Stepping back

Lots of comments about how exchange rates and equity-price movements show that the UK is (a) doomed or (b) well-placed post-Brexit. Movements and values over a few days tell us nothing except the climate of hope or fear in those few days. How do things stand on a broader perspective? Let's compare:

A. Currencies: USD vs GBP vs EUR

B. Markets: FTSE100 vs FTSE250 vs Dow vs DAX

The national sub-prime borrower

Here's a bemusing statistic to follow on from the earlier post.

Question: Given that the US federal deficit is expected to be $1.8 trillion this year, taking the total national debt to $12.8 trillion, by how much does the US government expect their interest payments on that debt to increase?

Answer: They don't, they expect interest payments to fall by 44%, from $253 billion in 2008, to $143 billion in 2009. And next year, when they expect to run a deficit of another $1.3 trillion, taking national debt to $14.4 trillion, they expect interest payments to fall further to $136 billion.

Confused? I am.

A. Interest rates

One explanation is relatively simple. Short-term interest rates have fallen. Tim Worstall recently provided a useful explanation of the yield curve. If they are able to borrow both the new debt and the rolled-over debt at lower rates than before, then interest payments might fall even if the principle has increased. Depends on the amount of the increase in the principle and the fall in the rates.

The average maturity of Treasury bonds is said to be around 5 years. Longer-term rates aren't that much lower now than they have been over the past decade. Yields on 5-year bonds are down to around 2.5% (from 5% a couple of years ago and 3.5% a couple of years before that), and get lower the shorter the bond, down to a fraction of one percent for 1-month and 3-month bonds.

US Treasury yield curves, 1990-2009 

If the Treasury borrowed much of the new and rolled-over debt on medium- to long-term bonds, net interest payments would be going up (or at least not down by anywhere near as much as assumed), as the increase in the principle would exceed the reduction in the rates on that portion of the existing debt that was rolled over. To achieve the reduction in interest payments that they assume, a substantial proportion of the existing debts must be coming to maturity this year and next, and must be renewed (along with the new debt) as short-term borrowing. So a large proportion of their debt will end up on short-term rates.

The trouble is, short-term borrowing needs to be renewed frequently, and short-term rates don't stay low in a recovery (nor do long-term rates come down). There is no scenario that I can think of where the economy rebounds to the extent that the Obama administration is assuming, from the point of view of the tax-revenue it is able to yield (see previous post), and short-term rates stay at a fraction of one percent. At that point, the recovery kills itself, because the interest that has to be paid on the projected national debt of $14.4 trillion in 2010 or $15.7 trillion in 2011 should be at least 3% and probably higher, given the strength of the assumed recovery implied by the tax revenue. That's $430 billion of interest payments in 2010 (compared to their assumption of $136 billion) and $628 billion if average rates are nearer 4% in 2011 (compared to their assumption of $254 billion).

Those discrepancies would mean either increased taxes to cover the extra payments, or increased borrowing to cover the increased deficit. The former would stunt growth just when it was starting to recover, reducing tax revenue in a vicious circle. The latter would further increase the cost of borrowing, making it necessary to borrow more, in another vicious circle. Taken at face value, it's hard to see how this house of cards can't collapse. It's Catch-22.

Ironically, it's a similar predicament to the situation that sub-prime borrowers got themselves into. The government is being tempted by the equivalent of teaser rates to borrow greatly in excess of what its assets are worth and what it can afford to pay back. Those rates aren't fixed for long, and are likely to be significantly higher when they come to renew (or their income significantly lower, if the economy hasn't rebounded in the way they project). And by then, they'll have racked up even more debts.

Unfortunately for the American people, there is no "jingle mail" option when its government can't afford the payments and its debts exceed the value of the economy. Or should that be "unfortunately for the bond holders", because the government will have to take one of the two options that are closest to "jingle mail": default or inflate?

B. Net interest

But this is where another explanation for the apparently improbable figures comes in. It's the explanation that has me really confused. The figure that the US government has to pay is not the whole of the interest payments due, but the net interest. The net interest takes account of the fact that the largest holder of government debt is... the government! It owes the money to itself. As this is effectively a transfer of money from one part of the budget to another, it nets-off these amounts and only counts the net interest (i.e. the interest payable to all external holders of government debt).

I can just about wrap my head around the origins of this circular notion. The US government first started to hold substantial amounts of its own debt after 1983, when the Reagan reforms to the Social Security budget left it with a surplus of social-security tax receipts over social-security outlays, and facing substantial future obligations. They used the surplus to buy Treasury bonds, which in a sense you could see as a sensible investment to provide for future obligations.

But it doesn't really stack up. Unlike corporate bonds, the money received by the government in exchange for its bonds is not invested in profitable assets that will provide the return to repay the bonds over future years. Whether used for current expenditure or capital investment, the government gets no yield from the expenditure, other than the hope that its measures will cause the economy to grow more quickly than it otherwise would have, which will allow for higher tax revenues. Ultimately, government bonds will have to be paid out of future tax receipts. And if the government hadn't borrowed from itself, the money for social-security obligations would have had to come from... future tax receipts. All that has really happened is that a convenient excuse has been found to make a surplus in one part of the government's activities available for current expenditure anywhere the government likes in its budget, and a slightly greater moral obligation has been placed on the government to raise tax in future to pay for obligations it was almost certainly going to pay for anyway.

And there was no real surplus. The US government's deficits ran at around $200 billion a year on average between 1983 and 1995 (in nominal terms, nearer to $300 billion in today's money), and at similar levels (in real terms) from 2002. Total government outlays were $800 billion at the start of that period, which should give some idea of the relative size of the deficit. In practice, this device was a way to disguise imprudent and spendthrift expenditure as somehow prudent and parsimonious.

The net effect has been to swell the US government's share of gross national debt from 17% in 1985 to 44% in 2007, while that gross debt has been increasing significantly (from $1.82 to $8.95 trillion in nominal terms, from $3.12 to $8.95 trillion in real terms, at 2007 dollars, or from 43.8% to 65.6% of GDP).

US national debt interest payments, 1962-2019 

We have become familiar with the concept of Quantitative Easing since the onset of the Credit Crunch. It might be thought that this is a sign that the policy had been running longer than we realized. But for the purposes of calculating the net interest, the Federal Reserve is treated as external to government. Payments due to the Fed are included in the net interest figures. QE as we understand it today would have resulted in an increase in the net interest payments. The Federal Reserve was not until recently a big buyer of government debt - it held only 5% of outstanding securities in June 2008 (around 10% of that big blue chunk in the pie chart below). The government had not got its money through the relatively transparent (if misguided) process of Federal Reserve balance-sheet expansion. It seems that the federal government simply issued itself IOUs in order to increase the amount of money it appeared to have available to spend. Rather than spending directly the tax it raised, it used some of the tax to buy its own debt. The money was made available for expenditure in the same way as if it had spent the tax directly, but the government had made obligations to itself to pay itself money in the future (money that will have to be raised from taxation and spent on the budgets for which the debt is earmarked, in much the same way as if the debt didn't exist).

Estimated ownership of US securities, 2008

It seems a strange thing to do. But in any case, the government doesn't have the tax receipts to buy as much of its own debt as usual, so the Fed is indeed buying a large chunk of federal debt this year (i.e. the government will have to expend future taxpayers' money to repay money borrowed from the Fed, which the Fed created out of thin air, and which was used to allow the government to continue to run unsustainable deficits and indirectly to blow bubbles in the stockmarket). The government's share of its own debt is projected to increase by "only" $150 billion (to $4.3 trillion), whereas debt held by the public (including the Fed) is expected to increase by $2.7 trillion. Last year, debt held by the public increased by twice as much as in the previous highest year ($768 billion, compared to $382 billion in 2004). This year's increase is 3½ times higher again, taking the total debt held by the public from $5.8 trillion to $8.3 trillion. This means that the share of the debt that is paid out of taxes to recipients outside the government has increased by a significantly higher proportion than the increase in the gross debt. And it is expected to increase by a further $1.35 trillion next year and nearly $1 trillion the year after that.

This is the context against which the net interest payable (the interest payable on the debt held by the public including the Fed) is supposed to fall dramatically and remain relatively low. The principle amount on which net interest is payable will more than double between 2007 and 2011, the economy will recover so strongly that it yields record tax revenues, and yet interest payments will remain modest, apparently. I'll have some of whatever the Obama administration is drinking.


Tax hiatus or deficit problem?

It is becoming popular amongst Keynesians (and perhaps some monetarists too) to suggest that Western governments do not have a deficit problem, they just have a hiatus in their tax receipts. Government's job, therefore, is to help the economy get back to a healthy state as quickly as possible (through deficit spending, low interest rates and quantitative easing), at which point tax revenues will be restored, the deficit will be eliminated, and normal service will resume.

Ummm... No. Here's a statistic that shocked me:

In real terms, the projected US deficit this year is more than the combined US deficits for the three years from 1943 to 1945.

This is from White House figures (see Table 1.3 of the Historical Tables of the Office of Management and Budget). Converted to year 2000 dollars, the projected deficit in 2009 is $1,440.1 billion ($1,841.2 billion in current dollars), and the deficits in 1943, 1944 and 1945 were $486.2, $448.2 and $456.8 billion respectively (in 2000 dollars). These were the previous highest deficits run until this year, with somewhat more justification.

This deficit isn't principally due to a collapse of tax receipts below the norm. In real terms, the total projected tax receipts in 2009 are higher than the total receipts in 2003 and 1997. In between, we have had two huge bubbles (in fact we were already well into the first bubble by 1997).

US tax receipts, 1940-2009, real (2000 dollars)

Depending whether you think we returned to trend in 2003-4 or remained above it (we could get a better fit with the period from 1940-1995 on the assumption that it remained above), the projected downturn has overshot the trend by somewhere between a few billion dollars and a couple of hundred billion dollars. That leaves $1.25 to $1.4 trillion in 2000 dollars ($1.5 to 1.8 trillion in current dollars) of deficit unaccounted for by tax revenue that might reasonably be anticipated, in the absence of another bubble even bigger than the preceding two.

That doesn't stop the Obama government from projecting exactly that, however. Here is how the above graph looks if we add in their projections for tax revenue to 2014:

US tax receipts, 1940-2014, real (2000 dollars) 

By 2011, they project that tax receipts will have returned to a level where they exceed the 2000 peak during the first bubble, and are only a little short of the 2007 peak in the second bubble. The following year (2012), they plan to excede the 2007 tax peak by almost 10%, and by nearly 20% by 2014. And even then, spending will be so much higher than these new peaks that they will still be running deficits of nearly $400 billion, and the deficit will be going back up again. They project the average spending in the period 2009-2014 to be 27% higher than it was at the tax-revenue peak in 2007, at which time they were already running a deficit of $133 billion.

All of this is in real terms, in 2000 dollars. The figures in current money will be significantly higher.

There is only one way to try to achieve this, and that is to blow the biggest bubble in history - a bubble to make the roaring twenties or the recent lunacy look sane. Failure and disaster are inevitable. The only question is when. Will markets buy this fantasy for a while (i.e. continue to buy Treasuries and/or hold off dumping the dollar) or will they return to sanity soon and prevent the US government from running up a bill it can't afford to pay back?

Note that this is not to say that other countries are much better, their projections more realistic, or their market bubbles more rational. This is the most egregious example of a more widespread delusion. All governments' stimulus plans and projected budgets are unrealistic. They will have to be curtailed, and hence will fail to deliver the economic recovery that markets are currently pricing in (but which they wouldn't have delivered even if they could somehow have been funded). It's not about flight from one currency to another, but flight from all fiat currencies.

There will be no alternative to major real cuts to government budgets, services and welfare provision, at the same time as unemployment is soaring from a reduction in public-sector employees to match the earlier reduction in private-sector employees. A shrunken economy will face a higher tax burden (proportionately) because of the imbalance between private-sector earnings and public-sector costs, despite reduced numbers of public-sector employees. The weight of taxation will inhibit economic recovery.

Our troubles have only just begun.


I was remiss in providing graphical representations only of the trajectory of tax receipts and not also of federal outlays to give a visual indication of the (budgetary and reality) gap. So here it is:

US federal tax receipts and outlays, 1940-2009, real (2000 dollars)

Clearly, the trajectories set by the historical trend over the past 35 years are unsustainable. And yet the projections of the Obama administration are massively more optimistic than those unsustainable trends. They are so fantastic that they make the Lord of the Rings look like cinema verite. What people need to ask themselves is what happens when governments fail to deliver on their fantastic projections?  


Hoover: Austrian or interventionist?

Following an interesting debate with Paul Halsall on Austrian economics and the possibility of economic calculation in a socialist system, Paul posted half the text of an Anatole Kaletsky article in The Times, which made various spurious claims about Austrian economics and history. One of them, which had long ago acquired the status of conventional wisdom, was that the Hoover government had pursued an Austrian approach following the Great Crash, and had thereby exacerbated the following downturn, and discredited Austrian economics from adoption by politicians for ever after. His "evidence" for this is the famous quote from Hoover's Treasury Secretary, Andrew Mellon: "liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate".

I meant to reply to this point, but I wanted to be sure I got my facts straight. That meant doing quite a bit of reading and note-taking, and by the time I had finished, it was really a bit late for a response to Paul. But it seems a shame for the effort to go to waste. So I thought I would post it here, for reference or as a challenge (depending whether or not you lazily accept the myth propagated by the interventionists to cover up for their own culpability, and failure (yet again) of their philosophy in practical application).


Tax sovereignty

Tim Worstall covers the efforts by Dan Mitchell to persuade the American government to step back from its efforts to clamp down on tax havens. This is picked up and expanded at Sounds in the Hickory Wind (nice blog, added to the blog roll).

I agree with a lot of this, as I have already posted. But I think some nuance is needed.

Where do you draw the line on honouring sovereign rights and encouraging tax competition, which I agree with, and preventing complicity in the sheltering of criminal proceeds? We are investing in Switzerland at the moment, and the tax position is one of the many attractions, but that is a legitimate transaction, which I feel no need to conceal. Is not some degree of international cooperation to deal with illicit transfers warranted, and would not some degree of transparency be a part of that?

For instance, should we be pushing for a system where a foreign government would present evidence of criminality to a court in a tax-haven country, and if the court were satisfied that the evidence did demonstrate criminality, details of that person's transactions would be provided to the petitioning government, who would be able to launch proceedings in the tax-haven's courts for recovery of the funds, on an agreed basis? Wouldn't some treaty to that effect respect sovereign rights sufficiently, but cut down the rampant laundering that is going on in some of these locations?


Smoke and solar mirrors

A member of the Claverton group of energy fantasists (of which I am amused to be a member), posted the following article not only to the other members, but to Ed Miliband, Mike O'Brien and Joan Ruddock. See if you can spot the flaw, children:

The United States may have helped to pioneer solar technology, but it has fallen behind nations like Germany, China, and Japan in producing it.

According to iSuppli Corp, these countries have moved ahead of the United States, with Germany holding the lead in this fast-growing alternative energy market due the nation's and Europe's long-term commitment to solar power.

"Europe's early and enthusiastic embrace of solar energy is paying off, with the region leading in production of photovoltaic (PV) cells, potentially paving the way for a 300 billion Euro savings in electricity costs," said Henning Wicht, senior director and principal analyst for photovoltaics at iSuppli, in a statement.

According to iSuppli's data, European companies supplied 27.4% of global PV cells in terms of wattage in 2008, just besting China's total of 25.8%, and exceeding Japan's 16.2% and the United States' 13.7%.

The market research company reported that more than 80% of new worldwide PV capacity installed in 2008 was in Europe. Germany and Spain accounted for 84% of Europe's installed PV capacity during the year.

"Beyond leading in the production of PV cells, Europe is by far the world's largest market for solar installations," Wicht said. "This hasn't happened by accident, as European governments, research institutions, and industry players during the last two decades have worked in close coordination to reach this point."

Behind the collaborative effort was an aspiration to move the European economies away from hydrocarbon-based electricity sources while creating jobs and establishing a new industry capable of competing on the global stage.

The US Recovery Act, endorsed by semiconductor industry groups including the IPC and the SIA, takes a similar approach in its alternative energy strategy and is expected to in part spur tech job growth while making the US a more formidable competitor in such spaces as solar energy.

ISuppli suggested that when looking for ways to boost the US solar market the Obama administration consider what the company called the "main factor behind Europe's leadership in this area," feed-in-tariffs. Feed-in-tariffs -- incentives that allow entities that feed the grid with solar energy to receive premium pricing, making the return on investment on PV installations more attractive -- are starting to slow in 2009, iSuppli said, noting this is especially true in Spain. However, such incentives have successfully served their purpose by driving down prices and building a large-scale, competitive PV supply chain, according to Wicht.

ISuppli also noted that during the recent Sustainable Energy Week event in Brussels, the EU Commission further presented a plan for renewable energy in which solar plays a strategic part and will generate 15% (12% by PV electricity and 3% by concentrating solar thermal systems) of the region's electricity demand by 2020.

According to iSuppli, the world's top producer of PV cells in 2008 was Q-Cells of Germany. As PV demand expands around the world in the coming years, iSuppli said it expects European companies will continue to play a major role.

That's right, Zippy, there's not a single mention of kW or MW, let alone kWh or MWh, in the whole thing. Nothing that gives us a feel what those percentages mean in real terms. Percentage of what?

Well, here's a couple of figures for you. PV contributed 2.5 TWh of the EU-27's total electricity production of 3,196 TWh in 2006 (the most recent year for which EU stats are available). Total final energy consumption in the EU-27 ("by far the world's largest market for solar installations") that year was 13,869 TWh. Germany's contribution was 2.2 TWh of PV, out of 595 TWh of electricity and 2,710 TWh of final energy consumed.

Solar photovoltaic power is so insignificant that, in almost all countries, its share of total electricity generation is under 0.05% and less than 0.01% of final energy consumption. Even in Germany, the supposed success story, it is less than 0.4% of electricity production and less than 0.1% of final energy consumption. The average across the EU is around 0.08% of electricity supplies, and without Germany would be 0.01%.

With that sort of start, and "large-scale, competitive PV supply chain", 12% of our electricity supplies by 2020 should be a doddle.

So go ahead, America. Copy the Germans' magnificent success at spending a fortune encouraging a technology that contributes two-fifths of bugger all. So long as you can light your houses with percentages, you'll be fine.

Or could this just possibly be yet another example of rent-seeking lobbying in the energy industry? After all, that "300 billion Euro" figure for potential savings in electricity costs looks a bit steep. Taking 150 Euros/MWh as a reasonable estimate of the European average of retail electricity prices, we would need to increase our PV output to around 2000 TWh p.a. to achieve this saving. That's a mere 80,000% increase. Now, there's a percentage that tells a story.


"Do nothing" conservatives

We might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put it into action... No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such times.

Barack Obama in a couple of years' time? Gordon Brown now, if only (as he surely thinks would be best) he were running America too?

No, Herbert Hoover in 1932, talking about the magnificent programme of government-intervention that had prevented the Crash from deteriorating into a Depression.

When our intelligentsia talk about the current circumstances being the result of laissez-faire and the cure being a massive dose of interventionism, we appear to be in the "second as farce" iteration of history.


London flooded or Miami wrecked? More bad weather on the way

Piers Corbyn, the man who has successfully forecast, weeks or even months ahead, much of this summer's extreme weather events, has issued a warning of further heavy rainfall on 5th-9th and 18th-23rd August. He also warns that there is a serious risk of flooding in London, as the floodwater from this rainfall hits the spring tides of 12th and 28th August.

London under waterI have no idea about the conditions required to cause flooding in London. We are often told (for instance by Ken Livingstone only this week in questions on the Olympics) that London is protected from flooding for at least the next fifty years by the Thames barrage. But given Piers's record (he was bang on with the rains of 12th-14th June and those of 24th-26th June, which caused the Sheffield and Hull flooding, but was out by two days in forecasting the recent heavy rain for 22nd-26th July, when it actually fell mostly during the period 20th-23rd July), and the less impressive record of the Government and the Met. Office, I would be inclined to take at least the weather forecast part seriously, and to ask questions of the Environment Agency about whether the conditions he forecast could really result in serious flooding in London.

The economic consequences, if Piers is correct, could be significant. He has written to Gordon Brown to warn him. We'll see whether the Government will take the threat more seriously this time, and take more decisive action to put preventative and rescue measures in place.

Meanwhile, on the other side of the Atlantic, we are well into Hurricane Season, which officially begins on 1st June. So far, it seems to have been a pretty quiet one, though one wouldn't expect the big storms yet - they tend to be concentrated between August and October. The Season Outlook issued by the National Oceanic and Atmospheric Administration (NOAA) at the end of May warns that it is very likely (75% probability) to be an above-normal hurricane season. This is not, as will doubtless be claimed if the Outlook turns out to be right, because of global warming, but because of "1) the continuation of conditions that have been conducive to above-normal Atlantic hurricane seasons since 1995, and 2) the strong likelihood of either ENSO-neutral or La Niña conditions in the tropical Pacific Ocean." As La Niña conditions have been fingered for our bad weather, it looks like that part of the forecast has been fulfilled, which was expected to lead to more extreme events than if there had been ENSO-neutral conditions.

All-in-all, it looks like this year could be a humdinger of a hurricane season, if the US government agency's models are right. It's always possible that the weather confounds the models, or that the models are wrong. Even if not, the agency is keen to point out that the scale of damage is not necessarily proportional to the activity of the season, as the precise paths of the hurricanes are an important factor in the scale of damage, and these paths cannot be predicted accurately. But it's yet one more risk of a high-cost weather event.

It must already be a pretty bad summer for insurers, given that southern Europe is experiencing its own extreme weather, Eastern India is under water, Japan has been hit by the strongest typhoon on record for a July, while in China, they seem to be managing to have floods and droughts almost simultaneously. If either or both of these threats - flooding in London, or a hurricane-strike on another major American city - occur, it could cause significant difficulties for the insurance industry. And any circumstance where high payouts are a risk can only mean one thing - higher premiums. It's just one more thing to add to the ongoing squeeze on the budgets of most households and businesses nowadays.


Bioethanol - winner or loser?

The production of ethanol from corn as a replacement/supplement for petrol is coming under increased attack from environmentalists. This month's Ecologist and today's Independent both led with a destructive assessment of its merits.

I do not claim to know whether ethanol is a good or bad solution to our energy problems. But I do know that George Bush and Tony Blair don't know, and neither do Zac Goldsmith (editor of The Ecologist) and Simon Kelner (editor-in-chief of The Independent). Because they are trying to establish the case by claim, counter-claim and posturing, little light is shed on the issue. And because no mechanism exists that simply values carbon equally from all its sources, we have no way of discovering in a market the reality that is being obfuscated in discussion. As usual, sweeping generalisations ("this technology is good/bad regardless") that ignore changing circumstances are a good sign that people are busy picking losers rather than allowing the most efficient and appropriate solutions for the circumstances to emerge and evolve.

Sometimes the debates seem intended to confuse, not illuminate. Perhaps this is the real objective. For an alternative take on the ethanol debate in America and people's motivations in presenting their arguments, have a look at the What's That Smell? site. The author's hostility to a local development has produced a scathing analysis of the process by which politicians and lobbyists adopt and promote losers for their own interests. Just remember that the other side - opponents of ethanol - have their own agenda too.