Category Archives: economics

Bitcoin and the Blockchain

It’s hard to believe that a whole year has passed since I last wrote on the topic of bitcoin, and my remaining 1 bitcoin is worth rather less than it was back then. During the week I presented at the Sydney Financial Mathematics Workshop on the topic of bitcoin, taking a rather more technical look at the mechanics of the blockchain than in my previous posts here on the Mule. For those who are interested in how Satoshi Nakamoto solved the “double spend” problem, here are the slides from that presentation.

Bitcoin and the Blockchain

As part of my preparation for the presentation, I read Bitcon: The Naked Truth About Bitcoin. If you are a bitcoin sceptic, you should enjoy the book. If you are a Bitcoin true believer, you will probably hate it. It is over-blown in parts and gets a few technical details wrong, but I am increasingly convinced by the core argument of the book: the blockchain is an extraordinary innovation which may well change the way money moves around the world, but bitcoin the currency will prove to be a fad.

The New Normal

With the Intergenerational Report now released, the meme of “intergenerational theft” is spreading. Bill Mitchell has already shredded the core assumptions of the report, and now first time guest author Andrew Baume brings to the Mule brings the perspective of a financial markets practitioner to our possible future wealth. In broad strokes, he concludes

  • post-paid retirement is now the exception not the rule
  • the balance sheet that supports your retirement is now your own
  • absence of inflation is the enemy

Many older Australians have ridden the magic carpet of high levels of inflation which brought asset valuations to today’s levels. This has been particularly felt in the property market which has been the foundation for most of the “unearned” growth in asset base for anyone aged 50 or older. Property has been the asset which we have been most comfortable to leverage at incredibly high multiples.

Downsizing has liberated much of this unearned wealth and turned it into retirement income. This transfer is much like Potential Energy being transferred into Kinetic Energy. As with physics there is no perpetual motion machine so the transfer is permanent for those who do it. It is however also true they do continue to store some of the liberated KE but not into the illiquid high ticket indivisible item that the large family home generally represents. It is usually reinvested into different asset classes.

Although investing is a core competence for some, (certainly not this author!) normal people with money have found good clips of that money fall into their lap by having lived somewhere or having contributed to super. They have been comfortable in property because it “always goes up” and over their lives they have traded it as little as twice. Reinvesting the nest egg is a massive step.

Some commentators have made very strong cases for being heavily invested in risk assets post retirement whilst others have argued that timing of shocks can have a massive and unexpected effect on post retirement incomes. Both are right of course but the big impact that seems less understood it the massive shift in post-retirement income from post-paid to pre-paid and how that has fundamentally changed the return equation.

Rates of Return
Once pre-paid retirement hits its straps the clamour for return creates a dynamic associated to the paradox of thrift. As the population ages and demographic analysis promotes the concept that the welfare safety net needs to be drawn tighter, government services are reduced. The need to build a safety net for ourselves drives our return expectations lower and lower as the “best” assets (like bonds and bank shares) are bid upwards and the marginal assets assets (including higher leveraged companies and marginal property assets) benefit from that bid due to a crowding in effect. The impact of this trend has been seen most clearly in the global bond markets.

30 years ago when I started as a foreign exchange and interest rates trader the US 30 year bond was the bellwether for the health of the financial system. It was highly volatile and its movements reflected the broad market’s view of the capacity for the US to manage its (and therefore the world’s) economy. It seemed strange to me at the time that an instrument that was the projected average fed funds rate over the next 30 years would have any movement at all that related to the near term health of the economy.

Its volatility existed because in 1985 most retirement incomes were funded by the issue of that bond and others like it (by other governmental authorities) or by corporate debt in the case of corporate pension providers. Most defined benefit schemes were not close to fully funded so debt financed the pension provider’s obligations.

US 30 year Treasuries

Chart 1 – US 30 year Treasury yield
Source: Bloomberg

I wish I was smart enough to have bought a zero coupon 30 year US Government bond back then. It would have smacked me in tax over the 30 years, but I would be getting back 17.5 times the money invested this month. As a comparison the US stock index the S&P 500 is up by a factor of 11.7 times (unfair direct comparison because it is not tax adjusted).

These returns happened because the bond market was pricing way too much inflation and the equity market benefitted by there being just enough.

The dynamic in 2015 is the almost total reverse. Equity markets have lofty valuations underpinned by mediocre revenue growth, capital buy backs (as the companies can’t use the capital themselves) and bond yields that are ridiculously low as pre-paid retirement drives yields lower and lower in concert with global government policy of zero rates and Quantitative Easing (QE).

There is little doubt that it is appropriate for governments around the world to try to influence capital to take risk in the current environment. The paradox of thrift has driven risk aversion even further than the salutary lessons of the global financial crisis.

The investment profile of most companies has gone defensive with little entrepreneurialism and widespread equity buy backs. This lack of capital formation sees equity markets continue to rally on flows not earning. Consequently investors have gone massively short volatility –and has done so with one overriding reason near total absence of inflation expectation.

Gordon Gekko said “greed is good”. If greed is good and it is fed by a healthy inflation expectation. Inflation has a musky quality, like a magnificent Burgundy it needs to have a little funk, but get too funky and it spoils everything. No funk and you have strawberry cordial. Current markets are strawberry cordial and they are thus by design at the government level reacting to fear still holding the upper hand in the zeitgeist. For the next generations’ sake let’s hope we get some fear back.

Most Baby-Boomers and older have experienced the best fortune inflation can bring you. Liabilities that are nominal in nature against real assets (property and equity) are able to bring massive compounding benefits. As wages grow to match inflation (and employees advance through the ranks) the liabilities whittle away into nothings. Those conditions allowed us to regurgitate the old saying “it’s not timing the market it’s time in the market”. History is a great indicator of history, but absent inflation and with an incredibly long period of defensiveness from a capital formation standpoint it seems ever more likely that the current and next phase of markets will look like little else that has gone before.

In the last two years the Australian Index has increased circa 18% which certainly gives the lie to this argument. That suggests that the drive to low returns is a long way from over, keeping the bid in the equity market strong. It is this authors’s contention that as over 9% of that growth has occurred since the RBA decided the Australian economy was fragile enough to require a rate cut to a level not seen in my lifetime, in fact we are solidly in the execution phase of this return compression. Those of us lucky enough to have money to invest should do so now in any asset with moderate leverage and a high yield.

Once the compression of yields is more complete, the market will roll down one of three clear but quite different paths:

  1. Inflation returns moderately and gradually and allows the central banks around the world to very very slowly unwind the extraordinary accommodation so that the dividend discount model is basically unchanged (i.e. dividends rise as fast as the need to raise rates to combat overstimulation). This path is technically known as Nirvana and we all get to retire rich.
  2. Inflation does not develop for some time meaning returns remain bid down and bond markets globally provide savers with approximately zero income driving investors into earning whatever they can from “real assets”. This is a great outcome for those already invested as they benefit from the compression in returns and their living expenses remain low. The paradox of thrift keeps returns low as fear remains in the system and lack of confidence provides negative feedback loop on inflation and fuels currency devaluation wars. This path is technically known as “the Baby Boomers stealing food from their children’s (and grandchildren’s) mouths.”
  3. Inflation takes some time to develop but when it does it takes a classical monetarist predicted path and smashes valuations very hard as rates back up markedly to try to not just reverse the accommodation but put the brakes on rampant price indiscipline. This path is technically known as “Timing the market has never been so important”

Interestingly path 3 is probably the best outcome for a youngster without much yet in the market. They may have leveraged a bit and after the valuations adjustment works through they get a higher wage and the absolute (not real) level of their assets recovers based on the higher cashflow brought by inflation. Anyone who doubts this should think about their own personal balance sheet in 1973.

The Balance Sheet
When retirement was provided by either a defined benefit scheme or government pension (especially pensions for the government) the issues of timing were completely irrelevant and the investment landscape was also largely irrelevant. Many firms’ pension schemes were “underfunded” and the government did not recognise future liability at all in the budget, only the current FY expense. Someone else’s balance sheet took all the variability. This all changed once governments realised that the unfunded liability would cripple them (admittedly rating agencies had a big role to play in helping them realise this). Post 1987 crash company balance sheets also began to recognize the potentially life threatening exposure that they were taking to equities via their pension schemes.

S&P estimates that the anticipation of quantitative easing in Europe squashed bond yields so much that the liabilities of defined-benefit pension plans rose by up to 18 percent last year. Its analysis looked at the top 50 European companies it rates that have defined-benefit pension plans and are “materially underfunded,” meaning, the plans have deficits of more than 10 percent of adjusted debt, and that debt is more than 1 billion euros. In 2013, liabilities outstripped obligations for that group by more than 30 percent on average.”

Source: Bloomberg

Moves to defined contribution and superannuation guarantees are not localized Australian issues. The world has shifted and as Chart 1 shows one key outcome has been that there is more money to be potentially invested for 30 year debt-like returns than there are creditworthy borrowers who want the money.

Companies that switched to “Liability Driven Investments” to fund their pension schemes more than 7 years ago are less vulnerable. These shortfalls will force many unprepared companies to play catch up in their asset allocations.

Variability is much harder to take in a personal balance sheet when external income is no longer being received (i.e. when you are retired). It seems that extreme variations in equity markets is an inevitable consequence of the current reach for yield unless world economic growth has a strong and sustained recovery that outweighs the downward pressure on valuations from the consequent increase in bond yields. In the case of Japan, time in the market has not been your friend:

Nikkei 225

Chart 2 – Japan’s Nikkei stockmarket index
Source: Bloomberg

I have actually been generous in this chart as the vertical axis starts well after the 38,915 peak in 1989. It is a dangerous assumption that markets will behave differently in the future than they have in the past, but perhaps this chart shows an economy operating a little like the new normal for the last 20 years. It is also interesting to note the massive rally over the past 12 months has been driven by QE.

Timing of that market would have been one of the most lucrative investments possible and funnily enough it was completely predictable and transparent.

The paradox of thrift has usually been applied to emerging economies where very few social services are supplied by the state. The aging of the population combined with the shift to pre-funded retirement in an environment where social services are being pared back is creating this phenomenon in the advanced economies. This is potentially the most egregious form of intergenerational theft.

The associated absence of inflation will also tend to remove the fantastic wealth building effect of unearned capital appreciation primarily through property. This source of wealth for over 50s may be replicated by modern young parents but the scale of success that older folk have had seems unlikely.

In all but the Nirvana case outlined above the outcome seems clear. The retirement age may stay where it is but the size of the pension relative to retirement income expectations will continue to deteriorate as pension growth does not keep pace with lifestyle. People will have little choice but to continue some form of labour-driven income generation into their late sixties and most likely their 70s. Our personal balance sheet which now bears the risk will demand it.

A set and forget equity portfolio may work but also lead us into a very active post retirement game of catch up. Those with no nest egg may struggle hard to get a retirement savings pool that allows them to leave employment until well into their 70s and further may be subject to violent valuation adjustments.

Government spending

Before, during and after this month’s budget, Treasurer Joe Hockey sounded dire warnings about Australia’s “budget emergency”. Amidst this fear-mongering, it was a pleasant relief to come across a dissenting view. In a recent interview on 2SER Dr Stephanie Kelton (Department of Economics at the University of Missouri in Kansas City) argued that the government budget is very different from a household budget, however appealing that analogy might be. Governments like the Australian government, with its own free-floating currency can spend more than they take in taxation without worrying about running out of money. While the economy is weak, the government can comfortably run a deficit. The constraint to worry about is the risk of  inflation, which means curbing spending once the economy heats up.

I posted a link to Facebook, and immediately drew comment from a more conservatively libertarian-minded friend: “of course a deficit is a bad thing!”. Pressed for an explanation, he argued that government spending was inefficient and “crowded out” more productive private sector investment. This did not surprise me. Deep down, the primary concern of many fiscal conservatives is government spending itself, not a deficit. This is easy to test: ask them whether they would be happy to see the deficit closed by increased taxes rather than decreased spending. The answer is generally no, and helps explain why so many more traditional conservatives are horrified by the prospect of the Coalition’s planned tax on higher income earners….sorry, “deficit levy”.

From there, the debate deteriorated. North Korea was compared to South Korea as evidence of the proposition that government spending was harmful, while a left-leaning supporter asked whether this meant Somalia’s economy should be preferred to Sweden’s. Perhaps foolishly, I proffered a link to an academic paper (on the website of that bastion of left-wing thought, the St.Louis Fed) which presented a theoretical argument to the “crowding out” thesis. My sparring partner then rightly asked whether the thread was simply becoming a rehash of the decades old Keynes vs Hayek feud, a feud best illustrated by Planet Money’s inimitable music video.

Macroeconomic theory was never going to get us anywhere (as I should have known only too well). Instead, the answer lay in the data, with more sensible examples than North Korea and Somalia. Aiming to keep the process fair, avoiding the perils of mining data until I found an answer that suited me, here was my proposal:

I’m going to grab a broad cross-section of countries over a range of years and compare a measure of government expenditure (as % of GDP to be comparable across countries) to a measure of economic success (I’m thinking GDP per capita in constant prices).

If indeed government spending is inherently bad for an economy, we should see a negative correlation: more spending, weaker economy and vice versa. My own expectation was to see no real relationship at all. In a period of economic weakness, I do think that government spending can provide an important stimulus, but I do not think that overall government spending is inherently good or bad.

The chart below illustrates the relationship for 32 countries taken from the IMF’s data eLibrary. To eliminate short-term cyclical effects, government spending and GDP per capita (in US$ converted using purchasing power-parity) was averaged over the period 2002-2012.

Govt. Spending vs GDP

The countries in this IMF data set are all relatively wealthy, with stable political structures and institutions. All but one is classified as a “democracy” by the Polity Project (the exception is Singapore, which is classified as an “anocracy” due to an assessment of a high autocracy rating). This helps to eliminate more extreme structural variances between the countries in the study, providing a better test of the impact of government spending. Even so, there are two outliers in this data set. Luxembourg has by far the highest GDP per capita and Mexico quite low GDP per capita, with the lowest rate of government spending.

The chart below removes these outliers. There is no clear pattern to the data. There is no doubt that government spending can be well-directed or wasted, but for me this chart convincingly debunks a simple hypothesis that overall government spending is necessarily bad for the economy.

Government Spending vs GDP per capita

Now look for the cross (+) on the chart: it is Australia (IMF does not include data for New Zealand and we are the sole representative of Oceania). Despite Hockey’s concerns about a budget emergency, Australia is a wealthy country with a relatively low rate of government spending. Among these 30 countries, only Switzerland and South Korea spend less. These figures are long run averages, so perhaps the “age of entitlement” has pushed up spending in recent years? Hardly. Spending for 2012 was 35.7% compared to the 2002-2012 average of 35.3%. The shift in the balance of government spending from surplus to deficit is the result of declining taxation revenues rather than increased spending. Mining tax anyone?

I’m with Felix

FT blogger Felix Salmon and venture capitalist Ben Horowitz have very different views of the future of Bitcoin. Salmon is a skeptic, while Horowitz is a believer. A couple of weeks ago on Planet Money they agreed to test their differences with a wager.

Rather than a simple bet on the value of Bitcoin, the bet centres of whether or not Bitcoin will move beyond its current status, as a speculative curiosity, to serve as a genuine basis for online transactions. The test for the bet will be a survey of listeners in five years’ time. If  10% or more of listeners are using Bitcoin for transactions, Horowitz wins. If not, Salmon wins. The winner will receive a nice pair of alpaca socks.

I have been fascinated by Bitcoin for some time now and have a very modest holding of 1.6 Bitcoin. Nevertheless, I believe that Felix is on the right side of the bet. I have no doubt that the technological innovation of Bitcoin will inform the future of digital commerce, but Bitcoin itself will not become a mainstream medium of exchange.


Only days after the podcast, the price of Bitcoin tumbled as MtGox, the largest Bitcoin exchange in the world, suspended Bitcoin withdrawals due to software security problems. Sadly, this means my own little Bitcoin investment halved in value. It also highlights how much of a roller-coaster ride the Bitcoin price is on. As long as Bitcoin remains this volatile, it cannot become a serious candidate for ecommerce. It is just too risky for both buyers and sellers. Horowitz acknowledges that the Bitcoin market is currently driven by speculators, but is confident that the price will eventually stabilise. I doubt this. Even during its most stable periods, the volatility of Bitcoin prices is far higher than traditional currencies, and has been throughout its five year history.

Bitcoin drop

The Ledger

One of the key innovations of Bitcoin is its distributed ledger. Everyone installing the Bitcoin wallet software ends up downloading a copy of this ledger, which contains a record of every single Bitcoin transaction. Ever. As a result, there is no need for a central authority keeping tabs on who owns which Bitcoin and who has made a payment to whom. Instead, every Bitcoin user serves as a node in a large peer-to-peer network which collectively maintains the integrity of this master transaction ledger. This ledger solves one of the key problems with digital currencies: it ensures that I cannot create money by creating copies of my own Bitcoin. The power of the ledger does come at a cost. It is big! On my computer, the ledger file is now almost 12 gigabytes. For a new Bitcoin user, this means that getting started will be a slow process, and will make a dent in your monthly data usage. A popular way around this problem is to outsource management of the ledger to an online Bitcoin wallet provider, but that leads to the next problem.

Trust Problems

A big part of the appeal of Bitcoin to the more libertarian-minded is that you no longer have to place trust in banks, government or other institutions to participate in online commerce. In theory, at least. If you decide to use an online Bitcoin wallet service to avoid the problem of the large ledger, you have to trust both the integrity and the security capability of the service provider. The hacking of shows that this trust may well be misplaced. Even if you have the patience and bandwidth to maintain your own wallet, trust is required when buying or selling Bitcoin for traditional currency. There are many small Bitcoin brokers who will buy and sell Bitcoin, but invariably you have to pay them money before they give you Bitcoin, or give them Bitcoin before you get your money. Perhaps the big exchanges, like MtGox, should be easier to trust because their scale means they have more invested in their reputation. But they are not household names, the way Visa, Mastercard or the major banks are. Growth of commerce on the internet has been built on trust in the names providing the transactions more than trust in the technology, which most people don’t understand. I would be very surprised to see the same level of trust being established in the Bitcoin ecosystem, unless major financial institutions begin to participate.

The Authorities

But will banks jump onto the Bitcoin train? I doubt it. Not because they are afraid of the threat to their oligopoly—most bankers still only have the vaguest idea of exactly what Bitcoin is, or how it works. What they do know is that virtual currencies are attractive to criminals and money launderers. Last year saw the FBI crackdown on Liberty Reserve, followed by the crackdown on the underground black-market site Silk Road. More recently, the CEO of one of the better-known Bitcoin exchanges was arrested for money-laundering. In the years since September 11, the regulatory obligations on banks to ensure they do not facilitate money laundering have grown enormously. The anonymity of Bitcoin makes it hard for banks to “know their customer” if they deal with Bitcoin and as law-enforcement increases its focus on virtual currencies, providing banking services to Bitcoin brokers becomes less appealing for banks. When I bought my Bitcoin last year, I used the Australian broker BitInnovate. For several months now, their Bitcoin buying and selling services have been suspended and, I’m only guessing, this may be because their bank closed down their accounts. To become a widely-accepted basis for commerce, Bitcoin will necessarily have to interface effectively with the traditional financial system. At the moment, the prospects for this don’t look good.

For these reasons, I think Felix has a safe bet, and can look forward to cosy feet in alpaca socks. But, even if Bitcoin does not become widely accepted, its technological innovations may well revolutionise commerce anyway. Banks around the world can adopt ideas like distributed ledgers and cryptographically secure, irrevocable transactions to make the mainstream global payments system more efficient.

Power to the people

Regular Mule contributor, James Glover, returns to the blog today to share his reflections on solar power.

I have been investigating solar power for years and finally bit the bullet and signed up for a system. A 4.5kW system cost me $8,500, after receiving the Government rebate (about $3,000). I’ve been meaning to write about my adventures in solar for a while now. It started because of a strange fact I discovered about 4 years ago. Even though the cost of solar cells has been dropping dramatically in the last 4 years (it’s gone down about 75%) the payback time has stayed steady at about 5-10 years. The payback time is based on what you save by not paying your power bills plus what you earn by selling electricity back into the grid. The peak time for solar generation is 10am-2pm while the peak time for domestic use is in the morning and evening outside these times.

The answer to my conundrum is that while the cost of solar cells has been steadily dropping so has the feedback tariff. When the feedback tariff was 60c per kWh, the excess power created during the day paid for the disparity in the price of the power consumed in the evening. In Victoria the feed in tariff has dropped to about 8c. In order to have a net zero cost of solar it is necessary to have an even bigger system as peak power cost is about 32c per kWh. A particularly good website I found for all things solar is SolarQuotes.  I thoroughly recommend it as has lots of info on solar power as well as cost benefit analysis. They recommended two solar companies in my area, both of who were very good.

From a financial point of view it makes sense that power companies would buy solar power at a lower rate than they would provide it‑it’s called the bid/offer spread and is how most companies make money. The cost of producing power is about 5c so it is still cheaper for them to produce and sell the power themselves than buy it from solar power generators.

There is a twist to this tale however. Electricity generators are monopolies and so left to their own devices would naturally gouge buyers. When the state governments privatised electricity generation they set up supervisory boards to ensure the companies made reasonable, but not immodest profits. In the absence of a competitive market one way to do this is on a “cost plus” basis: set the profit at say 10% above cost of electricity generation. It seemed reasonable until power companies found a way to game this system. If they increased the cost of providing electricity then they increase their profits.

But surely, you say, the costs of generating electricity are based on market forces for the raw materials plus the cost of running the plant? One way is to spend much more on investment than is actually necessary. And the electricity companies did this beautifully. They convinced the state government oversight bodies that not only was electricity consumption forecast to rise well above GDP growth but that existing infrastructure needed to be “gold plated”: improved to reduce the probability of a widespread failure. A combination of inflated growth predictions (and hence building new plants) and gold plating is the real reason electricity prices have risen 20% year on year over the last few years. Yes, the carbon tax has had a small effect as a one-off increase. The Coalition (now the Government) exploited this in the run up to the election, although I am pretty sure this not was the real reason the Labor government lost office.

If you take solar power growth into consideration then electricity generation from traditional sources such as coal and hydro is expected to fall, not rise. Gold plating (soon to include actual gold power lines…I think I am joking) is now seen for what it is and is being reined in.

One of things I have always wondered is why someone doesn’t set up a virtual power company which buys solar power and sells it to distributors? Turns out they already exist. The thing which swung me to the solar provider I chose (the price was identical to the others) was that they could hook me into just such a company.  Sunpower is a US company which has set up in Australia to do just this. Currently their feed in tariffs are higher (guaranteed 20c for 2 years as opposed to 8c for coal generating providers) though I have no expectation they will remain this high. Australian Diamond Energy is another example of a virtual power company. Diamond Energy buys green power from retail solar producers (i.e. you and me) as well as independent wind farms. They also invest in their own larger scale solar and wind farms. Market forces will dictate the future price and I am happy to offset the environmental cost of running my air conditioning at full bore over summer.

In the US they already have communities which set up solar farms to provide their bulk electricity and sell their excess to the grid. Old style electricity companies have resorted to making claims that there are problems with solar electricity, either because it’s at the wrong time of the day or because old style inverters produce modified sine waves from direct current rather than pure sine waves and some electrical appliances don’t operate as well with these modified sine waves. Increasingly though inverters are of the pure sine wave type anyway. While there is some truth to their arguments, it is worth remembering that power companies would prefer that there was no solar at all. They have an axe to grind, their arguments are designed to limit the onward march of solar, or totally compensate them for lost revenue which will achieve the same aim through higher solar costs or lower feedback tariffs.

Another example of why traditional power companies are increasingly out of touch is smart meters. Solar power companies, monitor power usage through smart meters and solar panel output monitoring.They then provide feedback directly to your table or smart phone, and also work to help users optimise their power usage and minimise costs. Traditional power companies see smart meters as purely a way to save on meter reader costs, they have no interest in reducing users’ power consumption.

It seems that in Australia, the “sunburnt country” we have missed a few tricks. The dinosaur coal-based power companies are fighting a rearguard action, trying to get governments to lower the feed-in tariff further or let them charge solar customers a fixed fee to cover their “costs”. I think they are on the wrong side of history. A consumer group Solar Citizens has already been effective in reminding governments that over 1m households have solar power. I think that 1m is a tipping point.

There are about 8m households in Australia. At a cost of about $5,000 we could make each a net producer of electricity for $40bn.  About the cost of the NBN. A new national Snowy River Scheme!

Power to the people. From the people. For the people.

The price of protectionism

An  article in Friday’s Australian began

Ford has blamed Kevin Rudd’s $1.8 billion fringe benefits tax overhaul for halting production, forcing at least 750 workers to be stood down in rolling stoppages that will further imperil Labor’s chances of retaining the nation’s most marginal seat.

and goes on to report that the Federal Chamber of Automotive Industries has called on Labor to reverse its changes to the application of fringe benefits tax (FBT) to cars.

So what exactly has Labor done to put these jobs at risk?

The previous regime provided two mechanisms to determine tax benefits for expenses incurred for cars used for work purposes:

  1. the “log book” method, whereby the driver maintained records to show what proportion of their use of the car was for work rather than personal use, or
  2. an assumed flat rate of 20% work use of the car (regardless of how often the car is actually used for work purposes).

The government has eliminated the second option. So, the estimated $1.8 billion saving is due to the fact that a significant number of drivers using the 20% method could never come close to a 20% proportion of work use if they took the trouble to maintain a log book. Either that or they don’t think it is worth the effort to maintain the log book records.

While the elimination of this tax-payer largesse for drivers may come at a cost to workers in the car industry, does it really make sense to reverse the changes to save 750 jobs? These jobs would be saved at a cost to the tax payer of $2.4 million per job. Now these are just the jobs at Ford and (for now at least) we should acknowledge that some Holden jobs may also be saved, bringing the cost closer to $1 million per job.

The car industry in Australia has long benefited from government support, but surely there are better ways of saving these jobs. A job guarantee springs to mind.

Of course, industry protectionism is far from unique to Australia and this week I had my attention drawn to an extreme example in the small central American nation of Belize.

On 7 August, the parliament of Belize met for the first time since April. With so long between sittings, there were many bills for parliament to pass that day. Included among these was one which increased the already high import tariff on flour from 25% to 100%.


Why such a dramatic increase? For some time, local bakers had been buying their flour from Mexico for 69 Belize dollars per sack (approximately A$38). It was hard to justify buying the more expensive local flour at BZ$81 per sack (A$45). The new tariff will push the price of Mexican flour up to around BZ$110 (A$61), which is good news for the domestic flour mill and its employees.

That domestic flour mill is operated by Archer Daniels Midland (ADM), one of the top 10 global commodity firms. This is the same ADM which is in the process of trying to buy GrainCorp, Australia’s largest agricultural business.

But back to Belize. ADM’s website proudly declares that it “employs more than 40 people” in its Belize mill. Presumably, parliament had an eye to saving these jobs from the threat of cheap Mexican flour when it hiked the import tariff. With a population of only 335,000, Belize is 1/70th the size of Australia. You could argue that saving 40 jobs in Belize is the equivalent of saving 2,800 in Australia and that this is a far more effective form of protectionism than reversing FBT reforms.

But protectionism always has consequences and in Belize these are easier to see than is often the case.

Bread in Belize is subject to price control, along with rice, beans and even local beer. By law, bakers must sell “standard loaves” of bread for BZ$1.75. The August sitting of parliament may have increased flour tariffs, but it did not increase the price bakers could charge for bread.

Bakers in Belize will see their profits squeezed, job losses may follow and there are more bakers in Belize than workers at the ADM mill. Needless to say, the Belize Baker’s Association is lobbying for an increase in the controlled price of bread.

Perhaps it is time for the Belize government to consider abandoning the flour tariff and trying a job guarantee instead.

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 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]



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:


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).

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