St Claude and the Dragon

St Claude and the Dragon

Once upon a time, a long, long time ago, a King and his Queen ruled over a peaceful and prosperous land, with fertile valleys surrounded by high mountains. The people were happy and contented, growing their crops and tending to their flocks.

Unfortunately, it came about that a great inflationary dragon began to prey on the country, wreaking havoc, burning crops and villages. The spears and arrows of the soldiers appeared totally ineffective and no-one knew what to do. The price of food went up and everyone was suddenly much poorer. In the end, the Finance Minister propose that what they should do was to strike a deal with the dragon -  by sacrificing a maiden to it every month so that it had enough to eat and would leave the rest of the people and their livestock alone. These were very politically incorrect times and so it was agreed, that every month there was to be a ballot and some poor young girl was to be left out by the dragon’s lair to be eaten alive. Everyone was very sad, but they all got on with life and things were a bit better than when the dragon was wreaking havoc. The economy prospered, in a sub-optimal sort of way, and prices came back under control. The Finance Minister gave himself a pat on the back for a job well done though the King wasn't so sure - surely they could aspire to do better than this?

So the King promised a huge reward to any brave knight who could kill the dragon. Many tried and they all failed, mostly ending up barbecued. And time passed until eventually, and inevitably, the name of one of the King’s own two daughters was drawn. The Queen screamed at her husband to do something, both his daughters cried and cried and the King summoned one of the last two remaining knights who were willing to take on the dragon.

Sir Al was not a young man, though he had been a renowned dragon-fighter in his youth. Nowadays, he preferred to play his saxophone in jazz bars. Still, he put on his armour and strapped on his sword, before setting off up into the mountains above the town to where the dragon had its lair. There, he found the Princess, tied to a tree, but of the dragon there was no sign. Fearlessly, Al wandered into the cave and crept forwards until he could see a long green snout. It wasn’t moving. Al gave it a poke with his sword. Nothing. He played his saxophone and still nothing. Clearly, the dragon was dead.

Well, that’s a piece of luck, he thought to himself, as he untied the Princess and set off back to the castle. ‘The dragon is dead’ he proclaimed and everyone was so excited at the news that nobody went to check. The King was over the moon and could not thank Al enough. He gave him his daughter’s hand in marriage, and recommended to the church that they pronounce him a Saint. Al went off to write his memoirs and to cash in on the lecture circuit.

For quite a long time everything was fine. The crops grew, the cattle got fat and the people got rich. House prices went up very fast but consumer prices were well behaved and everyone felt very rich indeed. What nobody seemed to realise was that dragons can sleep for a very long time and hardly breathe at all when they do. But eventually, they do wake up and when they do, they tend to be very hungry.

And of course, that is exactly what happened. Eventually, the dragon woke up, looked out of its cave, couldn't find anything to eat and set off in search of breakfast. It burnt down whole villages, killed all sorts of animals and not a few farmers. Everyone was in a state of panic. Immediately, they held a new draw to find a new sacrifice and this time, it was the King’s second daughter’s name which came out of the hat. She cried, the Queen cried, and the King went to call on the last remaining Knight – who had always been the maddest of them all.

Sir Jean-Claude, whose friends just called him Claude, lived at the top of a tower,  down by the main river in the valley. He had never believed that the dragon was dead because he was a historian. ‘Dragons don’t just die, they can sleep for a thousand years’ he had been crying out. You can’t control them by good fortune; you need strict monetary principles and an independent central bank, preferably a German one.’

Well, as before, the Princess was tied to a tree outside the dragon’s cave and Sir Claude was dispatched to do his best. Nobody held out much hope and they all went and hid in the homes.

Claude waited until evening when there was no-one out and about. He put on his armour, for show, and fetched his sword. He also packed a mule with explosives. Then off he set. He crept up as quietly as he could to the dragon’s lair and unloaded a huge pile of explosives inside the entrance of the cave. Then, he attached a long fuse and unrolling it, went and hid some considerable distance away, connecting the other end to an electric ignition plunger.

When Claude pushed the plunger down he set off an almighty explosion. And a huge landslide, which sent boulders the size of houses crashing down the mountain into the town around the castle. It was supper time and everyone was at home. Hundreds of people were killed, not to mention the devastation that was caused to crops and to the animals that were in the fields.

‘Boff’ thought Claude, giving a very Gallic shrug and lighting his thirtieth Gauloise of the day. ‘You can’t make an omelette without breaking a few eggs, as they say’. The mountain had fallen down on top of the dragon which really was dead this time. And by some miracle, the Princess was still alive – just. She was very badly injured and would never look quite the same again but she was alive. So, Claude picked her up, put her on the mule, and brought her back down the mountain to the castle, where he expected to receive the same lavish rewards as Sir Al.

The King saw his wounded daughter, looked around at the total devastation and tried to kill Sir Claude, who fled for his life.  That was the last that was seen of him though rumours persisted that he had returned to his native land and was to be found smoking, drinking Pernod and muttering about the need for constant vigilance.

Meanwhile, the destruction of infrastructure resulted in an outbreak of deflationary plague. Many people died, others just moved away, so house prices collapsed and businesses closed. The once-prosperous Kingdom, was now populated mostly by the aged who could not leave, whose pensions were inadequate to live off comfortably and who were saddled with the huge debt the state had incurred in attempting to rebuild the broken homes and the broken economy. But the dragon was gone and they tried very hard to convince themselves they were now better off than before. 

A Christmas Carol, 1997

A Christmas Carol

As Christmas Day approached, Alan Scrooge reflected that although not everyone was looking forward to the festive season, the family firm had enjoyed another record year. Since he had taken over the Family Reserve Board from his uncle, Paul Ebenezer ‘Humbug’ Scrooge, ten years ago, he had prospered. At it might not have happened had it not been for the change that came over Ebenezer shortly before he retired.

For years, Ebenezer Scrooge had been known as a man hard and sharp as flint, who despised Christmas, hated the company of his fellow man and was happy only when he was in his counting house, counting his money supply – which he targeted assiduously to make sure it increased by just the right amount each year. Indeed, the only thing he cared about more than his money was his reputation and the credibility of the Family Reserve Board (which had been in pretty poor regard when he himself took over, way back in the early 80s)

Then, one year, something happened. Ebenezer never spoke about it but a terrifying experience changed his whole outlook on life. Having spent his whole career trying to make sure his money supply didn't grow too fast, he was confronted with the risk of its growing too slowly, instead. That was a huge shock, so much so that when young Alan took over the family firm, Ebenezer’s message was that there is another way, a new paradigm, a path to a Goldilocks period where all is for the best in this best of all possible worlds.

Alan Scrooge took this message to heart and as the firm prospered, he employed more and more people, paid them more and more money and watched the company’s share price soar.   His clerk, Bob Cratchit, was promoted to Treasury Secretary and even Tiny Tim followed in his father’s footsteps, becoming a partner at one of the firm’s subsidiaries. True, the company’s bank accounts with both the Bank of Japan and the Bank of Europe were deep in overdraft, but he paid his interest in full and on time, so Scrooge wasn't unduly worried.

As Christmas 1997 approached, and Scrooge prepared to relax with his wife in the comfort of his Virginia home, he took the liberty of opening a bottle of vintage port, lighting a long cigar and reflecting that he, unlike some of the managers of competitors’ firms in Asia and elsewhere, was doing rather well – and achieving this wealth without any of the nastiness that characterised his father’s era. Indeed, he was (he thought to himself) just about the most popular guy around these days.

After dinner, Alan received a phone call from an old G7 colleague, Karl-Otto Marley, who he had not seen for so long he didn't realise he was still alive, phones from his castle high in the Taunus Hills.

‘Alan, I know you think your uncle was a miserable old so and so but I fear you have gone soft in the head. Furthermore, the ghosts of your predecessors are inclined to agree with me. You've forgotten your principles and are so keen on having fun you could ruin the whole party. I have a message for you. When the clock strokes ‘One’ on each of the following three nights, you will be visited by a Spirit. Listen to what they have to tell you and ignore them at your peril’.

‘Oh stop being so miserable, have a beer and a bratwurst and call me when you’re in a good mood’ answered Alan before hanging up. Not in the least bit bothered, he settled down with his glass and drifted off to sleep, dreaming of excessive exuberance on his next vacation – at a beach resort in Thailand, which is such good value at the moment.

He was woken by the sound of the old clock above the fireplace sounding twelve. He looked at it, remembered what Marley had said and spent the next hour rather nervously watching the minute hand tick round. No sooner had the bell sounded the hour, than lights flashed and the curtains were drawn aside, by a mysterious hand.

‘What or who are you?’ screeched Scrooge, terrified.

I am the ghost of Christmas Past. And I have something to show you.

Scrooge was so scared it took a major effort to move but he had no choice other than to sit up and look at the television screen, which was flickering to life. What looked like an old newsreel came into sight. The first frame showed a hotel in New York – a hotel Scrooge knew well, the Plaza. There was a group of men in a meeting-room and he recognised his uncle, old Ebenezer. Then, the scene moved: He could see a big screen covered in numbers and Japanese symbols. In front of it were frantically excited traders watching a sea of blue as prices rose, seemingly fo ever. The film continued and now he could see Japanese tourists queuing in shops in New York and London, Japanese bankers buying works of art, and huge buildings. Everyone was smiling. But after a while, the mood in the film changed. Now the traders were watching red prices, falling and falling. The people in the streets were looking miserable and there were shots of tramps and beggars. Then, the screen went black.

What happened? Asked Scrooge

‘They believed in a new paradigm, thought asset price inflation didn't matter, because goods prices were under control. They allowed a liquidity bubble to build and it all went wrong. Good night.’

The next thing he knew, Scrooge was awake, in his bed, shaking. The pale light of dawn filtered into the room.

That night, Scrooge was nervous. He had been promised three visitations. Still, that didn't stop him eating a hearty dinner washed down with an excellent claret (the merits of a strong Dollar are many, he mused). After dinner, he smoked his cigar and went to bed, albeit a bit apprehensively.

This time, he did not know what woke him but when he looked at the clock by the bed, it was five to one. Five minutes later, he heard the clock downstairs chiming. Nothing else happened so he walked to the door and opened it. On the other side, stood another ghostly figure.

‘Come along’ said the spirit. I am the Ghost of Christmas Present, and I have things to show you’.

Scrooge followed the spirit into the living room, where the television came to life and people appeared on then screen. This time, he saw groups of people he knew vaguely from the Pacific Central Bankers’ Conference. They were discussing the merits of pegging their exchange rates to the Dollar. Then, he saw dealing rooms with people selling Dollars for Thai Baht, Korean Won and so on, while elsewhere in the same room, others were buying Treasuries of brash young Americans in braces. Then the scene moved on and he saw more happy people watching as large screens showed share prices rising, across Asia. He saw them build gold courses, and buy gold clubs, cars, airplane tickets and queue at shops across Europe and the US. They even bought real estate off the rather unhappy-looking Japanese he had observed the night before.

Then, he saw the central banks defending their currencies as they collapsed; share prices were falling, "For Sale" signs were on the luxury real estate projects, building sights were covered in idle cranes and the faces of the people were all dejected.

‘What happened?’

‘They fixed their currencies to a soft Dollar, woke up to find a strong one, failed to control their money supply, didn't watch their balance sheets and thought that asset price inflation is good. They allowed a liquidity bubble to build and it eventually burst. Good Night.’

The next thing he knew, Scrooge was awake in his bed, shaking, as the pale light of dawn once again came in through the window.

That evening, he limited dinner to a bowl of soup and lay off the wine completely. He didn't bother going to bed at all – he just sat in the living room, in front of the TV drinking hot chocolate and reading the IMF annual report. When the clock struck one, a knock sounded at the door. With some trepidation, he called out: ‘Come in, Ghost of Christmas Yet To Come!’

The spirit said nothing, but turned to look at the television.

This time, Scrooge saw himself, at New York’s swanky ‘21’ club, proclaiming the wonders of the new paradigm. He saw the happy faces as the big board at the New York Stock Exchange showed blue. He saw the rising Dollar, and the queues at the department stores. He saw ‘Sold’ signs on houses in the Hamptons and most of all, he saw brash young men wearing braces, smoking cigars and looking happy.

Then, he saw newspaper reports of profit downgrades, he saw people receiving notices that they had lost their jobs, in companies that exported to the East. He saw prices go up in the shops but nobody pay them. He saw banks merging but most of all, he saw the screens at the stock exchange turn red and the happy smiling faces turn grim. And the Dollar, his precious Greenback, did exactly what the Won, the Baht and the Yen had done before it, falling precipitously.

What happened?

They thought there was a new paradigm. They thought asset price and wage inflation didn't matter. They failed to spot the deflation from the rest of the world. They allowed am, liquidity bubble to build ant it all went wrong.

‘But what can I do?’ asked Alan. ‘If I raise rates, it will make things worse in Asia. If I don ‘t, the bubble at home will get bigger.’

‘I am a spirit, not a shadow FOMC member’ said the ghost, ‘but if I were you, I would persuade Congress to increase the IMF quota, bail out those unfortunates in Asia, and raise rates a little to let the air out of your bubble. But what do I know?’ And with that, he vanished. 

The Elves and the Loanmaker

Once upon a time there was a young banker, who had followed his dream of making a fortune in the financial markets. He worked very hard and was very honest but he could not earn enough to live upon – at least, not to live to upon in the most expensive city in the world. 

The young banker knew that he wasn't making enough loans for the bank, and that the loans he made were not very exciting. Very soon, he would lose his job and with a mortgage and no savings, he had no idea what would happen then. 

So the banker laid out his loan proposal paper-work tidily on his desk, put his blackberry in his overcoat pocket, and stopping for just one half-pint of shandy with his friends, headed for the small Docklands flat he shared with his wife, who had prepared for him a simple meal. They didn’t know what to do, as there were no more jobs available in the banking industry, particularly not for hard-working and honest bankers. And the skills he had learnt in his time in finance didn't set him up very well for anything else. So, the banker and his wife ate their meal, watched X-Factor, said their prayers and went to bed.

In the morning, the banker joined the trudge to work long before the sun came up. He could no longer afford the ruinously expensive Financial Times to read, not could he visit Starbucks for his morning beverage. A copy of the Sun and a cup of tea from the local greasy-spoon had to suffice.

But when he got to his desk, the young man found that his loan paperwork had been re-structured into a proposal of awesome complexity and beauty. On the front of the file, he read the word ‘CRAPPY’, which stood for Collateralised, Rate Adjusted Principle Protected Yield. The good man looked at the workmanship, and while he didn't really understand how the thing was put together, he knew it was wonderful. It was a masterpiece. So good, in fact, that when he showed it to a Ratings Specialist, he was so impressed with its sub-clauses and margin-adjustments, that he declared it to be a ‘Sure Thing’ which offered the elusive ‘Money for Nothing’ of investment.

The wonderful new product was sent to the sales force at the bank –a brash group of young men and women who mostly drove fast cars and drank imaginatively-named cocktails after work. And pretty soon, there was demand for the CRAPPY product. A wealthy investor from the Far East even came in and bought some, at above the market price.

The honest banker went home happy for the first time in ages. His share of the credits from the sale would be enough to keep him and his wife clothed and fed for many weeks and now he had a little more time to work on the next loan product. He had once again started, and laid out his file on his desk before going home, but this time he had done so with a spring in his step.

The banker bought the Telegraph and a cup of coffee – not quite the FT and Cappuccino favoured by the sales force, but he still didn't want to trust his luck had turned. But when he got to his little cubbyhole of an office, he was amazed. Once again, on his desk, all his work had been most awesomely transformed.

This time,  the file read ‘Uncorrelated Synthetic Enhanced Leverage Equity-Sourcing Strategy’ Or USELESS.

Once again, the young banker could only stare and marvel at the workmanship, the detail, the acronyms, the legal jargon and the overall beauty of the thing. He signed the bottom and sent it to the head of sales after completing the necessary PIMP (product implementation) form. And once again, the sales force rejoiced and the investors loved it. Everyone was so impressed that the young (honest) banker was taken out to drink cocktails by exotic credit sales people who flattered his ego and whetted his appetite for the finer things of life.

And so it went on. The poor young banker got a bit less young and lot less poor. The pied-a-terre was a bijou residence in Mayfair, the frugal wife was magnificently adorned in Jimmy Choos and Dolce & Gabbana. 

The banker was still honest however that he wanted to know where his good fortune had come from. So one evening he arranged to meet his wife after work, and they had a tete-a-tete."Darling", he said, "tonight I think we should go back to the office and sneak into my (rather opulent) office on the 43^rd floor. I want to see who or what it is that has brought us such good fortune".

So that is what they did. They went to his office and hid behind a plasma TV. And in due course, they were amazed to see two elves sneak into the room. They sat at his desk and they worked for several hours, structuring incredibly brilliant credit products, and then left.

"Wow", said the banker. "Cute" said his wife, "but we must do something for them". The elves, she pointed our, did not look very opulent. They were wearing very few and very old and very torn clothes, and they didn't have shoes at all.

Now the banker’s wife had been,( before the previous recession when there was still a manufacturing industry in the country" a very talented seamstress. So when they got home, she set to work. She took down some curtains and made a set of glamorous velvet suits for the little elves. And then she cut up a leather jacket to make some little boots. And the next night, her husband left the bundles on his desk before he left for the night.

The next morning, there was no new exotic product on the desk. Just a note, saving "Thanks".

The banker’s act of kindness didn't do his career any good. Without the help of the elves, his next few ideas were for more conventional lending. He was, in any case, beginning to understand that all the products the elves had designed depended on borrowers increasing leverage and on investors selling the correlation of default probabilities between different parts of the global economy. This seemed dangerous, for reasons the honest (but, frankly, not very clever) banker couldn't quite put his finger on. Anyway, he decided to focus on helping companies reduce leverage, and on helping the bank lend rather less money than they had before.

The sales force couldn't see any point in this and o could the management. The honest banker’s bonus shrank and after a while, he decided enough was enough,.

The banker invested in a dress design business for his wife, and while she was at work, he became a house-husband, looking after their new child and studying for a degree in economics.

His ex-colleagues were not so lucky. Those pesky elves had appeared to help them but got everyone into a whole heap of trouble. Everyone ended up defaulting on the super-complicated loan products and sued the banks for not explaining them properly. The King of the country had to come in and buy all the credit products, handing over money newly-printed by Santa Claus in his workshop at the North Pole, in a Quantitative Christmas experiment. this did mean that there was enough money for some most Christmas presents, but the cocktails with fancy names, the designer shoes and the glamorous frocks were out of reach of everyone but footballers and their friends.

Ben's Magic Cooking Pot

Once upon a time, long ago and far away in an erstwhile land called the Austro-Hungarian Empire, there was a little boy called Benjamin who lived with his widowed mother. They were very poor and one day, they found they had neither money nor food.

The widow cried, and the little boy went out into the woods, where he foraged for mushrooms and tried in vain to catch a rabbit. But he was little and it was winter and the animals had gone East where the job opportunities were better. Cold, hungry and miserable, he sat on a tree trunk and burst into tears.    

There, an old woman found him: “What is the matter my child?” she asked, “Why are you crying?” “Because I’m tired, and cold and hungry.” replied the little boy. “I’m so hungry I can’t sleep, and I’m a failure.”

“Well that’s no good.” said the old woman. “I am your Fairy Godmother and it’s my job to look after you! Here is a natty scarf to keep you warm, an economic textbook to help you sleep and here is a special present”.

To his amazement, the old woman handed Ben a little old cooking pot. “When you are hungry, just say to the pot: ‘Cook, little pot, cook’ and it will cook up some very fine porridge. And when you want it to stop, you must say ‘Stop, little pot. Please stop’”.

With that the old woman left. The boy didn’t really believe what she had told him, but he gave it a try anyway. And indeed, when he told the pot to cook, it cooked (porridge) and when he asked it (nicely) to stop, it stopped. He filled his empty belly, went home, filled a bowl for his (very grateful) mother, and after reading the opening pages of The General Theory of Employment, Interest and Money, he fell to sleep.

For a while, everything was much better. The widow and her son had plenty to eat, and they were happy until one day, when the boy was out, his mother told the pot to cook, using the words she had heard her son speak.

“Cook, little pot, cook” she said. And it did. But she could not for the life of her remember what to say to make it stop, and soon there was porridge everywhere.

By the time Ben had returned from his long walk to the library where he had gone to borrow another economics book, the whole village was swimming in porridge.

It took ages for the townsfolk to clean the town and they turned in anger on the widow and her son. They told them to leave, and then they offered them some money to leave. Not a lot but just enough to pay for a ticket to America, and so the widow decided to seek her fortune in the land of opportunity on the other side of the Atlantic.

They didn’t take much with them, but Ben packed his textbooks and without saying a word to his mother, his little cooking pot.

For years, Ben didn’t use the pot. His mother found work as a teacher in a local school and they developed a fondness for many kinds of American food. Porridge isn’t as exciting as toasted marshmallows and peanut butter sandwiches. Ben took up the saxophone, and fell in love with economics. In due course, he was offered a place at Harvard, and though his mother was sad to see him leave, she was very proud that her little Hungarian boy was going to be a big cheese in his new country.

At Harvard, Ben occasionally used his pot to make sure he had plenty to eat, and saved up his money to go out with his friends. He joined a blues band with Al Verpont, and played football with Leroy, Mark and Mario, as well as many others. Ben was the worst footballer, a reasonable sax player (not as good as Al), but he was by far the best theoretical economist, because he had powers of imagination that the others simply did not possess.

After Harvard, the friends all went their separate ways, but they vowed to stay in touch. Some went on to study, or teach, while others went to work for the government and quite a few went to work in a new firm called Goldilocks LLP, which was trying to take over the whole global financial system to make it more fun (for them).

Time passed. The friends got older, in some cases much richer and in other cases much more influential. But then, catastrophe struck. The banks went bust and the whole country ran out of money. And not only that, but like dominoes, the banks of countries around the world toppled over and there was no money anywhere.

The President of the United States called his closest advisors together and asked what should be done. Of course, more than one of them was an old student friend of Ben’s, and it didn’t take long to conclude that in these unprecedented times, the man the President needed was Ben.

Ben was quietly minding his own business, eating porridge, playing the sax and writing books. But when  the President of the United States asked him for advice, he couldn't exactly say no!.

The problem was explained; Ben scratched his beard, and his bald head. He consulted his books and went for a walk to think. And then a thought occurred to him: “What if I just tell the pot to cook enough porridge for everyone? Then at least no-one need starve!”

No sooner had this thought crossed his mind, however, than another popped into his head - the sort of idea that made him so brilliant. He went home, gave his little pot a good clean, put a silver dollar in it and said, “Print, little pot, print”. And no sooner had he spoken than the pot filled with coins and as they overflowed, they kept on coming. 

He called the White House. “You need to put me in charge of your central bank, Mr President” he said, “and then I think can solve the problem.”

“How will you do it?” asked the President.

“I’m afraid I can’t tell you, you will just have to trust me.”

Desperate, the President trusted him.

With pots and pots of money being made every day, Ben set about buying up bonds. Mostly government ones, but pretty soon he realised that he couldn’t afford to be fussy and was calling almost all the investors and traders on Wall Street.

What Ben could not tell the President was that he didn’t actually know how to stop the money being made. He knew how to tell the pot to stop making porridge, but everything he tried to make it stop making money, failed. So he was handing over truckloads of money to the folks on Wall Street, which made them happy, and hoping that they would do something with it (he wasn’t sure what) that would help revive the economy, fix the banking system and earn him the gratitude of his President.

As the money kept on coming, Ben realised he needed to get some of it out of the country. Desperate, he called his circle of university friends and persuaded them to help. Leroy bought gilts off the British pension funds, Mario bought them off all the banks in Europe, while the Goldilocks LLP folks worked tirelessly to engineer a situation where someone could use the money to buy Japanese bonds.

Still the problem wouldn’t go away. There was money everywhere and it was sending the prices of all sorts of things up. The banks and the fund managers bought copper, and gold, and platinum, and wine, and paintings and truffles and billions and billions of iPads. But the pot kept on making money

So Ben flew back to his homeland, and secretly visited the woods where he used to play as a child. He desperately needed to find his fairy godmother and ask her for help.

He searched and searched but to no avail. Exhausted, he sat down on an old tree stump, not realising that it was in fact, exactly the same one he had sat on all those years ago.

“Hello, Ben.” said a voice behind him.  “I’ve been waiting for you.”

“Hello – is it really you? I have a problem!” said Ben, hugely relieved that the only person who could help was with him.

“Yes, I know. I’ve been watching you. Go back to the pot, and tell it to stop, auf Deutsch!  Halt, Kochtopfchen, Bitte Halt! That should do it.”  - “Oh and Ben, I’ve got a new book for you. This one’s by a man called Joseph Schumpeter. I’m afraid it’s long, badly written and all about wild spirits and stuff, but I think you’ll find some of the ideas interesting.”

And so Ben went back and told the pot to stop, in German. The stock market went back down, but the housing market had recovered and the economy was growing again. His friends were all relieved that although their currencies had fallen sharply, they hadn’t experienced a huge inflationary shock. Their governments were pleased with them and either because they were rewarded or because they had shrewdly bought vast stocks of wine and sold them before the pot stopped, they were all rich. Leroy bought a beautiful villa overlooking the sea, Mario bought a football club and others bought fine French chateaux.

Ben wasn’t into such material things. He was just happy to have helped and even happier to have found his fairy godmother. He went back to his books, starting by reading the newest one, and pretty soon he was an expert on creative destruction and the importance of allowing the business cycle to run its natural course rather than mess with nature.

Thoughts on Autumn, and tax...

There's an incredibly autumnal feel to the UK on the last day in August. Sunny, a good bit colder, while the first leaves are falling. Dartmoor is bright but wet. The mardle is much bigger than it usually is at this time of year. Most of the big shots in the central banking community are in Jackson Hole, Wyoming.

Here's a world to imagine...

In the UK, in 2008, pre-crisis, the top 10% of earners received £313bn in income, out of a total of £870bn. They paid income tax of £ 88.5bn, out of a total of £163bn.

In 2012, post-crisis, this same top 10% earned £293bn, out of a total of £ 873bn. They paid £85bn in income tax out of a total of £154bn.

What does this mean? Between 2008 and 2012, total income in the UK increased by £3bn, but total tax fell by £ 9bn. the top 10% saw its income fall by £17bn, but it's tax bill fell by only £3.5bn. The average tax rate on this group rose from 28% to 29%. The other 90% of the workforce saw a £23bn increase in incomes, but a £5.5bn fall in tax. And a tax rate that consequently fell from 13.3% to 11.9%.

This is 'just' the income tax side of the equation. total income in 2012 of £873bn, is only a little over half of the  £1.56trn in GDP. And £154bn in taxes is an even smaller fraction of the £687bn the government spent in the last fiscal year.

But what the data do show, is how a recession affects different groups.

The pre-tax income of the 'typical top 10% earner' if such a person exists, fell from £120,000 in 2008 to £113,000 this year. His/her post tax income has fallen from £86, 500 to £80,000. The 'average bottom 90%'  non-banking non-footballer, had a pre-tax income of £ 23,800 before the crisis, rising to about £25000 now. His/her post-tax income has increased from £20,600 to £22,000.

In any system where some earn more than others, and where there is a desire to ensure that a minimum amount of income as well goods and services (schools, hospital, roads, you name it) are provided to everyone, a major economic shock will increase the burden on the well-paid. Their incomes will fall and their share of the tax burden will go up. And so it is that in cash terms, 90% of the people employed are richer in cash terms than they were four years ago, even if they feel poorer, while 10% are without a shadow of a doubt poorer however you look at it.

Both sides of this argument are going to feel aggrieved. The well paid will reckon that they are already paying more, even as they earn less, and won't like to be told they must pay more to contribute their 'fair share'. The rest will see 10% of the population earning four times as much on average as the other 90% and reckon it is only right and proper they should carry the burden of any additional hardship. And then someone will talk about wealth.... I'm not sure I have a strong view on the morality of the issue and what is 'fair'. But I am sure that the outcome of recession will be further increases in the tax burden on the well-paid, because there is no alternative. You can only tax those who earn and there are clear limits to how much spending can be cut in a democracy where we are all used to the benefits of public schooling, health, and policing.  The answer is to grow the economy, because if total income is growing, you can more easily  provide a better level of service for everyone. But that's obvious in principle and elusive in practise!

http://www.hmrc.gov.uk/stats/income_tax/table2-4.pdf

UK jobs and GDP

Predictably awful UK industrial production data this morning - predictable because we have already seen the dire Q2 GDP data, which we blamed on the weather (a bit) and the Jubiilee (mostly). But here's a chart of annual GDP growth and annual employment growth. The red line shows year-over-year percentage gowth in workforce jobs, the black line percentage growth in real GDP. I may update it too look prettier when I have time. But the story is obvious - the lasst time we had this pace of job creation we had 3% GDP growth, not a recession at all.

I don't think the UK economy is powering ahead, but I don't believe the official GDP data, either.....

The bubble economy and the Olympics.

If you want to find out about asset bubbles, don't care for dry academic work and haven't read it yet, go and buy a copy of Tulipomania, by Mike Dash. GBP 5.99 for the Kindle version, apparently. I have already had one copy 'borrowed' and never returned.

The bad photo is of a great painting by Frans Hals,  which you can find at the Alte Pinakothek in Munich. Perhaps his most famous picture, of a Laughing Cavalier, is at the Wallace Collection in London. Closer and free to see. The one in Munich is of a cloth merchant, as is obvious from the sword he's holding. Looking at it, I was struck that this is a painting of an asset bubble. The rich people who bought tulips at silly prices also paid the Dutch masters to paint their pictures so they could show off their new found wealth. This one was painted in 1629, just when the bubble was getting monstrous. Hals' later work is more sober,  reflecting what happened after the bubble burst.

I don't know what it says about this era, that bubble-beneficiaries are more inclined to buy old masters than commission new work. Or they buy houses, super-yachts and football clubs.

The current asset bubble is different from is predecessors because it's truly global. That means it  changes shape and moves around the world. It started as a credit bubble, that spawned housing bubbles. The first of those burst spectacularly. The second too, in many places. But as central banks shovel newly-minted money into bond markets, so the bubble turns up in different places. The near-zero levels of Treasury and Bund yields are obvious examples. The Swiss National Bank can only keep its currency in check by allowing a Swiss asset bubble to grow.

But if asset bubbles all have one thing in common, it is that they widen the divide between "have's" and "have not's". Money is almost free but brutally rationed. Germany can have as much is it wants, Spain can have none. Apple could borrow as much as it wanted except it has ludicrous amounts of cash sitting round, unused, already. Hals' cloth merchant was part of a small elite that wanted to show off its wealth. And even today, you can see a country in recession produce sell-out audiences to the Olympics day after day.   Huddled over laptops, Londoners try to by more tickets, not put off for a second by the prices. In the last half hour, a few tickets have been out on for sale -  GBP 450 for Tuesday's athletics, GBP 150 for a ticket to the women's hockey final? GBP 1500 for a ticket to the closing ceremony? Snapped up in an instant!

The Olympics are a huge success on many levels, and the amount of money spent by spectators will be one of the positives, even if it takes time to turn up in official data that struggle to capture something quite so esoteric. Oxford Street, after all, is much quieter than usual.   I wish I could think of the equivalent incentive  for the like of Apple and other cash-rich companies to spend more. For the most part though, in our 'bubble-economy' the assets which will do best continue to be ones the newly-minted central bank money gets to most easily. So don't be surprised to see stock markets out-perform economic growth (or profits), and don't be surprised if the yields on 'safer' government bonds remain far too low to finance a pension safely.

Overpriced Milk

Why does a skinny cappuccino cost Eur 3.20 while a skinny Latte costs a mere Eur 3 at Starbucks in Munich? Milk is cheaper than froth, something that will register with British dairy farmers, who are complaining about falling milk prices.

The Starbucks index currently puts a tall late at Eur 2.85 in Alicante, 3.00 in Munich and 3.50 in Paris and Amsterdam, but Eur 3.85 in Athens, which plays right into the hands of those who think Greece is the European economy which suffers most from excessive prices.

Mind you, CHF 6.10 for the same drink in Zurich this week is scary, while GBP 2.15 could be argued as a reason to buy the pound were it not for iPad prices. It seems the Swiss, relative to the Brits, value coffee more highly than Apples.

iPad prices are normalising

The Dollar price of an iPad 2, now and last year. Many thanks to Edward, who did the web research for me as his 'work experience' yesterday!

Some countries have seen prices come down, all countries have seen exchange rate movements, The big outlier a year ago was Brazil but Real softness is going some way towards sorting that out. Cheapest place to buy an iPad is still the USA. Japanese prices are added and highlight that years of deflation mean Japan isn't over the top expensive any more.

In the UK, we're being over-charged.....and while Switzerland is super-expensive for many things, an iPad is cheaper in Zurich than in London, apparently.

If you only traded FX on the basis of iPad prices (would have got you short real last year, but it's not really a sophisticated strategy!) you would sell the Swedish krona and buy the dollar or the yen...

Terra Mitica and the carousel of austerity

Terra Mitica, the world’s best theme park, opened in 2000, in the bright dawn of Spain’s Euro Zone membership. Money was cheap and plentiful, the economy embarking on a boom. The pound was on a high and the local economy in Benidorm was re-inventing itself from cheap package holiday destination to appeal to a wider clientele. The local savings banks were happy to finance a theme park, as well as hotels, a golf course and a nature reserve.

Twelve years on and Terra Mitica is still the world’s best theme park. For visitors, not for the Cajas who financed it. What makes it so good is partly the theme of the rides – a journey through the Ancient World, allowing a small dose of cultural education along with the thrills. More than that though, visitors can enjoy far, far smaller queues than they would at most other theme parks.

Since my children were 1 and 4 years old when the park opened, it has been a regular destination, the rides they enjoy changing gradually as they have got older. My annual season pass costs me Eur 51, and since I can visit as many times as I want, I tend to indulge the children’s appetite for frequent visits, either keeping them company for a ride or two in between cups of coffee, or simply dropping them off and heading for the gym of golf course down the road. As the chosen rides got scarier, coffee and golf started to appeal more and more.

Terra Mitica has lost several hundred million euros in its short life. It has changed ownership and management, running a profit only briefly in the halcyon days before the credit bubble burst – and is now run by a waterpark operator. I have regularly fretted that it would close down and deprive the children of one of their favourite holiday treats, but the banks are still trying to avoid writing off all their loans.

Since it ran into trouble, some rides have changed, and restaurants have abandoned all but the quickest fast food. Pondering the thinking about what to change or close, it is clear that one factor above all makes the difference – how labour intensive a ride, or restaurant is. So my wife’s favourite ‘cultural’ ride, a genteel water ride based on Odysseus’ journey round the Med, is no more, and the aerial climbing centre has closed down. As for the days when I could sit down and have a four course a la carte meal, they are a distant memory. 

The trouble is that since Spain joined the Eurozone, wages have risen sharply. And European labour laws have been imported. That’s not a bad thing, but closing down labour intensive jobs in a part of Spain with incredibly high unemployment doesn’t actually make sense. If labour costs were a bit lower, there would be demand for many more services, and the work would create its own demand.

Closing a ride on the grounds of labour cost while youth unemployment heads ever higher, hits local demand twice over – tourists have less to spend their cash on and locals just have less cash. Europe’s austerity-solution will be to reduce unemployment benefit, and raise consumption taxes. That will reduce demand even further, obviously.

The latest twist is a cut in unemployment benefit and an increase in VAT. Will that boost employment? Probably, but not at Terra Mitica. The successful businesses around here are small family-operated ones, where unemployed children with degrees in architecture help work in the family bar, for example. Here, prices have been cut. Are these businesses diligently reporting all their income for VAT? Who knows!

It all ends with the banks writing off the loans to finance all sorts of  infrastructure projects. It ends with freer labour markets and a scaled back social welfare system. It would be nice if there were an offset in the form of cheap money, or cheaper currency but at the moment neither is on offer. In the absence of either, tighter fiscal policy will result in weaker demand, higher unemployment, weaker tax receipts, reduced government spending, a lower credit rating, higher borrowing costs and on round and round the austerity carousel… 

Even in the depthts of an Ice Age, the sun can shine

Just in case anyone wondered - the ECB's dramatic policy shift isn't going to save the Euro Zone from recession, nor will it cure internal imbalances. But lending half-a-trillion cheap  euros to the banking system for 3 years relieves all the worries about where the money will come from to repay maturing bank debt, and the success of the frst loan will probably increase enthusiasm to come back for even more in February  - and that cash will be used to buy higher-yielding assets, boosting profits and helping the process of financial rehab.

A word on those imbalances. It's fashionable (see Martin Wolf taking to John Authers on FT video) to talk about Europe's internal balance of payments imbalances in terms of 'the surplus countries' and 'the deficit countries'.  In practise, that's a bit simplistic. Almost all of Europe's balance of payments surplus comes from just two countries - Germany and the Netherlands. And almost all the deficit comes from Spain, France, Italy, Portugal and Greece. The other ten countries don't have much of a surplus or deficit at all. Maybe it's semantics but when we say 'surplus countries' we really mean Germany, and 'deficit countries' we mean 'Club Med, plus France'.

In the US, the housing market - crucial to economic recovery - has worked off its excess inventory and is very, very slowly coming back to life. The economics profession under-estimates lags between policy action and effect, and underestimates the multipliers that cause both recovery and recession. 'New normal' growth won't be anything like 'old normal' and we can reasonably term the new economic environment an 'ice age'. But even so, there will be days, weeks and months when things fell better. This is one such day, enjoy it.