This is the text of my spiked article published on Thursday

 It is hard to resist the conclusion that Barack Obama loathes Benjamin Netanyahu, the Israeli prime minister, after watching videos of their joint press conferences. President Obama’s eyes sometimes seem to glaze over as Netanyahu explains Israel’s official position in his characteristically forthright style.

In fact, it isn’t necessary to rely on body language to discern Obama’s feelings. His dislike of the Israeli leader has been an open secret for years. Although Obama has avoided insulting Netanyahu to his face, the US media have clearly been made aware of the president’s view. Obama has also made trenchant public criticisms of Netanyahu, blasting his recent address to Congress as ‘theatre’ and warning that Netanyahu is threatening to ‘erode the meaning of democracy’. It is also inconceivable that Denis McDonough, the White House chief of staff, would have called for an end to Israel’s ‘50-year occupation’ of the West Bank without the president’s permission.

It is likely that at least a small part of this animosity is personal. Netanyahu, known as Bibi in Israel, is a consummate practitioner of what Israelis call dugri: a slang term that can be roughly translated as frankness or straightforwardness. Foreigners often see what Israelis regard as honest directness as rudeness or arrogance. A BBC article on the subject gave several examples that will no doubt ring true for many who have visited Israel. For instance, the author recalled being told off for time-wasting by a museum official after asking politely whether it was permissible to take photographs.

But even interpersonal tensions should be seen in a broader context when they strain relations between two national leaders. Obama clearly resents Netanyahu’s failure to treat him with what he regards as due deference. He is, after all, the president of the United States, while Netanyahu is, when it comes down to it, the leader of a small Middle Eastern state.

When looked at from this perspective, it soon becomes apparent that stark double standards are in play. No doubt Netanyahu lacks diplomatic tact. It is also true that his recent address to Congress, made at the invitation of the Republican speaker of the House of Representatives, represented interference in domestic American affairs. However, Obama has no qualms about America’s right to intervene overseas, including launching drone attacks in several countries and, in effect, endorsing the 2013 military coup in Egypt. Western leaders are apparently allowed to use all means they see fit, up to and including military force, to interfere in other nations’ affairs. In contrast, Netanyahu’s slightly partisan approach to US politics is seen as the outrageous stance of an uppity Israeli. From the Obama administration’s perspective, Netanyahu’s biggest sin was acting as if he were equal to the American president.

Ironically, many self-proclaimed supporters of the Palestinians, as well as some prominent members of the Israeli elite, essentially endorse the view that Netanyahu is failing to show due deference to the American president, and to the West more broadly. In recent months, pro-Palestinian activists have redoubled their calls for Western diplomatic action, often including sanctions, against Israel. In one stroke, they are endorsing the West’s right to interfere overseas and supporting the scapegoating of what is, by global standards, a small nation: Israel.

Such critics point to Netanyahu’s ill-judged remarks in a Facebook video, in which he referred to leftists bussing in Arabs to vote in ‘droves’. But those who argue that Israel should be singled out as a pariah state should reflect on the West’s own record. Perhaps they should visit the 1,954-mile border, heavily fortified across much of its length, between the US and Mexico. If they did, they should be left in no doubt that the American authorities discriminate against Mexicans. Or maybe they should take a voyage to the Mediterranean, where they can witness a European Union naval armada keeping out desperate migrants from Africa and the Middle East. As a result, the sea has become a watery graveyard for many thousands of people over the years.

Sometimes the singling out of Israel for particular moral condemnation is justified by its supposedly special relationship with the US. According to this view, Israel is especially dangerous because of its close ties to the world’s largest economic and military power. In the most common version of the argument, which has echoes of traditional anti-Semitism, the Israeli lobby is portrayed as a shadowy body manipulating US politics. An alternative version, generally associated with the left, is that Israel acts as a watchdog for the West in the Middle East.

Historically, until about 1990, there was a degree of truth in the second view. The US typically saw Israel as a strategic asset that would generally align itself with American interests in the Middle East. This was partly because both were hostile to what were then radical movements of Palestinian nationalism and pan-Arabism. Both those movements viewed themselves as fighting for a degree of autonomy in the region outside of Western interference. It was also a time when the US was itself reluctant to intervene too openly in the Middle East. Instead, it depended on local allies, such as Israel and (until 1979) Iran, to help pursue Western interests.

What the contemporary critics of Israel miss, however, is that this set-up was swept away a quarter of a century ago. In Operation Desert Shield (1990/91), the US led a huge military force against Iraq. This was followed by a full-scale Western invasion of Iraq in 2003, and the sending of large numbers of troops to Afghanistan from 2001 onwards. There have also been numerous smaller-scale interventions, including the 2011 military intervention in Libya and the launch of numerous drone strikes in Yemen.

Such interventions mean that Israel has long since ceased to play its role as a strategic asset for the West in the Middle East. On the contrary, in the days of the Islamic State and civil wars across much of the region, the Israeli state is typically viewed by the West more as a liability than an asset. The West is increasingly keen to distance itself from Israel rather than to befriend it.

This is the broader context that explains Obama’s falling-out with Netanyahu. It is far more than just a personal matter. In the decades that followed the Second World War, both of the main US political parties could be relied upon to give Israel broad support. However, in recent years Israel has become particularly estranged from a large section of the Democratic Party, including the current president. It is true that, for the time being at least, Israel still has generally warm relations with the Republicans. But the fallout with the Democrats represents an important shift in relations between Israel and the US. It is also one that is likely to persist after Obama leaves office in January 2017.

That still leaves what critics of Israel typically regard as their trump card: the fact that the US still gives Israel about $3 billion (£2 billion) every year in aid. This, they contend, proves that the two countries still have a special relationship.

But a closer look at the aid figures shows the trend is going in exactly the opposite direction to that the critics claim. For a start, the $3 billion aid figure should be set against Israel’s GDP of $320 billion and US GDP of $16.5 trillion. In other words, US aid to Israel is equivalent to about 1% of Israel’s annual economic output.

A closer look at the figures also shows that, in real terms, the amount of US aid to Israel is steadily trending downwards. A study by the official US Congressional Research Service shows that official US assistance to Israel peaked at about $4.9 billion in 1979 (the year of the overthrow of the pro-Western shah in Iran, as well as the signing of the peace treaty between Israel and Egypt). Converted into current prices, using the official US inflation calculator, that is equivalent to about $15.8 billion in today’s money. In real terms, then, the level of US aid to Israel is running at less than a fifth of what it was running at at its peak. This confirms that the US is distancing itself from Israel. Even if 1979 is regarded as an exceptional year, the amount of US aid to Israel has diminished sharply in real terms over the years.

It is time for some Israeli-style straight-talking on the changed realities in the relationship between the Middle East and the West. Relations between Israel and the US, particularly the Democrats, are at an all-time low. Israel no longer plays the role it once did as a strategic asset for the West in the Middle East. If anything, it is increasingly seen by Western leaders as a problem. And under such circumstances, it is more important than ever to oppose Western intervention against all countries in the Middle East — and that includes Israel.

It was only recently that I recognised the adoration Britain’s leading financial newspaper has for the man often dubbed the thinker behind the Occupy movement. The Financial Times published a long extract from David Graeber’s new book, The Utopia of Rules, on the front page of its weekend Life and Arts section.

I quickly realised it did not end there. There was an associated podcast with Graeber and two leading FT columnists. Then there was the review of the book by Gillian Tett, another FT star, where she called his previous work a “brilliant treatise”. It was only recently that I recognised the adoration Britain’s leading financial newspaper has for the man often dubbed the thinker behind the Occupy movement. The Financial Times published a long extract from David Graeber’s new book, The Utopia of Rules, on the front page of its weekend Life and Arts section.

Helpfully BBC Radio 4 was running a 10-part serialisation of Graeber’s earlier book on Debt: the first five thousand years at about the same time. This provided me with the opportunity to grapple with his ideas having shamefully failed to read the earlier work. I do not begrudge David Graeber the publicity and I am not criticising the FT for covering his books (full disclosure: I sometimes write for the FT on a freelance basis). What I do find telling is that the newspaper apparently feels so comfortable with views many would assume are so far from its own.

The thrust of his argument is essentially that the world has been organised around the repayment of debt for at least five millennia. Not only does debt provide the economic rationale for society but, in Graeber’s view, it is also the basis for morality and religion. He argues it is a contradictory outlook since it assumes people should repay their debts but, at the same time, regards lenders as evil.

In emphasising the importance of debt rather than money he claims to be debunking a core assumption of economics. To make his point he cites Adam Smith who argued in The Wealth of Nations that barter preceded money. Graeber, who is a professor of anthropology at the London School of Economics, says that Smith and his followers get it the wrong way round. Graeber says the evidence shows that debt preceded money. Complicated credit arrangements were in place long before money was introduced.

Although it is not a central point there is more than one sleight of hand in this claim. For a start Graeber tends to assume that in earlier eras money meant coinage but that was not what Smith argued. In the chapter on the origins of money in The Wealth of Nations he wrote that during the time of Homer, the ancient Greek writer, oxen sometimes acted as a means of valuation. In any case, the assumption that barter predated money is not central to Smith’s economic model. The thrust of Smith’s argument is that specialisation and trade can make society much more prosperous.

This latter point relates to Graeber’s main error: his fetishisation of debt. In other words he attributes enormous power to debt but is virtually blind to the realm of production and even circulation. Graeber takes a blinkered view of the workings of the economy.

This narrow outlook can be attributed to what could be called Graeber’s anthropological method. His starting point is that of interpersonal relations rather than examining the operation of society as a whole. This leads to a fundamentally ahistorical approach in which the changing forms that social organisation has taken over 5,000 years are blurred.

No doubt many financial journalists would bridle at Graeber’s call for debt cancelation and a radical redistribution of wealth. But his fetishisation of finance and downplaying of the real economy are completely in line with the contemporary orthodoxy.

This post was first published yesterday on Fundweb.

I had not had any articles published for a while and then suddenly four appear in one day. I will upload the full text over the next week or so but meanwhile here are the links:

* A spiked article on why Barack Obama loathes the Israeli prime minister.

 * A Financial Times feature on the links between the Jesuits, accounting and classical humanism. You may need to register (free) to read.

 * A Financial Times book review on neoliberalism. You may need to register (free) to read.

 * A Fundweb blog post on the work of David Graeber, often credited as the thinker behind Occupy Wall Street.

I appear in the latest Institute of Ideas podcast discussion the authoritarian implications of the frenzied debate about tax dodging.

For those interested in my more technical articles here is a piece I wrote for the March issue of IPE magazine (it can also be read on the IPE website here).

Smart beta has had a foothold in the foreign exchange market for years, although the approach is less pervasive than those of other asset types, and it rarely gets called by that name. There are certainly arguments for the presence of risk factors, most notably the currency carry, which investors have long sought to exploit.

Before considering these factors and how best to utilise them through smart beta, the peculiar features of the markets should be appreciated. These shape the contours of currency investment and highlighting them helps to identify the potential pitfalls of applying the smart beta approach.

First, there are no straightforward benchmarks within foreign exchange. In this, it is unlike bonds or equities where there is generally at least one index, often more, that suggests itself as a starting point for comparisons. In relation to currencies the means for gauging relative performance are less evident.

No obvious beta

For this reason Thomas Heckel, who leads quantitative research into foreign exchange at BNP Paribas Investment Partners, argues that it is inappropriate to use terms like smart beta in relation to foreign exchange.

“It’s a little strange to talk about smart beta because there is no obvious beta for this market,” he says. In his view it would be better described as a form of factor investing.

Another market peculiarity is that the odds are not in favour of a buy-and-hold strategy producing positive returns in the long run. On an aggregate global level, investing in currencies is a zero-sum game.

“One cannot simply hold a currency and expect to make money,” says James Wood-Collins, CEO of Record Currency Management. He contrasts it with the equity markets where the default position for long-term investment is to be long equities and short cash.

The number of different possible assets is also far smaller than with bonds or equities. There are only about 180 national currencies, many of which have a negligible presence outside their own borders. Of course the number of possible currency pairs and weightings is much greater but this still leaves it trailing by far other asset classes. Some would even dispute whether currencies should be called an asset class at all.

In stark contrast, the foreign exchange market dwarfs others in terms of size. According to the latest triennial survey from the Bank for International Settlements, the average total daily turnover of foreign exchange instruments was $5.3trn (€4.6trn) in 2013. In contrast, the daily turnover on the New York Stock Exchange was only about $30bn in January.

Yet most players in foreign exchange are not in the market for the purposes of profit maximisation. Non-profit-seeking market participants include firms engaged in hedging or trade, central banks and tourists. It is this combination of huge liquidity and a relative dearth of profit maximisers that, currency enthusiasts argue, helps create profit-making opportunities that can be exploited: one consequence of the vast depth and liquidity of these markets is that it would take a lot for the opportunities to be arbitraged out. In that sense, foreign exchange is not an efficient market in which news is quickly reflected in changing exchange rates.

It should not be a surprise that active managers have long tried to exploit the risk factors embedded in the market. Smart beta simply uses different tools to try to take advantage of the opportunities.

“What is new is smart beta lends itself to a much more structured and disciplined approach to implementing several of these strategies side by side,” says Wood-Collins.

The carry trade

The carry trade (which exploits a currency market anomaly known as the forward rate bias) is by far the best-known strategy. It first gained popularity in the early 1970s with the breakdown of the Bretton Woods system of fixed exchange rates.

Carry investing involves borrowing money at low interest rates and investing in high-interest-rate currencies. For example, borrowing in euros or yen to invest in Australian or New Zealand dollars. The typical pattern is for countries with a current account surplus to, in effect, provide funding to those with a deficit. Investors are therefore being compensated for the risk of investing in the higher-interest-rate, higher-deficit country.

Momentum or trend investing has also existed in the foreign exchange market for decades. It is usually explained in behavioural rather than fundamental economic terms. A common assumption is that there is a bandwagon effect, with investors assuming that currencies that are depreciating or appreciating are likely to continue to move in their existing direction.

Value investing is based on frameworks designed to gauge the fair value of currencies relative to one another. Typically it relies on the purchasing power parity (PPP) value of a currency which is defined by the World Bank as “the number of units of a country’s currency required to buy the same amounts of goods and services in the domestic market as US dollar would buy in the United States”. Using this conversion factor it is possible to gauge a currency’s value relative to the dollar and, by extension, to other currencies too.

Organisations such as the Organisation for Economic Co-operation and Development (OECD), the University of Pennsylvania (the Penn World Table) and the World Bank have long established data series on PPP. The Economist’s Big Mac index – which is based on the prices of burgers in different countries – is essentially just a simplified form of a PPP measure.

Although value investing can, in principle, be used for all currencies, it has a particular application for emerging economies. Typically, emerging currencies can buy a larger basket of goods and services within their own borders than can their advanced economy counterparts. However, as emerging economies gradually converge with richer ones in terms of their level of development, the PPPs would also be expected to converge over the long-term.

Volatility investing in currencies is premised on the assumption that many participants in the currency markets are looking to hedge themselves. Investors can therefore benefit from being on the other side of such transactions.

It is also possible to exploit risk factors indirectly by investing in particular themes. For instance, investing in the currencies of resource producing countries on the assumption that their economies are likely to grow faster than those of non-producers over the long-term.


Although currency investing can be lucrative at times, it has several potential pitfalls. For example, there is considerable controversy about the viability of the carry trade as an investment strategy. It can yield spectacular losses as well as gains. According to Deutsche Bank research the AUD/USD strategy gained 31.5% cumulatively between June 2004 and December 2007. It then went on to lose roughly the same amount during the market turmoil from July 2008 until February 2009. Currency investing is not unique in being prone to both large gains and large losses but it is a characteristic of which investors should be aware.

It should also be borne in mind that the success or failure of any strategy is highly sensitive to the particular definition used. The fine details matter. For example, anyone who was short the Swiss franc in January, when the peg with the euro was broken, would have made substantial losses. In contrast, carry investors who eschewed that particular trade could have made large gains. Even if carry works in the long term, its practitioners need to be aware of the possibility of substantial hits.

Another possibility is simply that now is a bad time to invest in carry. Marc Chandler, the global head of currency strategy at Brown Brothers Harriman, an American private bank, says that he suspects the current environment is “not really conducive for carry trades”. In his view the current high levels of volatility and narrow interest differentials between the main economies make the carry trade relatively unattractive. He adds that the advent of negative interest rates could have complicated the situation still further.

Others counter that new opportunities may be emerging with increasingly divergent behaviour by central banks. In particular, the Federal Reserve has stopped buying assets while the European Central Bank has embarked on a policy of quantitative easing.

Matthew Roberts, a senior investment consultant at Towers Watson, warns there are particular pitfalls of currency investment when it comes to smart beta.

“It is important to keep a close eye on the amount of money flowing in to factor-based strategies such as trend, value or carry, since one of the risks is that they become crowded over time,” he says.

In any case, there is widespread agreement that smart beta approaches are only appropriate when stringent risk controls are in place. Diane Miller, a principal at Mercer, is sceptical about whether this is being achieved in practice.

“I’m most concerned about a lack of risk controls in the naïve strategies,” she says. In her view, a lot of strategies look good on paper but they may not take into account all of the trading costs.

Proponents of smart beta in currencies contend that diversification between the three major risk factors can be effective in mitigating downside risks. A 2012 paper by a Bank of England economist illustrated one way this could work. According to the study by Gino Cenedese, investors would be better off unwinding carry trade positions during bear markets and following momentum, for example.


Currency investors have the choice of several ways of implementing a smart beta approach. These include UCITS funds, exchange-traded funds and linking bespoke swaps and options to indices. Traditionally institutional money managers have played the leading role in providing such products but in recent years the investment banks, such as Deutsche and Citi, have become increasingly important.

There are also specialist indices such as the FTSE Forward Rate Bias (FRB) 10. This series, developed with Record Currency Management, represents the return that can be generated from investing, on an equally weighted basis, on all 45 currency basis that can be derived from 10 developed world currencies: the Australian dollar, Canadian dollar, euro, Japanese yen, New Zealand dollar, Norwegian krone, sterling, Swedish krona, Swiss franc and the US dollar.

Russell Investments eschews the term smart beta but essentially follows the approach in its Russell Conscious Currency index series. There is one index each for carry, trend and value as well as an overall index that aggregates the other three.

It is also worth recognising that smart beta can even play a useful role for investors not interested in gaining exposure to such trading strategies. Jeppe Ladekarl, partner, investments at First Quadrant, says the income streams available from smart beta can be used to evaluate active management – although he hesitates to use the term ‘benchmark’ in this context. In other words, the returns on smart beta products can be used as a way of gauging whether or not active management fees are reasonable.

He goes on to contend that fixed-income managers can use smart beta returns as a tool to measure the extent to which they have unwittingly taken on currency exposure. In Ladekarl’s view, many such managers are not fully aware of the risks that have been taken on in this respect.

Towers Watson’s Matthew Roberts is sceptical about the possibility that fixed-income managers have unknowingly taken on currency risk on a large scale. However, he accepts that “it’s possible that some fixed-income managers could have unintended factor bets”.

Roberts agrees that smart beta strategies can be used as a quasi-benchmark to measure the performance of active managers. “It’s well worth thinking about it and using it to measure the alpha embedded in active managers,” he says.

I feature on a discussion in Worldbytes’ TV Don’t shout at the tellyslot. Topics discussed include inequality and quantitative easing (QE).

Forget the real world

26 Feb 2015

Those who see themselves as practical students of the real world are condemned to never understand it.

To grasp how society works demands an entirely different approach. Simply responding to what happens to be in the news is doomed to yield superficial and one-sided results.

The recent calls by economics students for their tutors to take a more reality-based approach provide a case in point. For example, the University of Manchester Post-Crash Economics Society has received a lot of publicity for its campaign for a better economics education. One of its premises was that the way economics was being taught “seemed separate from the economic reality that the world was facing”.

Much of the blame for this alleged unworldliness is pinned on the supposed dominance of free market economics: “Our economics education has raised one paradigm, often referred to as neoclassical economics, to the sole object of study. Alternative perspectives have been marginalised.”

In relation to the latter point the PCES apparently failed to appreciate the implications of its own report’s foreword, entitled “the revolution in economics”. It is deliciously ironic that the author was Andrew Haldane, the executive director for financial stability at the Bank of England, an unlikely revolutionary.

Haldane took the opportunity to assert “the power of economics is that it affects real lives in real ways”. Indeed the inspiration for PCES was a 2011 conference on “Are economics graduates fit for purpose?” supported by the British Government, the Bank of England and the Royal Economic Society. Despite its anti-establishment pretensions it is hard to imagine a more mainstream initiative.

One of the main backers for such projects internationally is the Institute for New Economic Thinking. As I have written before on Fundweb this organisation presents itself as the voice of embattled radicalism, but is itself a bastion of the economics elite.

Its advisory board includes among others five Nobel laureates (James Heckman, Sir James Alexander Mirrlees, Amartya Sen, Michael Spencer and Joseph Stiglitz), two former chief economists at the IMF (Simon Johnson and Kenneth Rogoff), a former economic adviser to the Bank for International Settlements (William White), a special adviser to the secretary-general of the United Nations (Jeffrey Sachs) and Haldane. Its chairman and co-founder is George Soros, a billionaire hedge fund manager.

Indeed the main reason student groups such as PCES have received so much attention is that they reflect the disarray in the economics profession and the policy elite. The professionals’ tools have failed to revive the developed economies from years mired in stagnation so they are desperately seeking alternatives. Only they lack the confidence or ability to produce anything genuinely innovative.

The critics’ goal is not to bury conventional economics but to save it.

This lack of imagination is apparent in the new coreecon project for teaching economics, produced with support from INET. Despite claims to the contrary its approach is not that different to what was being taught previously.

When the mainstream critics of economics call for a reality-based approach they seem to mean several different things:

  • Economic studies should focus on providing a rapid response to recent events. But those seeking to develop a systematic approach should be asking more fundamental questions rather than demanding quick insights into recent developments.
  • An outlook that is orientated towards policy. But looking at the world through the narrow lens of the policymaker tends to detract from understanding the underlying dynamics of the economy.
  • An approach that is “realistic” in the sense of respecting the limits on economic growth posed by such challenges as extreme inequality and climate change. But many authorities from an earlier era, including Adam Smith, were concerned with transcending limits rather than being constrained by them.

Those seeking a genuine alternative should instead read some classic texts rather than paying so much attention to the “real world”.

A useful first step might be to ponder the words of John Maynard Keynes in his General Theory where he took aim at an earlier generation of those claiming to be immersed in the real world. He expressed disdain for “practical men” who “believe themselves to be quite exempt from any intellectual influences, [but] are usually the slaves of some defunct economist”.

Or, even better, follow the advice of Karl Marx in the 1872 preface to the French edition of Capital where he emphasised the hard work needed to develop a balanced view of the world: “There is no royal road to science, and only those who do not dread the fatiguing climb of its steep paths have a chance of gaining its luminous summits.”

Students would benefit enormously from reading the classic works of such Dead White Males rather than adopting the blinkered outlook of policymakers. Systematic study of the past would open the way for a radical step forward in their understanding.

This blog post was first published today on Fundweb.

This is my latest article for spiked.

The sanctimonious war of words against tax dodging embodies a fundamental attack on individual freedom. Although the offensive appears to be aimed mainly at wealthy individuals and multinational corporations, it threatens to undermine liberty for everyone.

Economics is not the real focus of the frenzied discussion of tax in Britain right now. Rather, this is essentially about the arbitrary exercise of state power. By blurring the line between legal and illegal action, this crusade threatens to undermine fundamental freedoms in all areas of human activity. The fact that the debate is framed in terms of tax payment is, in many respects, incidental.

A careful examination of recent developments illustrates the considerable dangers involved.

On 8 February, the Guardian broke the story that HSBC’s Swiss banking arm had helped wealthy customers dodge taxes and conceal millions of dollars of assets. The report was based on files obtained by an international collaboration of media outlets, including the Guardian, Le Monde, the BBC’s Panorama TV show, and the International Consortium of Journalists based in Washington, DC.

Although the files covered the period 2005/07, it was the first time their content had been made public. Hervé Falciani, an IT expert who worked for HSBC at the time, had obtained them by hacking into customer accounts. In late 2008, he fled from Geneva to France, where he was detained but not extradited by the authorities. In early 2010, the French authorities distributed a list of names based on Falciani’s data to their counterparts in several other countries.

Unfortunately, the subsequent discussion muddied the traditional distinction between tax evasion and tax avoidance. It used to be the case that evasion referred to illegal activity while avoidance simply meant the minimisation of tax payments by legal means. So, in a simple example, someone claiming their full entitlement of allowances would be engaging in tax avoidance. Of course, tax-avoidance schemes can also be incredibly convoluted and complex.

This crucial distinction between evasion and avoidance was long embodied in British law. For example, in the 1936 Duke of Westminster case, the judges ruled that no one could be compelled to pay more tax than is required by statute.

The discussion of tax dodging in recent years has removed this key distinction. In the debate about the HSBC case, the two different practices, one legal and the other illegal, were frequently jumbled. For example, Lord Fink, a former co-treasurer of the Conservative Party, was attacked by Ed Miliband, the Labour leader, for having undertaken ‘tax-avoidance activities’. Lord Fink, after initially baulking at the description, went on to argue that ‘everyone does tax avoidance at some level’. In his original statement, Miliband had called David Cameron ‘a dodgy prime minister surrounded by dodgy donors’, but in a follow-up speech Miliband made clear he was not suggesting Lord Fink was dodgy. The Labour leader therefore played a part in blurring the line between illegal and legal activities.

But Miliband was only treading where the Conservatives have gone before. George Osborne, the chancellor of the exchequer, used his 2012 Budget speech to describe ‘aggressive tax avoidance’ as ‘morally repugnant’. The following year, the Finance Act embodied the idea of ‘abusive’ avoidance in law. The legislation created a new anti-abuse rule in which the government outlawed activities that were within the letter of the law.

Such action undermines the traditional liberal notion of the rule of law, which requires laws to be limited, certain and clear. The new ‘anti-abuse rule’ outlaws tax arrangements that ‘cannot reasonably be regarded as a reasonable course of action’. This law is uncertain and unclear and puts considerable discretion in the hands of tax inspectors and courts to determine what is and is not lawful. This empowers the state to stigmatise and punish those by deciding after the event that a form of tax avoidance is deemed unlawful.

It has long been understood, at least from a classical liberal perspective, that widening the scope of laws can undermine individual autonomy. But blurring the line between what is legal and what is illegal can have the same effect, by creating uncertainty as to what the law-abiding citizen can and cannot do.

If politicians want to make certain forms of behaviour illegal, they have the power to do so with clear and specific legislation. If they want to make tax rules stricter in future, they can. But stigmatising legal practices and possibly even making them illegal after the event sets a dangerous precedent. It opens the way to a substantial increase in state power.

The pious war against tax dodging is much more dangerous than any schemes for evading or avoiding tax.

When individuals or corporations act to minimise their tax payments the worst that can happen is that the authorities lose billions in tax revenue. In contrast, the stakes in the sanctimonious offensive against tax dodging are much higher. By blurring the line between legal and illegal activity it threatens to undermine fundamental freedoms.

A careful examination of the discussion over the last few days illustrates the considerable dangers involved.

On 8 February the Guardian broke the story that HSBC’s Swiss banking arm had helped wealthy customers dodge taxes and conceal millions of dollars of assets. The report was based on files obtained by an international collaboration of media outlets including the Guardian, Le Monde, the BBC Panorama programme and the International Consortium of Journalists based in Washington DC.

Although the files covered the period 2005-7 it was the first time their content had been made public. Hervé Falciani, an IT expert who worked for HSBC at the time, had obtained them by hacking into customer accounts. In late 2008 he fled from Geneva to France where he was detained but not extradited by the authorities. In early 2010 the French authorities distributed a list of names based on Falciani’s data to their counterparts in several other countries.

Unfortunately the recent frenzied discussion has muddied the traditional distinction between tax evasion and tax avoidance. It used to be the case that evasion was illegal while avoidance simply meant the minimisation of tax payments by legal means. So, in a simple example, someone claiming their full entitlement of allowances would be engaging in tax avoidance. Of course, tax avoidance schemes can also be incredibly convoluted and complex.

However, in the discussion of the HSBC case the two different practices, one legal and the other illegal, were frequently jumbled. For example, Lord Fink, a former hedge fund manager and also a former co-treasurer of the Conservative party, was attacked by Ed Miliband, the Labour leader, for having undertaken “tax avoidance activities”. Lord Fink, after initially baulking at the description, went on to argue that “everyone does tax avoidance at some level”. In his original statement Miliband had called David Cameron“a dodgy Prime Minister surrounded by dodgy donors” but in a follow-up speech the opposition leader made clear he was not suggesting Lord Fink was dodgy.

The Labour leader therefore played a part in blurring the line between illegal and legal activities but the prime minister has previously done the same. Cameron’s attacks on “aggressive” tax avoidance have played a similar role. The implication of this new category is that legal activity should be outlawed.

If politicians want to make certain forms of behaviour illegal they have the power to do so. If they want to make tax rules stricter in future they can. But stigmatising legal practices and possibly even making them illegal after the fact sets a dangerous precedent. It opens the way to a substantial increase in state power and undermines the rule of law.

This article first appeared today on Fundweb.

It is one of the most bewildering discussions in a confusing area. Deflation is welcomed by some economists but condemned by others as a grave threat. Some basic distinctions are necessary to understand the debate.

Let’s start by outlining recent developments. The eurozone’s inflation rate fell by 0.2 per cent in the year to December according to a flash estimate from Eurostat. For many commentators the drop signaled the possibility that the region was descending into a protracted period of stagnation akin to Japan’s painful experience since the 1980s. For other pundits, particularly in Germany, the slight downturn in prices was no cause for alarm.

Shortly after the eurozone estimate was released the Office for National Statistics in Britain said that the consumer prices index (CPI) had risen by only 0.5 per cent in the year to December 2014 – the lowest level since records began.  In response David Cameron tweeted that: “The fall in #inflation is good news for families. Our long term economic plan is on track and helping hardworking taxpayers.”

Mark Carney, the governor of the Bank of England, said that the dip was nothing to worry about. It was caused by a fall in global fuel and food prices rather than a generalised slowdown of the economy. In his view this sort of low inflation could grease the wheels of economic activity.

The pessimists typically point out that deflation is often associated with stagnation. In other words falling prices and sluggish economic performance often coincide. This phenomenon was common in the western economies in the 1930s and has often prevailed in Japan in recent years. Indeed the term “deflation” is used in two different ways: to simply mean falling prices or alternatively to refer to a downward economic spiral.

Typically the pessimists go on to suggest ways in which falling prices and stagnation could be linked. One popular line of argument is that the economy can get caught in a liquidity trap: consumers are reluctant to buy goods today as prices could be lower tomorrow. Another common claim is that falling prices increase the real burden of debt that economies are suffering.

Deflation optimists, in contrast, often argue that there is no correlation between lower prices and economic stagnation. From that perspective they are challenging one of the key premises of the doomsters.

But the differences between deflation pessimists and deflation optimists are often less than first appears. For example, Carney simply claimed that at present falling prices are confined to niche areas of the economy. If deflation became more widespread, with the overall price level falling, he would no doubt identify it as a problem.

It is also worth noting the all too common tautology used by Carney and many others. He said falling fuel and food prices caused the inflation rate to drop. But this is simply saying that falling prices cause falling prices. It fails to identify the underlying driver.

It would be better to pay much less attention to changing price levels. Instead a more fundamentalist approach to the economy is necessary.

Although it is true that falling prices can coincide with stagnation they can also be a sign of strength. The rapid improvements in information technology in recent years provide an example of the latter trend. Consider how much it costs to buy one kilobyte of computer storage compared with, say, 20 years ago. In effect the price of computers has fallen rapidly. Yet it is a symptom of innovation in this particular sector rather than, on the contrary, a sign of stagnation.

If falling prices can be both a symptom of economic weakness and of strength they have little value as indicators. It is far better to try to discern what is happening in the underlying economy rather than draw illegitimate conclusions from the changing price level.

Analysts should focus on the state of the productive economy rather than the inflation rate. Key statistics to consider include the levels of business investment and productivity growth.

The huge attention paid to the price level – both inflation and deflation – in the past two decades has corresponded with a narrowing view of the economy. Most discussion has focused on relatively superficial questions, including the state of the financial sector, rather than grapple with the underlying dynamics of the economy. It is not that inflation or finance are unimportant but they should be understood in relation to developments in the real economy.

This narrowing of intellectual horizons is the paradoxical effect of the end of the Cold War in the late 1980s. In the earlier era the battle between socialism and capitalism forced individuals to have more fundamental discussions on the nature of the economy. Each side was anxious to prove that their side knew best.

There is no going back to the past but it should be possible to recapture some of the better elements of the earlier discussion. Those who argue the world is facing economic stagnation should start from an examination of the real economy rather than become preoccupied with changing prices.

This column first appeared in the February issue of Fund Strategy.