Why postive money have got it wrong: Banks do not create money.

This morning I stumbled across positive monies critique and solution to the banking and debt crisis.  After reading through it I remember AS level religious studies and the ontological argument for the existance of God. Which seemed fairly thorough until you start looking at the shaky principles on which it is founded.

The argument put forward by the positive monies (pm from herein) is that banks create money, there is even a "banking 101" section which shows the internal double enteries performed in a banks ledger claiming this to be proof. 

Banks cannot create money from accountancy, no more than a local wholesaler can conjur up sweets from accountancy. 

Think of your local shop.  It phones up it's  wholesaler and agrees to buy £100 worth of sweets to be delivered in a week.  The wholesaler now has both a payable (we owe  £100 of stock  in 7 days) and a recievable (we will recieve £100 of cash in 7 days).

Note no money has yet to be transfered here, yet the wholesaler in it's accounts (if it keeps them diligantly) will have both increased recivables and liabilities.  This is exactly the same transaction as you agreeing a loan with your bank, the only difference is one is trading in stock one in money.

BANK

DR LOAN RECIEVABLE £100,000

CR LOAN PAYABLE TO MR SMITH £100,000

WHOLESALER

DR RECIEVABLES £100

CR PAYABLE OF SWEETS £100

We could not say that the local wholesaler has increased the number of sweets in the world by merely posting these journals in it's ledger.  Similarly, we cannot say the bank is creating money by doing the same thing.

In the same way, when the sweets need to be delivered or the money sent to Mr Smith the bank and wholesaler will need to own the actual monies /  sweets to deliver these to Mr smiths's accounts.    Thus they cannot possibly create money out of thin air, no more than they can create sweets out of thin air.

5 steps to Understanding The Crisis

I've recently been starting to look at the financial crises of the past years in terms of a slightly different narrative to the traditional. 

1. Deregulation of the market in 80s leads to rising inequality
2. This causes a lack of demand (the poor's spending doesn't increase), but also an increase in the amount of spare capital seeking a return on investment. (80-00s)
3. Demand is boosted by Consumer Debt. (80s-00s) financial deregulation allows the lack of money of the majority to be met with the excess, loaned resources of the majority.
4. Peak (consumer debt) is reached, households realise they cannot make interest payments at current level of spending. They both impose austerity to pay things back and default on loans. A great de-leveraging of both personal, corporate and national balance sheets occur.
5. This reduces aggregate demand, causing recession.

If we frame the problem in these terms how do we sort it out? We need to increase demand, both at home and abroad.

At home: Reduce inequality, increase government spending on progressive policies, increase labour rights, minimum wage and benefit payments.  (Is this possible if the government itself is trying to pay off debt?)

Abroad: Pray for a quick recovery in key export markets. 

Trying to sort your life out? It's best to go one step at a time.

You've finally decided it's time to take the plunge and sort your life out, give up the booze, the fags, start eating healthily, exercise , look for a new job, take up the piano, read some classics and build up the gumption to ask the pretty girl at work to spend a bit of time with you out of work.

In a few months time you imagine your body honed to perfection, a chiselled six pack adorning your midriff, your diet is now so healthy your bowel movements emerge fragrant enough to resell to trendy urbanites as organic room freshener.  You've really taken to the piano too, now shyly agreeing at parties to perform a little Gershwin to an adoring audience. An audience in which the girl from work stands, now stunning in a knee length black satin dress, adoring your every move with that glint in her eyes that tells you that once she gets you home you two are going to continue where you left of this morning, wrapped in a tantric embrace. All this will be yours, it as simple as eating the celery, going to the gym and learning some scales. 

It is no surprise however to find that the majority of such life changing aims fail, most people are fat, do too little exercise and are poor musicians.  But Why, and what can we do if we do want to make all these changes.

Well, the first thing worth mentioning is that the more we try to do the more difficult it is.  Firstly, because when we fail at doing one thing (i.e. not going for a run on Thursday morning) we are far more likely to give up on everything we are aiming to do.  Secondly, willpower depletes. In other words the more times you have to exert self control the harder and harder it becomes.  This is known as Ego Depletion. Interestingly, although not strictly relevant, exercising self control also makes you more likely to lie and take risks.

So when we take on many different challenges at the same time (get fit, eat healthy, learn an instrument, become a sexual dynamo etc) failure at one makes us far more likely to give up on all of them and, possible even worse passing on dessert at dinner makes it harder to sit down and learn those all important piano scales.

It seems all very negative, and to be honest it doesn't take Albert Einstein to work out that these ventures usually fail. Why? Because they aim to do too many things at once and people give themselves unrealistic ambitions.  It is likely that if you've spent the last 10 years living like a slob that in the next 6 months you are going to drastically become un slob like.  In reality what you can hope for is a gradual process to become less slobish. 

So the answer may well be, attempt to do one thing at a time, remind yourself that one little slip up doesn't mean that the whole project is not worthwhile. So say just start with the healthy eating, one day a week, keep track of this.

In modern times everyone wants a quick fix; however it seems that such an attempted quick fix may scupper your chances of long term change for the better.

 

A quick post on dishonesty

Economists have for a long time thought of honesty and crime through the guise of the simple model of rational crime (SMORC) which presumes that we act dishonestly if it is in our interest to do so (the chance and probablility of getting caught are outweighed by the gains of acting dishonestly).  Given this then why then is there not far more fradulent and dishonest behaviour in the world?

In his new book Dan Ariely trotts out expirement after expirement attempting to discredit the SMORC.  In fact we cheat upto the point that we can still rationalise ourselves as honest.  So, creative thinkers are more likely to cheat as they are better able to rationalise their own dishonesty.  Similarly, if we see others from the same peer group cheating it becomes more acceptable (If everyone is doing it, it isn't immoral / dishonest behaviour).

Similarly if we can physically distance ourselves from something cheating becomes more acceptable. So, in experiments run with tokens that will later be exchanged for money people cheat more than in experiments without the intermidiary step. Similarly, golf players are far happier fraudulently moving their ball to a better lie with their club than their hands. 

However, what Ariely fails to acede is that just as survival of the fittest can deal with altruism so the rational theory of crime can deal with these seeming inconsistancies.  Perhaps seeing ourselves as "good people" keeps us happy and sane, thus to preserve this image it is not rational to allways commit crimes.

Nevertheless the message is clear the majority of people will cheat to a degree when given the opportunity.


This post was inspired by Dan Ariely's book The Honest Truth About dishonesty.

The Economic consequences of peace; Keynes and the Eurozone crisis

In 1919 John Maynard Keynes wrote the Economic consequences of peace, a tirade against overzealous yet political expedient WW1 repatriation claims on Germany which he argued would lead to;

 "the absolute falling off, for the time being in Europe's internal productivity, second, the breakdown of transport and exchange by means of which its products could be conveyed where they were most wanted; and third, the inability of Europe to purchase its usual supplies from overseas"

The only answer was to make repatriations far less harsh, and interest free; a cancellation of inter-ally indebtedness and passing over English debt claims to Belgium, Serbia and France.

"By fixing the repatriation payments well within Germany's ability to pay, we make possible the renewal of enterprise and hope in her territory"

Keynes argued that the future of European nations was entwined with one another, now was a time for politicians of creditor countries to realise this and aim for the prosperity of all nations.

Today, with a single currency, single market and open borders the European relationship is positively symbiotic.  Germany is far better off with a strong Greece, Italy and Spain (GIS) than a weak GIS. This is incredibly simple. So why do our leaders not act with this in mind?  

If this means jointly backed Eurobonds so be it. If this means debt forgiveness so be it, if this means a massive loan at 0% interest so be it.  This may be harmful in the short run economically and politically for creditors nations but it is the right thing to do in the long run for the good of every single European. If you have a blister, sometimes it is painful to take it out, but it is better than cutting your finger off.

The ability to believe that the way the world is now, is how it always will be, is one of the fundamental errors of humanity. It is possible such an inability to conceive of a future so very different from the present is what stops us from acting now.

We have an unerring belief that the problems of war, famine, instability, political extermism are behind us, but so did they in 1919. Then the First World War was known as "the war to end all wars". It is always worth remembering that there are far worse evils than cancelling a bit of paper, or earning slightly less interest.

There needs to be a shift into the argument. We need to talk about what we can do to help these countries in trouble. Not merely what we can do to help get our own money back.

Stop agreeing with yourself: Overcoming Confirmation Bias in Investing

In an experiment people are told that the following sequence; 2-4-6 conforms to a rule. Their job is to work out the rule by selecting sequences of three numbers which they are then told works or does not. Initially people see the rule as going up by 2. To test this they will select sequences like 8-10-12, or 50-52-54, once they are told that these fit the rule they will happily deduce the rule is sequences that go up by two. However, on this front they are wrong, the actual rule is any three ascending numbers so not only do the examples above conform but also 1-7-109 or 1-2-3 do too.

 The reason people rarely work this out is because they look to confirm their current theory instead of testing numbers that could falsify their theory. The confirmation bias.

So, we look for confirmation of already held beliefs. How does this affect our ability as investors?

Well, say you think apple may be a great buy so you are far more likely to dutifully type into google "is apple a great buy" or "reasons to buy apple" than "reasons not to buy apple" or "is apple a bad buy". Or, if you are an equity analyst poring over financial statements and industry data you are again in the vast swath of data likely to find evidence to support the position you already hold (buy, sell or hold) rather than counter it.

You are probably thinking that this is a very good way of understanding how other people behave, but not me. I'm far more impartial, I can let the evidence speak for itself. Sadly, this perspective is a deluded as the little boy jumping off his sofa, thinking if he can flap his arms fast enough, he may be the first human ever to fly. We are human which makes us both irrational and incapable of aidless flight. So, however hard we flap our metaphorical brain arms there is no getting around this fallibility. We do this, you do this, no one specially gifted with full rationality.

So, if you choose to accept your not a special case, what is the answer.

Well, it's impossible to overcome these biases in all areas. However, if we ingrain counter-intuitive thinking into our processes (and ensure we don't skip them) then it's possible to protect ourselves. Here is what I would suggest;

1.) Have a set procedures when making an investment and build into this the requirement to look at the dissenting view. (i.e force yourself to research and write down 5 possible negatives about the stock before purchasing)

2.) Carry out a pre-mortem.  This is done by imagining yourself 5 years in the future and the investment has gone badly. You generate ideas over what has caused this, possibly alerting you to weaknesses you may have overlooked.

Are intuition and instinct useful investment tools?

Which of the following portfolios would you buy into?

The one that made over 20% right? You probably want to know what the secret of its success is and whether it can be bestowed on you for a relatively small sum.

Well, sadly, there is no secret. Each portfolio was assigned 10 stocks picked (from a sample of 363 FTSE companies with names begging by A's) by a random number generator. Averages were taken and the results plotted as above. The idea is to show that even with just 26 portfolios there is a massive amount of variance in returns. 

The point to emphasis is that statistically speaking when there are thousands of investors there are bound to be quite a few who have been very succesful purely down to luck.  The difficultly comes in attempting to distinguish between what is caused by luck and what is caused by skill alone.  One reason for this is illusory superiority or that we all think we are better than we actually are. (E.g. over 50% of people think they are above average in terms of intelligence.)

Thus individuals are likely to attribute their success to their own positive attributes and or strategies rather than luck. Conversely, upon failure they are more likely to chalk this up to bad luck than any inherent inability to think.  Which means that even if you believe that this argument works for other people, you will still believe you are special case.

Therefore, I would like to consign to the universe of luck is that based on Gut instinct, feeling, or intuition as opposed to reasoned analysis of the pertinent factors.  Instincts of experts have continually been shown to be a poor judge in a variety of cases none more so than in investing. There are all sorts of ways we are unknowingly led astray from the rational course when we let our intuition take control leading us to sell losing stocks too slowly, sell winners too quickly, trade too much, choose stocks in the media eye and many many more.  There is no doubt that our instinct is a poor investor.

There will be many people out there, confident of their own instincts having had high returns which they will attribute to their impressive intuition. However, given two contrasting explanations for this, luck vs. Gut feeling it is rational to conclude that what is more likely to be the case (luck) is the case unless it can be proved otherwise.  (See Occam’s Razor for justification of this conclusion).