this hullabaloo over your decision to equalise the regular and old-age tax free allowances.  The ‘granny tax‘ (nice work on getting the Telegraph to rail against a Conservative chancellor, by the way).  There’s no way you could have seen it coming, right?  Right?


Really, George, it is quite simple.  Newspapers look for news.  Given all the leaks that you and the Lib Dems fed the media over the last couple of weeks during your bargaining, this was the only morsel, juicy or otherwise, that was left.  Here, I’ll spell it out for you:

  • If it is something new, it is more likely to be in the news (funny, that).
  • If it was in the news last week, it is less likely to be in the news this week.
  • If a loss is to be imposed on a group of people that are commonly taken to be sacrosanct, it will be the news.
  • A pound lost is at least twice as news worthy as a pound gained.
  • Furthermore, gains and losses are always described in whichever way looks more miserly.  That means:
    • Gains are expressed in real terms
    • Losses are expressed in nominal terms if they can be and real terms if they must

This whole kerfuffle hits every button on the nose.

Terrible news from Apple (AAPL)

Apple just reported their profits for 2011Q4.  It turns out that they made rather a lot of money.  So much, in fact, that they blew past/crushed/smashed expectations as their profit more than doubled on the back of tremendous growth in sales of iPhones and iPads.  [snark] I’ll bet nobody’s talking about Tim Cook being gay now. [/snark]

It’s an incredible result; stunning, really. I just wish it didn’t make me so depressed.

I salute the innovation and cheer on the profits. That is capitalism at its finest and we need more of it.

It’s that f***king mountain of cash (now up to $100 billion) that concerns me, because it’s symptomatic of what is holding America (and Britain) in the economic doldrums.

The return Apple will be getting on that cash will be miniscule, if it’s positive at all, and conceivably negative.  Standing next to that, their return on assets excluding cash is phenomenal.

Why aren’t they doing something with the cash? Are they not able to expand profits still further by expanding quantities sold, even in new markets? Are there no new internal projects to fund? No competitors to buy out? Why not return it to shareholders via dividends or share buybacks?

Logically, a company holds cash for some combination of three reasons: (a) they use it to manage cash flow; (b) they can imagine buying an outside asset (a competitor or some other company that might complement them) in the near future and they want to be able to move quickly (and there’s no M&A deal that’s agreed upon faster than an all cash deal); or (c) they want to demonstrate a degree of security to offset any market perceived risk with their debt.

Apple long ago surpassed all of these benefits.  The net marginal value of Apple holding an extra dollar of cash is negative because it returns nothing and incurs a lost opportunity cost.  So why aren’t their shareholders screaming at them for wasting the opportunity?

The answer, so far as I can see, is because a significant majority of AAPL’s shareholders are idiots with a short-term focus. They have no goddamn clue where else the money should be and they’re just happy to see such a bright spot in their portfolio.  Alternatively, maybe the shareholders aren’t complete idiots — Apple’s P/E ratio has been falling for a while now — but the fundamental point is that they have a mountain of cash that they’re not using.

In 2005 that wouldn’t have been as much of a problem because the shadow banking system was in full swing, doing the risk/liquidity/maturity transformation thing that the financial industry is meant to do and so getting that money out to the rest of the economy.[*] Now, the transformation channel is broken, or at least greatly impaired, and so nobody makes any use of Apple’s billions. They just sit there, useless as f***, while profitable SMEs can’t raise funds to expand and 15% of all Americans are on food stamps.

Don’t believe me?  Here’s a graph from the Bank of England showing year-over-year changes in lending to small- and medium-sized enterprises in the UK.  I can’t be bothered looking for the equivalent data for the USA, but you can rest assured it looks similar.  The report it’s from can be found here (it was published only a few days ago).  The Economist’s Free Exchange has some commentary on it here (summary:  we’re still in trouble).

So what is happening to all that money?  Well, Apple can’t exactly stick it in a bank account, so they repo it, which is a fancy way of saying that they lend it to a bank (or somebody else in the financial industry) and temporarily take some high quality asset like a US government bond to hold as collateral.  They repo it because that’s all they can do now — there are no AAA-rated, actually safe, CDO tranches being created by the shadow banking system any more, they’re too big to make use the FDIC’s guarantee (that’s an excellent paper, btw … highly recommended) and so repo is all they have left.

But the financial industry is stuck in a disgusting mess like some kid’s hair with chewing gum rubbed through it. They’re all just as scared as the next guy (especially of the Euro problems) and so they’re parking it in their own accounts at the Fed and the BoE.  As a result, “excess” reserves remain at astronomical levels and the real economy makes no use of Apple’s billions.

That’s a tragedy.




[*] Yes, the shadow banking industry screwed up. They got caught up in real estate fever and sent (relatively) too much money towards property and too little towards more sustainable investments. They structured things in too opaque a manner, failed to have public price discovery and operated under distorted incentives. But they operated. Otherwise useless cash was transformed into real investment and real jobs. Unless that comes back, America and the UK will stay in their slow, painful household deleveraging cycle for another frickin’ decade.