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.

Although the claim is frequently repeated it is untrue that a debate about economic equality is underway. To those who follow it carefully it should quickly become clear that something else is happening.

Take the recent discussion at the World Economic Forum in Davos. A televised debate involving some of the main protagonists helps make some of the themes clear. The focus was not on equality but on what was regarded as excessive inequality.

A call for income equality would, strictly speaking, suggest that everyone should have the same earnings. But none of the key proponents in the current debate are calling for anything remotely like that. On the contrary, they insist that inequality is both desirable and necessary to provide incentives for people to work hard.

In this respect it was notable that the IMF chief, Christine Lagarde, corrected another panelist in the TV debate who suggested she was advocating equality. The French technocrat protested, quite rightly, that she had said no such thing.

New egalitarians such as Lagarde instead claim that inequality has become too extreme. In their view it has reached the point where it is having damaging social effects. The exact nature of these negative impacts is debated but it is typically claimed that excessive inequality can damage social cohesion and distort the political system. Often the argument is about plutocracy – it is alleged that the rich have too much political power.

This focus on extreme inequality also helps explain why there is such an obsession with the super-rich. To be merely rich is no longer considered noteworthy. The focus is on those at the very extreme end of the income distribution; such as the 85 billionaires who according to Oxfam have as much wealth as the poorest half of the world’s population.

If there is no debate about equality it begs the question why so many people assume it still exists.  This should be understood in relation to the difficulty many people have in breaking from the intellectual landscape of the past.

In relation to the equality discussion it is often those who regard themselves as having a free market perspective who find the discussion most tricky. They are too ready to detect echoes of their leftist opponents of yesteryear when they hear criticisms of extreme inequality. Such free marketeers fail to appreciate how much the discussion has moved on since the 1980s.  The old scripts are of limited use in understanding contemporary anxieties.

It is particularly striking that nowadays it is often the wealthy and the best connected who profess the greatest concern about inequality. At the Davos get-together, which after all is a jamboree for the global elite, complaining about the dangers of the inequality gap has become an annual ritual. The TV panel included not only Lagarde but Mark Carney, the governor of the Bank of England, and Robert Shiller, a Nobel laureate in economics. Winnie Byanyima, the executive director of Oxfam International, was co-chair of the entire conference.

To understand the current obsession with extreme inequality and the super-rich it is necessary to appreciate the discussion is fundamentally different from the debates of the past.

This blog post was first published on Fundweb today.

Supercars for all

14 Jan 2015

The contemporary obsession with the super-rich often combines an intense interest in breathtaking bling with a quiet loathing of those with spectacular wealth. Both ingredients in this peculiar cocktail were on display in BBC2’s recent Meet the Super Rich season of documentaries.

Rich, Russian and Living in London focused on the lavish lifestyle of wealthy Russian expats including an entrepreneur, an art collector and a supermodel. Perhaps their most striking characteristic was a desperate desire to distance themselves from the old stereotype of ostentatious Russian oligarchs. The new generation of wealthy Russians loves fine wine, expensive art, the best British public school education and the glamour of traditional debutante balls.

Next came Billionaire’s Paradise: Inside Necker Island. The programme was essentially a publicity vehicle for Richard Branson’s exotic Caribbean island which doubles as his home base and an exclusive playground for the super-rich. For £40,000 a night the staff of nearly 100 is ready to meet the desires of the exclusive resort’s 28 guests.

The documentary clearly implied that literally every whim of its guests could be satisfied. Those staff who dealt directly with the guests were almost all under 30 and chosen for their good looks. A previous management team which insisted that staff should not share drinks or have “relations” with guests was quickly dismissed. Branson made clear that such restrictions were inappropriate on Necker Island.

Although both documentaries could be enjoyed as lavish spectacles they could also be viewed as outrageous displays of excess. Indeed many viewers probably experienced both emotions: vicariously enjoying the luxury on display while feeling appalled that so few should have so much wealth. The combination of these two elements probably helps explain the popularity of magazines, television programmes and films featuring the super-rich.

The Super-Rich and Us was different in that it purported to be a serious documentary on the topic. However, early indications augured poorly as, according to the BBC’s own More or Less  programme, the trailer made the incorrect claim that the world’s richest 85 individuals own half the world’s wealth. This is a garbled version of Oxfam’s similar-sounding but entirely different contention that the richest 85 own as much wealth as the poorest half of the world’s population.

Episode one overlapped with the other documentaries with numerous examples of conspicuous consumption including Lamborghini supercars, expensive watches and Lear jets. However, it also purported to offer a serious discussion of those it called the “have yachts” as opposed to the “have nots” or the “haves”.

Its central claim – never properly investigated – was essentially that the economy embodies a tug of war between the super-rich and the rest over scarce resources. Free market thinkers such as Arthur Laffer were brought in on the implicit assumption that they were apologists for the ultra-wealthy.

The underlying premise of the programme was that economic activity is essentially a zero-sum game. If some people become extremely wealthy then, so the argument goes, it must be at the expense of the rest of us.

No consideration was given to the possibility that it might be possible to make the size of the overall pie bigger. The population as a whole can benefit from a more prosperous society. Yet, despite persistent inequality, that is broadly the trend of the past two centuries.

The challenge now is to work out how to kick start economic growth. That way it could become possible for everyone to enjoy fine wine, fine art and extravagant cars.

This blog post was first published on Fundweb today.

The last thing I expected to be thinking about after a long and boozy Christmas lunch was economics. However, my first ride in an Uber taxi set me thinking.

For those who have not used Uber, which operates in over 50 countries, it is service that allows users to order taxis using their mobile phone. Gettaxi provides a similar role for licensed cabs.

On Christmas Day I had found myself in Crystal Palace with the prospect of a long and expensive taxi ride to North London looming. Rather than pay a large premium for a minicab, a friend recommended that I use Uber instead. To my surprise the fare was far less than the seasonal hit I had expected.

The taxi driver was more than willing to fill me in with more details on how the service worked. In his previous guise as a minicab driver he would suffer a large amount of “dead time”. For instance, if he drove a passenger from London to Reading he would usually find himself with an empty cab on his way back. In contrast, Uber would generally find another customer who wanted to travel from Reading to London. It is a textbook case of the introduction of technology leading to higher productivity.

The result is lower fares for customers and, at least in the short-term, more revenue for Uber drivers. The service’s efficiency means that drivers can charge less per passenger mile but earn more in total.

Of course there are losers too. Minicab firms and black cab drivers are increasingly finding themselves undercut by Uber drivers. This probably helps explain the backlash with its focus on safety and customer privacy.

Nevertheless it is an example of what economists call creative destruction. The market economy is creating a more efficient way of doing business but at the expense of existing providers.

Whether the incremental increase in productivity justifies its high valuation is another matter. The Silicon Valley start-up was valued at $40bn (£26bn) at the completion of a funding round last month. That makes it one of the world’s largest private companies. A flotation could follow this year.

Despite the benefits for consumers and investors the revolutionary force of Uber and similar apps should not be overdone. The Economist’s claim that such apps will reshape the nature of companies and restructure careers is over the top.

For a start only a tiny proportion of new internet and mobile applications are likely to have anything like the productivity raising potential of Uber. Much of it, such as Angry Birds or Candy Crush, may provide entertainment but it is hard to see it transforming the economy. Some applications, including Facebook and Twitter, could arguably lead to lost output with all the immense amount of time many users expend on them.

In addition, more mundane forces play an important although often underplayed role in economic change. The shift towards greater emphasis on freelance work is in large part a result of the drive of traditional cost cutting.

The hype around Uber and mobile applications more generally is overdone.

This blog post was first published on Fundweb today.

Celebrate cheap oil

20 Dec 2014

One of the great paradoxes of 2014 was the apparent mismatch between falling oil prices and military conflict in strategic regions. Normally fighting in the Middle East and the Ukraine would be expected to push up oil prices. Only this year the price has fallen sharply since June. According to the US Energy Information Administration the price of a barrel of West Texas Intermediate crude fell from almost $108 per barrel in mid-June to below $56 in mid-December.

It would be a mistake to conclude from this discrepancy that geopolitical uncertainty has no effect on the oil price. A more accurate conclusion would be that the forces pushing the price of oil down were greater than those pulling it up. In other words the balance between supply and demand has tilted in favour of the former.

Two key factors on the supply side helped push down oil prices. Together they constitute what the Economist dubbed sheikhs vs shale. The rising production of shale oil, particularly in America, as well as Saudi Arabia’s decision to maintain its crude output both played an important role.

But it would be wrong to underestimate the role of sluggish demand growth, particularly in China and Europe, in reinforcing the downward trend. Although demand for oil is still heading upwards the rate of growth is being called into question. The slowdown in China’s economy in particular will weaken what has been one of the main upward drivers of the oil price for many years.

Of course some of this is subject to change. A low oil price weakens the impetus to invest in the industry and so could lead to curbs on supply growth in the future. Exploration and development that was once profitable may no longer be economical at the lower price.

However, there is a more fundamental lesson that should be learnt from this whole saga. It is not the oil price that drives the state of the global economy. On the contrary, the state of the world economy plays a key role in determining the oil price.

Too many commentators are ready to pin a large part of the world’s economic fortunes on the price of crude. From their perspective low prices boost growth while high prices carry the risk of inflation.

It would be more accurate to see things the other way round. A dynamic global economy should enjoy rising energy demand alongside strong economic growth. It should also show strongly rising supply as investors put their money into developing new sources and better technology. Ideally rising production should outrun increasing consumption and so help to keep prices low.

It is true that over time different sources of energy could come to surpass oil in importance. Indeed coal, natural gas, nuclear and renewables already play a big role in the energy mix. News of the largest ship the world has ever seen, designed for use as a processing platform for natural gas, is a positive sign of determination to develop new supplies.

Nevertheless oil is still a key energy resource and it likely to remain so for some time to come. The rapid development of new sources of supply and better extraction technology should be widely welcomed.

I would like to wish my readers a Merry Christmas and a Happy New Year.

This blog post was first published on Fundweb yesterday.