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Poll Dancing

With elections looming, and Kevin Rudd’s return to power, it is time for our regular guest blogger, James, to pull out his beer coaster calculator and take a closer look at the polls. 

It is really that time again. Australian election fever has risen. Though in this case it feels like we have been here for three years since the last election. Polls every week telling us what we think and who we will vote for. But what exactly do these polls mean? And what do they mean by “margin of error”?

So here is the quick answer. Suppose you have a two party election (which two party preferred, 2PP, effectively amounts to through Australia’s preference system). Now suppose each of those parties really has 50% of the vote. If there are 8 million voters and you poll 1,000 of them then what can you tell? Surprisingly it turns out that of these inputs the number of 8 million voters is actually irrelevant! We can all understand that if you only poll 1,000 voters out of 8 million then there is a margin of error. This margin of error turns out to be quite easy to compute (using undergraduate level Binomial probability theory) and only depends on the number of people polled, and not the total number of voters. The formula is:

MOE = k × 0.5 /√N.

where N is the number of people polled and k is the number of standard deviations for the error. The formula √1000 = 33 so 1/√1000 = 0.03 = 3%. The choice of k is somewhat arbitrary but in this case k = 2 (because for the Normal distribution 95% of outcomes lies within k=2 standard deviations of the mean) which conveniently makes k × 0.5 = 1. So MOE=1/√N is a fairly accurate formula. If N=1000 then MOE=1/33=3% (give or take). This simply means that even if the actual vote was 50:50 then 5% of the time, an unbiased poll of 1,000 voters would poll outside 47:53 due purely to random selection. And even if the actual vote is, say, 46:54, the MOE will be about the same.

Interestingly in the US where there are about 100m voters they usually poll at N = 40,000 which makes the MOE = 0.5%. In this case the economics of polling scale as the number of voters hence they can afford to poll more people. But the total number of voters, 100m or 10m, is irrelevant for the MOE. As the formula shows to improve the accuracy of the estimate by a factor of 10 (say from 3% to 0.3%) they would need to increase the sample size by a factor of 100. You simply can’t get around this.

One of the criticisms of polling is that that they don’t reach the same number of (young) people on mobile phones as older people on land lines. This is easily fixed. You just adjust the figures according to what type of phone they are using based on known percentages of who uses what type of phone. Similarly you can adjust by gender and age. The interesting thing though is that the further you get from actual phone usage/gender/age in your poll you also need to increase your MOE, but not your expected outcome.

Okay so that is it: MOE = 1/√N where N = number of people polled. If N = 1000 then MOE=3%. My all time favourite back of the beer coaster formula.

The recent jump in the 2PP polls for Labor when Kevin Rudd reassumed the PM-ship from about 45% to 49% were greeted by journalists as “Kevin Rudd is almost, but not quite, dead even”. I found this amusing as it could statistically have been 51%, within the MOE, in which case the headline would have been “Kevin Rudd is ahead!”. Indeed barely a week later he was “neck and neck” in the polls at 50:50. Next week it may be “51:49” in which case he will be declared on a certain path to victory! However within the MOE of 3% these results are statistically indistinguishable.

From my point of view, as a professional statistician, I find the way many journalists develop a narrative based on polls from week to week, without understanding the margin of error, quite annoying. Given the theory that if a politician has the “The Mo” (ie. momentum) it may end up helping them win when it is irresponsible to allow random fluctuation due to statistical sampling error to influence the outcome of an election. Unless of course it helps the party I support win.

Can I trust MtGox with my passport?

Liberty Reserve logoIn March 2013, the US Financial Crimes Enforcement Network (“FinCen”) published a statement saying that companies which facilitate buying and selling of “virtual” currencies like Bitcoin constitute “money service businesses” and are subject to reporting obligations designed to prevent money laundering and other financial crimes.

A couple of months later, the seizure by US authorities of Liberty Reserve has shaken money service businesses around the world, whether they deal in “real” or “virtual” currencies.

Two days later, the largest Bitcoin exchange, MtGox, tightened their anti-money laundering (AML) controls, posting the following statement on its website:

Attention Users: From May 30th 2013 all withdrawals and deposits in fiat [real] currency will require account verification. However withdrawals and deposits in Bitcoin (BTC) do not require verification.

What MtGox is attempting to do here is meet one of the most fundamental requirements of AML legislation around the world: know your customer. It is so fundamental that it too earns its own three-letter abbreviation, KYC.

So, how does an online business like MtGox verify the identity of its customers? After all, you can’t walk into the local MtGox branch with a fist full of paperwork. Instead, you must upload a scan of “proof of identity” (passport, national ID card or driver’s licence) and “proof of residency” (a utility bill or tax return).

MtGox are not alone in this approach. More and more online money service businesses are attempting to get on the right side of AML rules by performing verification in this way.

Here in Australia, there are still some Bitcoin brokers which do no verification whatsoever, including BitInnovate (who helped me buy my first Bitcoin) and OmniCoins. Australia’s AML regulator, AUSTRAC publishes a list of  “designated services”, which make business subject to reporting obligations including customer verification. The list includes

exchanging one currency (whether Australian or not) for another (whether Australian or not), where the exchange is provided in the course of carrying on a currency exchange business

So I strongly suspect that all local Bitcoin brokers too will soon be demanding scans of your driving licence and electricity bill.

But is the MtGox approach to customer verification a good idea? I don’t think so. I believe it is a bad idea for MtGox and a bad idea for their customers.

It is a bad idea for MtGox because scans of fake identity documents are very easy to come by. For example, one vendor at the online black market Silk Road offers custom UK passport scans with the name and photo of your choice, complete with a scan of a matching utility bill.

It’s a bad idea for the customer too, because it exposes them to increased risk of identity theft. Although my intentions were not criminal, I chose BitInnovate when I bought Bitcoin precisely because I did not have to provide any personal documents. How well do you know MtGox or any other online money service? How confident are you that they will be able to keep their copies of your documents secure? Securing data is hard. Every other week it seems that there are stories of hackers gaining access to supposedly secure password databases. I have no doubt that scans of identity documents will also find their way into the wrong hands.

So what is the alternative?

Third party identity management.

Using a passport or driver’s licence scan is effectively outsourcing identity verification to the passport office or motor registry respectively. Before the days of high quality scanning and printing, these documents were difficult to forge. A better solution is to retain the idea of outsourcing, but adapt the mechanism to today’s technology.

Here’s how it could work.

A number of organisations would establish themselves as third party identity managers. These organisations should be widely trusted and, ideally, have existing experience in identity verification. Obvious examples are banks and government agencies such as the passport office.

Then if I wanted to open an account with MtGox, its website would provide a list of identity managers it trusted. Scrolling through the list, I may discover that my bank is on the list. Perfect! When I first opened an account with my bank I went through an identity verification (IDV) check (ideally, this would have been done in person and, even better, the bank would have some way to authenticate my passport or driver’s licence*), so my bank can vouch for my identity. I can then click on the “verify” link and I am redirected to my bank’s website. Being a cautious fellow, I check the extended validation certificate, so I know it really is my bank. I then log into my bank using multi-factor authentication. My bank now knows it’s really me and it presents me with a screen saying that MtGox has asked for my identity to be validated and, in the process, has requested some of the personal data my bank has on file. The page lists the requested item: name, address, email address and nationality. I click “authorise” and find myself redirected to MtGox and a screen saying “identity successfully verified”.

MtGox is now more confident of my true identity than they would be with scanned documents and I have kept to a minimum the amount of information I need to provide to MtGox: no more than is required to meet their AML obligations.

This authentication protocol is a relatively straightforward enhancement to the “OAuth” protocol used by sites like Twitter and Facebook today. OAuth itself is subject to some controversy, and it may be better to create a new standard specifically for high trust identity management applications like this, but the tools exist to put identity management on a much safer footing.

* Today, unfortunately, banks and other private sector entities are not readily able to authenticate passports or driver’s licences. Once government agencies are able to provide this service, the options for third party identity management will be even greater.

 

BitTorrent Sync

BitTorrent Sync logoI have been a long-time user of Dropbox. It synchronises important files across computers, provides offsite backup and remote access to these files. But it does have its limitations.

A free Dropbox accounts gets you 2 gigabytes of storage (although persuading friends to sign up can earn you an an increase in this limit). If you need more space, paid plans start at $10 per month.

I have found a new solution for file synchronisation without the size limits. BitTorrent Sync is still in its beta stage of development, but so far I have found it works very well. It is fast, efficient and does exactly what I want it to do.

BitTorrent Sync is not a cloud storage system, so it does not offer all of the features of DropBox. But anyone with with more than one computer, or anyone who wants to regularly share files with a friend or colleague will quickly find BitTorrent Sync an invaluable tool.

So what exactly does BitTorrent Sync do, and what doesn’t it do?

Two-Way Synchronisation – YES

BitTorrent sync really does one thing and one thing well: synchronisation. Install BitTorrent on two computers, point it at a folder on each computer and it will ensure that the contents of the two folders stay in sync. Change a file on one computer and it will change on the other. Add a new file and it will quickly appear on the other computer.

I have a desktop machine and a laptop. They both have Dropbox installed, so I usually save documents in my Dropbox folder to ensure I have access from both machines. But my Dropbox account is getting full, so if I am working with a large dataset or large image files, I keep them out of Dropbox. I then inevitably find I need to use those files on a different machine. BitTorrent Sync has solved that problem for me.

Synchronisation works like a rocket on a local network, but will also work over the internet. As the name suggests, BitTorrent Sync makes use of the same technology use in BitTorrent and is extremely efficient when it comes to dealing with very large files. Synchronisation over the internet when users at each end are behind their own routers works well, thanks to similar “NAT traversal” techniques to those used by Skype. All file transfers, whether local or over the internet, are encrypted. As long as you keep your secret safe, your data is safe.

Setting up synchronisation is straightforward. When you first point BitTorrent Sync at a folder, a “secret” is generated. Secrets are strings of numbers and letters, like this: WBUAH4P6P41KAPJ7ERSAWXY5RB2BCT28. Then, when setting up other machines to share the same folder, all you need to do is enter the secret from the first computer. Multiple machines can share the same folder with the same secret and BitTorrent Sync can also manage multiple folders with different secrets.

One-Way (Read Only) Synchronisation – YES

While Two-Way synchronisation works well for sharing files with family and friends. Sometimes you will want to give others read access to files without allowing them to delete or edit the files. This is where one-way synchronisation comes in. Each synchronised folder has a “read only secret” in addition to the main secret. Give this read only secret to your mother and she can see all of your family photos and you need not worry that she will accidentally delete any of them*.

As far as I know, Dropbox does not offer one-way synchronisation.

Mobile Access – NOT YET

Dropbox offers apps for iPhone, iPad and Android devices which allow you to access files on the go. Mobile apps for BitTorrent Sync are not yet available, but they are under development.

Cloud Backup – NO

BitTorrent Sync directly syncs content machine to machine. Dropbox, on the other hand, syncs each machine with the Dropbox’s own servers. If all of your computers suffer catastrophic failure, you can still recover your data from Dropbox. BitTorrent Sync does not provide any cloud backup. Of course, you could always set up a Rackspace server and install BitTorrent Sync there…

Web Access – NO

With all of your files on their servers, Dropbox can easily provide web access to your files. BitTorrent Sync cannot. The files will only be available on machines with BitTorrent Sync installed.

Version Control – NO

Another useful feature offered by Dropbox is version control. If you make some drastic edits to your latest presentation, which you later regret, Dropbox allows you to recover previously saved versions. BitTorrent Sync will not help you with version control.

BitTorrent Sync does not do as much as Dropbox and other cloud backup services. But what it does do, it does very well. I expect to get a lot of use out of it.

* Two-way synchronisation does provide protection against accidental deletion: when a file is deleted on one machine, copies on other machines are moved to a hidden folder rather than deleted, so they can be recovered later.

 

 

Bitcoin: what is it good for?

Bitcoin has been a hot topic in the news over the last few weeks.

The digital currency has its adherents. The Winklevoss twins, made famous by the movie Social Network after suing Mark Zuckerberg for allegedly stealing the concept of Facebook, now purportedly own millions of dollars worth of Bitcoins.

It also has its detractors. Paul Krugman has argued that the whole enterprise is misguided. Bitcoin aficionados are, he writes, “misled by the desire to divorce the value of money from the society it serves”.

Still others cannot seem to make up their mind. Digital advocacy group, Electronic Frontier Foundation (EFF) accepted Bitcoin donations for a time, but became uncomfortable with its ambiguous legal status and shady associations, such as with the online black market Silk Road, and decided to stop accepting Bitcoin in 2011. A couple of years on and the EFF’s activism director is speaking at a conference on Bitcoin 2013: The Future of Payments.

Recent media interest has been fuelled by the extraordinary roller-coaster ride that is the Bitcoin price. In early April, online trading saw Bitcoins changing hands for over US$200. At the time of writing, prices are back below US$100. As with many markets, it’s hard to say exactly what is driving the price. Speculators, like the Winklevoss twins, buying Bitcoins will have helped push up prices, while reports that Silk Road has suffered both a deflation-driven collapse in activity and hacking attacks may have contributed to the down-swings.

Bitcoin (USD) prices

Although not obvious on the chart above, dramatic price movements are nothing new for Bitcoin. Switching to a logarithmic scale makes the picture clearer. After all, a $2 fall from a price of $10 is just as significant as a $40 fall from a price of $200. The 60% fall from $230 to $91 over April has certainly been dramatic. But back in June 2011, after reaching peak of almost $30, the price fell by 90% within a few months.

Bitcoin price history (log scale)

The volatility of Bitcoin prices is orders of magnitude higher than traditional currencies. Since the start of the year the price of gold has been tumbling, with a consequent spike in its price volatility. Even so, Bitcoin’s volatility is almost ten times higher. The chart below compares the volatilities of Bitcoin, gold and the Australian dollar (AUD).

Historical volatility of Bitcoin

A week or so ago, armed with this data, I was well advanced in my plans for a blog post taking Bitcoin as the basis for a reflection on the nature of money. I would start with some of the traditional, text-book characteristics of money. A medium of exchange? Bitcoin ticks this box, with a growing range of online businesses accepting payment in Bitcoin (including WordPress, so not just underground drug sites). A store of value? That’s more dubious, given the extremely high volatility. It may appeal to speculators, but with daily volatility of around 15%, it’s hard to argue that it is a low risk place to park your cash. A unit of account? Again, the volatility gets in the way.

That was the plan, until a conversation with a colleague propelled me in a different direction.

She asked me what this whole Bitcoin business was all about. Breezily, I claimed to know all about it, having first written about Bitcoin two years ago and then again a year later. I launched into a description of the cryptographic basis for the operation of Bitcoin and went on to talk about its extreme volatility.

I then remarked that when I first wrote about it, it was only worth about $1, but had since risen to over $200.

“So,” she asked, “did you buy any back then?”

That shut me up for a moment.

Of course I hadn’t bought any. What gave me pause was not that I had missed an investment opportunity that would have returned 20,000%, but that I was so caught up in the theory of Bitcoin that it had not occurred to me to see what transacting in Bitcoin was actually like in practice. So I resolved to buy some.

This turned out not to be so easy. While there are many Bitcoin exchanges, paying for Bitcoins means jumping through a few hoops. Perhaps because the whole philosophy of Bitcoin is to bypass the traditional banking system. Perhaps because banks don’t like the look of most of them and will not provide them with credit card services. Whatever the reason, your typical Bitcoin exchange will not accept credit card payments. Many insist on copies of a passport or driver’s licence before allowing wire transactions, neither of which I would be prepared to provide.

Eventually I found BitInnovate, which allows the purchase of Bitcoin through Australian bank branches. Even so, the process was an elaborate one. After placing an order on the site, payment must be made in person (no online transfers), in cash, at a branch within four hours of placing the order. If payment is not made, the order is cancelled. Elaborate, but manageable, and no identification is required.

But before I could proceed, I had to set myself up with a Bitcoin wallet. As a novice, I chose the standard Bitcoin-Qt application. I downloaded and installed the software, and then it began to “synchronise transactions”. This gets to the heart of how bitcoins work. As a purely digital currency, they are based on “public key cryptography”, which is also the basis for all electronic commerce across the internet. The way I make a Bitcoin payment to, say, Bob is to electronically sign it over to him using my secret “private key”. Anyone with access to my “public key” can then verify that the Bitcoin now belongs to Bob not me. Likewise, the way I get a Bitcoin in the first place is to have it signed over to me from someone else. In case you are wondering what one of these Bitcoin public keys looks like, mine is 1Q31t2vdeC8XFdbTc2J26EsrPrsL1DKfzr. Feel free to make Bitcoin donations to the Mule using that code!

In this way, rather than relying on a trusted third party (such as a bank), to keep track of transactions, the ownership of every one of the approximately 11 million Bitcoins is established by the historical trail of transactions going back to when each one was first “mined”. Actually, it’s worse than that, because Bitcoin transactions can involve fractions of a Bitcoin as well.

So, when my Bitcoin wallet told me it needed to “synchronise transactions”, what it meant was that it was about to download a history of every single Bitcoin transaction ever. No problem, I thought. Two days and 9 gigabytes (!) later, I was ready for action. Now I could have avoided this huge download by using an online Bitcoin wallet instead, but then I would have been back to trusting a third party, which rather defeats the purpose.

The cryptographic transaction trail may be the brilliant insight that makes Bitcoin work and I knew all about in it theory. But in practice, it may well also be Bitcoin’s fatal flaw. Today, a new wallet will download around 10 gigabytes of data to get started, and that figure will only grow over time. The more successful Bitcoin is, the higher the barrier to entry for new users will become. I suspect that means Bitcoin will either fail completely or simply remain a niche novelty.

Still, it is an interesting novelty, and despite the challenges, I decided to continue with my investigations and managed to buy a couple of Bitcoins. The seller’s commission was $20 and falling prices have since cost me another $20 or so. So, I am down on the deal, but, as I have been telling myself, I bought these Bitcoins on scientific rather than investment grounds.

Of course, if the price goes for another run, I reserve the right to change my explanation.

NDIS and how many disabled people are there anyway?

Regular guest writer, James Glover, returns to the Mule today to look at the figures behind the proposed NDIS.

The National Disability Insurance Scheme (NDIS) is in the news again. A welcome development for people with disability and their carers and families…and friends and pretty much anyone else who cares about their fellow humans. It is not a platitude to say that disability can strike anyone at any time in their life and the stories of these people are truly moving and shaming, especially as we live in one of the richest countries in the world. Adults who are only provided with two assisted showers a week and parents providing 24/7 care to profoundly disabled children but who cannot afford a new specialised wheelchair because there is limited funding for such things (wheelchairs cost from $500 for the basic models, of which I have two, and range up to $20,000 or more). In August 2011 The Productivity Commission reported on and recommended the NDIS and since then pretty much everyone agrees it is a good idea if we could only agree how to fund it.

So what does it replace? Currently most people with serious disabilities that prevent them from, inter alia, working, can receive the disability support pension (DSP). A small number will have insurance payouts if they were “lucky” enough to to have someone else to blame for their disability. In addition, anyone can receive a rebate on medications in excess of about $1,200 a year and, of course, access to (not quite free) public health care. On top of that, there are concession cards for public transport and a taxi card system which provides half-price taxi fares to partially make up for many disabled peoples inability to use public transport. The DSP does not depend on a specific disability and for a single adult over 21 with no children it is about $19,000 a year. For child under 18 who is living at home it is about $9,000 a year. While this would appear enough to live on (forgetting overseas holidays or a mortgage) most such people rely on additional support services for everything from basic medical equipment to respite for carers. There are currently 820,000 people, about 4% of the population, on the DSP. The Productivity Commission estimates 440,000 people on the NDIS so most of these will not be eligible for the NDIS but may still receive the DSP. People 65 and over of pensionable age are not eligible for the DSP and will not be eligible for the NDIS.

The purpose of the NDIS is to provide funding for care in line with the specific requirements of the recipients, and will mean additional support to the DSP for some. You can read more about it at ndis.gov.au. Unlike the DSP, it isn’t a fortnightly stipend or, like standard disability or employment insurance, a lump sum. The government is planning to roll out pilot programs in many regions in the next few years, aiming for a complete national program by 2018-19. I won’t go into the politics but it seems even politicians can feel shame and  bipartisan support for the NDIS is emerging with a good chance of a bill through this parliament in the next few weeks. The total cost of the NDIS is often quoted as $18bn a year. Some funding is proposed from an additional 0.5% to the Medicare levy. Other funding wil come jointly from the federal government and the states. The proposed levy will raise about $3.8bn a year, so nowhere near enough for the full cost. If you subsume the half the DSP cost of $11bn a year that (only) leaves an outstanding amount of $8-10bn a year to be funded even with the Medicare Levy. Hopefully with bipartisan support the full NDIS will be implemented sooner rather than later.

So that’s the background on the NDIS. The real purpose of this article though is to consider the question “How many disabled people are there in Australia anyway?”.

Well that’s easy, just read any article on disability–for instance this one by disability advocate and media personality Stella Young–and you’ll be told the answer: 20%. 20%. 20%! I am a huge admirer of Stella Young’s work, so don’t get me wrong if I choose to disagree with her on this. The 20% figure gets quoted so frequently it must be true. Well maybe. People questioning this figure are directed to the 2009 ABS Census report on disability where the self-reported disability figure is 18.1% (+/-1.3%). So a round 20% is not too bad, right? Well like all statistics, the details are important. Firstly this includes people of all ages and, not surprisingly, many more older people have disabilites. From 40% at 65-69 to 88% at 90+. For those under 65 the figure is 13.2%. It increases with age and, in the 45-54 age group, is about the average 18%. Anyway why does it matter if the true figure is overstated? Well one reason is that while there is widespread support for the NDIS, the one concern that keeps coming up is who is eligible.

According to the Productivity Commission report they estimate 440,000 people on the NDIS of whom 330,000 would be disabled, and the rest made up of carers and people on preventative programs.

This report has a deeper analysis, which takes the figures at face value. It also includes breakdowns by disabling condition. I have paraphrased these in the following table based on some of the major causes of disability. And look, there are those perennial favourites of those who think all disabled people are really bludgers: back problems,stress and depression, making up about 18% of the total. Not quite bankrupting the country then.

Disability table 1

But what constitutes disability? It is basically a lack of normal activity rather than a set of diseases per se. The ABS report has 5 activity based categories, four of which are based on “restrictions on core activities: communication, mobility, self care”. There are “profound”, “severe”, “moderate” and “mild” levels of disability. A fifth category is  “schooling or employment restriction”, but overlaps with the first four. Here is a table with the breakdown by category and age group. Combining those with a core activity limitation with employment/school limitations the figure is 15.3%. The difference between this and the higher self-reported 18% figure I suspect comes from peope who feel a bit crap a lot of the time, but aren’t signficiantly prevented from their activities. So I would estimate the number of disabled people to be more like 15% than 20%. For those under 65 this is 11%. The NDIS has a similar definition but includes social activities as well, but don’t yet provide any breakdowns.

Disability table 2

So much for the figures from the ABS, which I think we can all agree are definitive, right?  Looking at the ABS figures for this group (under 65) they total 345,000. But wait! The figure of 15.3% is based on a total number of respondents to the census of only 9.5 million people. If the reportage rate was the same as the general population of 22m then there would be about 700,000 severe or profoundly disabled people. But the Productivity Commission only estimates 330,000 or half this number on the NDIS! The alternative to the unlikely event that less than 50% of profoundly or severely disabled people will end up on the NDIS is that the reported ABS figure for people in this category is correct but the rate is wrong. While the overall reportage rate is about 50% it looks like the reportage rate for disabled people in the severe and profound category is closer to 100%. If this was also true for the other categories of disabled people then that suggests that the real rate of disability is less than 9% and maybe as low as 7%. Assuming the reportage rate is the same as the rest of the population, ie 50%, for the other categories then the disability rate might be as high as 13%. So lets split it and say 10%. In any event the widely reported figure of 20% is well above the highest estimates based on the ABS and Productivity Commission data. The real rate of disability is closer to 10% than 20%.

Does it matter? Maybe. If you claim that 20% of the population are disabled, people start quickly calculating that the cost is unsupportable if all of those people are on the NDIS! Which of course they won’t be. Fewer than half of disabled people are already on the DSP. Less than half of those will transfer to the NDIS. Overstating the percentage of disabled people isn’t necessarily a good argument for the NDIS if it reduces support from otherwise sympathetic people.

A final thought: in the large Australian organisation I work for, there are a fair few disabled people, some of whom I think would be categorised as severe. With proper support many disabled people can gain suitable education or training and hence employment and support themselves and contribute to the economic activity of the nation. The more people with disability who are employed the fewer on the DSP or NDIS, the more money for those who really have no choice. Supporting people with disability into employment is as important, in my opinion, as supporting them in living and care through the NDIS.

[This article was rewritten following some comments and some further research. In line with all my articles on Stubbornmule this article is about estimating rough numbers from scarce data “back of the beercoaster” style rather than disability politics, it just happens I have a personal interest in this subject]

 

Quandl

I spend a lot of time trawling the internet for data, particularly economic and financial data. Yahoo Finance and Google Finance are handy for market data and “FRED”, the St. Louis Fed is an excellent, albeit US-centric, resource for a broad range of financial aggregates. While these sites make it very easy to automate data downloads, most sites (including, unfortunately, the Australian Bureau of Statistics) provide data in Excel format or other inconvenient forms. At times this has become sufficiently frustrating that I have periodically entertained vague plans to build my own time-series data web-site that would source data from across the world and the web, making it available in consistent, useful way.

Needless to say, I never got around to it, but it seems that someone else has. Today I stumbled across Quandl, which aggregates and re-publishes over 5 million time-series. The data can be presented as charts on their website, downloaded or accessed programmatically through their application programming interface (API). There is even an R package available to make it easy to load data directly into my favourite statistical package, R.

Here is an example of how it all works. Quandl has data on the Australian All Ordinaries index. To read this data into R, you will first need to register with Quandl and obtain an authentication key for the API. This key is a random string, which looks something like this jEGfHz9HF7C3zTus6ZuK (this one is not a real key!). Once you have your key, you can fire up R and install and load the R package by entering the following commands:

install.packages("Quandl")
library(Quandl)

Once this is done, you will need to find the Quandl code for the data you are interested in. Near the bottom of the Quandl page, there is a pane showing the data-set information, including the provenance of the data.

Screen Shot 2013-04-20 at 10.54.02 PM

Armed with the text labelled “Quandl Code”, in this case “YAHOO/INDEX_AORD”, you now have everything you need. I will assume you already have the ggplot2 and scales packages installed. To plot the history of the All Ordinaries, simply enter the following code (replacing the string in the third line with your own authentication key).

library(ggplot2)
library(scales)
Quandl.auth("jEGfHz9HF7C3zTus6ZuK")
aord ggplot(aord, aes(x=Date, y=Close)) + geom_line() + labs(x="")

All Ordinaries

I can see I am going to have fun with Quandl. It even has Bitcoin price history. But that is a subject for another post.

Wall of Liquidity

Once again a misconception is gaining currency. There is increased talk of a build up of cash just waiting to be converted into equities or other assets. I wrote about this years ago in cash on the sidelines, but apparently the financial commentariat did not read the post, so it is time to revisit the subject.

I believe that the reason the misconception is so widespread is that the subject is not discussed in technical terms, but in metaphors. Some of you have heard the phrase “the great rotation”, which refers to the idea that investors will shift en masse from cash and bonds to shares. It’s a compelling phrase, but it leaves one question unanswered: who will sell the shares to these rotating investors and, given that these sellers will be paid for their shares, what happens to the money they receive? It’s still cash after all. Likewise, if these rotators are selling their bonds, someone has to buy them. Post-rotation, there is still just as much cash in the system and just as many bonds. Cash and bonds don’t just magically turn into shares. Reality is messy…why spoil a good metaphor?

A simpler, more dramatic and more vacuous metaphor that has also made a reappearance is the “wall of liquidity”.

Wall of Liquidity

No one using this compelling phrase would be so crass as to explain what it means. Such is its power, it is assumed that we all know what it means. So, let’s have a look at “wall of liquidity” out in the wild. In an article about rising bank share prices, Michael Bennet wrote in The Australian:

But pump-priming by global central banks has created a so-called wall of liquidity looking for income that is flowing out of cash and into high-dividend-paying stocks, with banks attractive due to their fully franked dividends.

Here it certainly sounds as though “wall of liquidity” is just “cash on the sidelines” in a fancy suit. But let’s zero in for a moment on the other metaphor in this sentence, “pump-priming”. Doubtless, the author has the US Federal Reserve (Fed) in mind. The standard line runs something like this: with low interest rates and purchases of securities through the “QE” (quantitative easing) programs, the Fed has flooded the banks with liquidity. More prosaically, reserve balances (i.e. the accounts banks have with the Fed) have grown. So far so good, as the chart below shows.

The next step in this line of thinking is that as this cash builds, it is a “wall of liquidity” desperate to find somewhere to go and, in the quest for investments, it will push up asset prices.

But before we can accept this reasoning, there is an important point to note. Reserves with the Fed are assets of banks only. Contrary to a common misconception, these reserves cannot be lent, they can only be shuffled around from bank to bank. Nevertheless, there is a theory that, because in the US and some other countries, a certain percentage of bank deposits must be backed by reserve balances, there is a “money multiplier” which determines a fixed relationship between reserve balances and bank deposits*. If this theory is correct, bank deposits should have grown as dramatically as reserve balances. They have not.

M1 money

Taking the same chart and displaying it on a log scale shows that growth in deposit balances has been very steady over the last 20 years.

M2 - log scale

Whatever is going on in financial markets, it has nothing to do with a dramatic build up of cash which is poised to be converted into “risk assets”.

Yet another way to see this is to think about what is going on in Australian banks at the moment. Credit growth is slow in Australia. This is not because banks are reluctant to lend. Quite the contrary. Banks are looking at the slow credit growth and fretting about their ability to deliver the earnings growth that their shareholders have come to expect. The problem is that there is a lack of demand for credit as households and businesses continue to save and pay down debts. In response, banks have begun to compete aggressively on price and, in some cases, on terms to attempt to grow the size of their slice of a pie that is not growing. And yet these very same banks continue to compete for customer deposits. Australian banks are not sitting on vast cash reserves that are compelling them to lend. Rather it is simply renewed risk appetite that is driving banks to compete for lending.

The same is true around the world. Looking at cash balances as a sign that yields will fall and asset prices will rise is a pointless exercise. What is happening is much simpler. Animal spirits are emerging once more. Low interest rates (not cash balances) will help, but fundamentally it is risk appetite that drives markets.

The last time I heard people talking in terms of walls of liquidity was in 2005-2006 in the lead-up to the global financial crisis. These putative piles of cash were used to support a change of paradigm in which the returns for risk could stay low indefinitely. Of course this turned out to be dramatically wrong. The cash didn’t disappear, but risk appetite did. I am not predicting another crash yet, but I do foresee this nonsense being used to justify more risk-taking for lower returns. If that happens for long enough, then there will be another crash.

* As an aside, given that Australia has no minimum reserve requirements, if the money multiplier theory was valid, there should be an infinite amount of deposits in the Australian banking system. For the record, this is not the case.

Photo credit: AP

Account Keeping

I have been digging through some family archives and came across an old bank passbook belonging to my great grandfather, William Booth. He lived in Perthville in the central west of NSW. His account was with the Bank of New South Wales, Bathurst branch.

Passbook

Pasted inside the front cover is a statement of the account keeping fees. I was born after decimalisation, so 5/- was not immediately meaningful to me. It turns out that the semi-annual fee is five shillings. To complicate matters further, the first transaction in the passbook is dated 1903, so these are British shillings. Australia did not introduce its own currency until 1910.

Passbook fees

Having worked out that much, I was interested to compare 1903 account keeping fees to account keeping fees today. So, the next step was to convert five 1903 British shillings into present day Australian dollars. The website Measuring Worth comes in handy for this purpose. The site’s banner features the following quote from Adam Smith’s The Wealth of Nations (1776).

The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it… But though labour be the real measure of the exchangeable value of all commodities, it is not that by which their value is commonly estimated… Every commodity, besides, is more frequently exchanged for, and thereby compared with, other commodities than with labour.

With that in mind, it provides a range of present day values for five 1903 shillings. Well, almost present day: their data series extend to 2011, so in 2011 terms five shillings is worth any one of the following

£22.00 using the retail price index
£26.00 using the GDP deflator
£86.80 using the average earnings
£134.00 using the per capita GDP
£200.00 using the share of GDP

 

Back in the day of William Booth, account keeping involved someone manually reconciling three columns of pounds, shillings and pence. These days the process is computer-assisted, so a retail price adjustment may be more appropriate than average earnings or any of the other measures.With UK inflation running at 2.6% over 2012, I can tweak £22.00 to £22.57. Using the current exchange rate, that amounts to A$33.33. Strictly speaking, even though Australia used British pounds in 1903, I should use an Australian retail index, but as Measuring Worth only has US, UK, Japanese and Chinese conversions at the moment, I will stick with the British approach.

So, Mr Booth was paying just over $5 per month in service fees for his banking. The Bank of New South Wales has since become Westpac. According to the Westpac website, the monthly service fee for the “Westpac Choice” transaction account is $5. Fees at other banks would be very similar. So, perhaps surprisingly, account keeping fees seem to have changed very little over the last 110 years!

Westpac fees

Given the level of automation in banking today, it would be reasonable to expect that fees would be lower than they are today. Certainly if the five shillings were adjusted based on average wages, the cost of Mr Booth’s account keeping would be more like $20 per month. Not only that, like every other bank, Westpac also offers a basic account option with zero account keeping fees. I am sure that would not have been an option in 1903.

Prisoner of Speed

A favourite podcast of mine is known in our household as “Danny’s podcast” in honour of the friend who first put me on to it. The podcast is better known as Radiolab and last week’s episode turned on the theme of Speed. After answering the question, what is the fastest sense, attention turned to high-frequency trading. As the Radiolab hosts are more comfortable with science than finance, they turned for assistance to David Kestenbaum from the Planet Money podcast.

In a past Mule post, I expressed reservations about the merits of high-frequency trading. Just last year, there was talk in the European parliament of enforcing a delay on electronic trading. Some critics argue that high-frequency trading creates instability in financial markets and may have been to blame for the “flash crash” of 2010.

One of the more intriguing aspects of high-frequency trading was brought out in the podcast during an interview with a technologist from the US trading firm Tradeworx. Bemoaning the cost of constantly competing to allow faster and faster trading (millions of dollars are being thrown at shaving milliseconds from the time to send trades to an exchange), he said that high-frequency traders were caught in a prisoner’s dilemma.

The prisoner’s dilemma is a staple of the study of the branch of mathematics known as “game theory“, which seeks to analyse strategic decision-making. Here is a quick overview for anyone unfamiliar with it.

Two criminals are arrested and taken to separate cells to ensure they cannot communicate with one another. The police have enough evidence to send each man to jail for one year. With a confession the police could get a conviction on a more serious charge. So, the police point out to each prisoner that cooperation will help reduce their sentence. If neither prisoner confesses, both will face one year in prison. If one testifies against his partner in crime, he will go free while the partner will get three years in prison on the main charge. But, if they both confess, that cooperation is not worth as much and both will be sentenced to two years in jail.

So, what should each prisoner do? No matter what the other prisoner does, confessing will improve their outcome, either from one year to none if the other does not confess, or from three years to two if the other does confess. So, the only rational thing to do is to confess. If both prisoners follow this logic, they will both get two years. And yet, if they had both kept quiet, it would have only been one year each, which would be better for both of them. The problem is that the “global optimum” is hard to obtain because there is too much of a risk for each prisoner that the other will defect.

The same is true for the high-frequency traders. While it might be cheaper for all of them to call a truce and freeze their technology at its current state, there would always be the risk that one firm breaks the truce and gains an edge. So, they all continue to compete in the speed race.

But the prisoner’s dilemma applies to more players than just the trading firms themselves.

If one of the major exchanges, such as the NASDAQ tried to stop the speed race, then it may well find itself losing business to any other exchange which continued to facilitate faster trading. An exchange without trading does not last long.

Governments too face the dilemma. There is already intense competition between exchanges operating in different countries and no government would want to lose the kudos and, more importantly, revenue that comes with playing host to a major financial centre. Would the UK government, for example, want to put London at a disadvantage to Europe or the US? Unlikely.

The German government is now delaying plans to curb high-frequency trading, in order to “clarify technical details”. I suspect that this will turn out to be a rather long delay.

 

Where is the money coming from?

PalmTreeIt has been quite some time since I wrote about the mechanics of money, but today I am at it again. The catalyst is not, as some might expect, the recent discussions about the possibility of the US Treasury minting a trillion dollar coin, but rather a recent discussion I had with a banker about deposits on a small tropical island.

While deposit levels at banks in Australia are below upcoming regulatory minimums, leading to intense competition in the pricing of term deposits, the banker I spoke to was facing the opposite problem in the small nation of Paradise Island (not its real name).

As he told the story, despite offering rather unattractive interest rates on deposits, deposit balances had continued to grow. Worse, demand for loans was weak and so the bank was forced to keep growing balances on deposit with the island nation’s central bank. Since banks like to diversify their investments, this situation was not ideal. Ordinarily, he said, deposits would build up as exporters took in payments for their goods, but periodically these balances would be swept out again as they remitted their profits to offshore parent companies. This did not seem to be happening any more. Exactly why these deposits were growing was a mystery and, short of closing the doors of all their branches, he did not really know how to stop these balances from growing.

With years of reading Bill Mitchell under my belt, I knew that the way to think about this question was to take a macro perspective rather than thinking from the perspective of one bank.

The first thing I focused on was the balances with the central bank. A popular misconception is that banks can choose between holding deposits with the central bank or lending the money to their customers. In fact they cannot. The central bank itself only has two types of “customer”: banks and the government. You and I cannot walk into the central bank and open up an account. This means that the only thing that can happen with central bank balances is that they move around from one bank to another or to and fro between the government and banks.

Imagine for a moment that the bank arranges a $100,000 loan for me to buy a nice little shack on one of Paradise Island’s beaches. If the shack vendor banks with my bank, then our bank will see both its loans and its deposits increase by $100,000. On the other hand, if the  vendor banks elsewhere, my bank will have to transfer $100,000 to the vendor’s bank. This is done by moving money between the banks’ respective  accounts with the central bank. So, in this case, my bank has an increase in its loans of $100,000 and a decrease of $100,000 in its deposits with the central bank. But that central bank deposit has not left the system (and it has not gone to me). Rather, it has moved from one bank to another.

While there will be movements in central bank balances in this fashion from one bank to another in the normal course of business transactions, balances will tend to average out to reflect each bank’s market share. So, my banker friend is unlikely to be alone in seeing deposits with the central bank growing. Indeed, looking at the aggregate bank balances with the Paradise Island central bank, it becomes evident that there is a systematic trend.

Deposit BalancesAggregate Balances with the Central Bank

So how does this happen? The most likely explanation is that the balances are coming from the government. As the government spends money, behind the scenes there will be money moving from the government’s account at the central bank to the accounts of commercial banks. This can happen if the government is running a deficit, spending more money than it is receiving. But that is not the case here. In fact, Paradise Island has been running a surplus of late.

A bit more digging through the national accounts reveals the answer. Paradise Island receives aid from larger developed nations and the  government has been spending most, but not all of this aid. The twist is that this aid has come in the form of foreign currency, which the government then deposits with the central bank in return for local currency balances which it is then able to spend. As a result, the central bank’s foreign asset balances have also been steadily growing. The similarity of these two charts is no coincidence: the two sides of a balance sheets must balance and the growth in the central bank’s assets directly mirrors the growth in their liabilities, in the form of commercial bank deposits. This is an example of what is known as “grossing up the balance sheet”.

Foreign Assets

 Foreign Assets of the Central Bank

So the growth in bank deposit balances with the central bank has nothing to do with Paradise Islanders hoarding money or choosing not to remit their profits offshore. Instead it is the direct result of the government spending its aid money. If the local banks want to have less of their money tied up in deposits with the central bank, rather than pointlessly trying to incentivise their customers to borrow or place their deposits elsewhere, they should consider encouraging the central bank to sell some of their foreign assets, reversing the grossing up of the balance sheet.

For me the most interesting aspect of this discussion is the fact that even if you can see exactly what is going on inside your own institution, it can be difficult to understand the workings of the system as a whole.