Monthly Archives: May 2013

The commentariat is getting up in arms at every little move up of Japanese Government Bond (JGB) yields, claiming that this augurs a failure of Abenomics.

They seem to be falling for a very basic money illusion type of error.

What is the status quo?

About 0-1% deflation, and long term yields at about +1%. That is the cost to the Japanese treasury to finance itself is 1-2% in real terms, which if I recall is in line with rates on index linked JGBs, as it should be. This is spot on the “normal” historical rate for developed countries for the past few decades. All business as usual and nothing to see here.

Where are we going?

The new monetary policy is to do what it takes to get 2% inflation. If they succeed the new bond yields required to maintain the steady state and “normal” rates — 1-2% real — will be about 3%, to get no change to the funding position of the Japanese treasury.

In fact, you could argue that the central bank has failed if rates stay below 2% as this is consistent with unchanged inflation expectations aka continuing deflation. Indeed whenever the rate on bonds is below the inflation rate, the existing debt stock shrinks every year in real terms (% of GDP) so if it was the case the Japanese debt would (slowly) disappear even if they never net repay a single yen.

Incidentally, if they achieve inflation and a matching adjustment to rates, the price of long dated legacy issuance sinks below par, which the government can arbitrage (via the central bank) if it wishes to make a profit and reduce the nominal debt to GDP ratio. So you get a win-win situation: funding costs unchanged with the real cost of legacy debt reduced, in addition to removing the brake effect of deflation on the economy.

(And I’m here skipping the fact that the Japanese government has no material funding requirement at all as a currency issuer, and could comfortably fund the kind of deficit they now have in perpetuity through monetary channels — the arithmetic exposed here works even if you believe in accounting for government finance in household/corporate terms.)


Yet another boring company has been acquired for the Obliquity London portfolio. This time it is Volex, a cable manufacturer. I stumbled on it for my stamp collection of UK small caps — that I’ve taken the occasion to publish as well — but realised that it was actually a good company for the main portfolio.

Volex power cord

A power cord made by Volex (source: Austin Hifi)

It is a small cap in market capitalisation only, at GBP 60 millions, despite being an operation with eight thousand employees and a turnover north of USD 500 million. It had somewhat haphazard profitability in the recent past but seems to be on the right path. Within its niche it’s quite well diversified geographically and in clients and projects. It’s also hard to sink as a business as once they’re the chosen supplier for a product they’re likely to remain so for many years, so slow decline is more likely as a worst case scenario than sudden collapse. It passes the Obliquity criteria very easily, only lacking a bit in data on the employee treatment one though from hints it seem OK for the sector.

I’m not usually looking that closely at valuation given that for large/mid caps most of the obvious public financial data is usually reflected in the price, but here it seems unusually cheap. The ratio to profits are already good as they stand now, and if you assume it’s going to make normal profits for its size in the future it’s exceptionally cheap.

A bit of excitement comes from the price chart:

one year chart

Volex (VLX) one year chart

The price seems stuck at a suspiciously round £1 since January, along with falls previous, on bad news presumably. It looks like it could be a large seller which could explain why it seems so keenly priced despite improving news and the low price. Let’s just hope the seller, if it is that, does not know something we don’t.

The acquisition was funded from accumulated dividends and a partial sale of SIG plc, the equally boring packaging company, which was just top sliced back to original weight according to the systematic rule (value increase of 50% above that of portfolio).

There is a bit of brouhaha about the Bundesbank’s deposition before the German constitutional court, arguing that the ECB goes beyond its mandate with policies like the OMT, in the direction of monetary financing of governments, which is explicitly banned under the treaties that establish the ECB.

The debate is generally spurious: the fluidity of money is such that you cannot devise an enforceable mandate in the common sense of the word. Whatever the rule book says, you could devise a transaction or set of transactions that respect the letter of the rule but not the spirit. Defining what is monetary financing itself is similarly virtually impossible: if the central bank makes policy that results in a vibrant economy, this increases taxation receipts and decreases fiscal expenses (or conversely), is that monetary financing? It does certainly achieve the same effect! It both always and never is, and it doesn’t matter once you have accepted that a central bank is an agency of government and that in any case it cannot not have a monetary policy (the central bank always sets the quantity and flows of money in a fiat currency system, by definition). What the ECB does is really what is politically acceptable, both within it (the governing body must come to an agreement) and without it (what the member state politicians, who can change the law if they really mean it, allow it to do). Like many institutions, it is better understood through its governance structure rather than its notional mandate.

Beyond the pointlessness of the debate, there’s been an argument whether the Bundesbank is going in the direction of arguing for Germany leaving the euro, given that the ECB’s measures are pretty much essential to euro survival, and have been extremely conservative so far. It could be. It could also be playing the role of the “useful idiot” by showing that there’s multiple forces pulling in different directions, so as to guarantee that wherever it goes some intransigence will prevent the ECB from going totally wild. This is actually quite positive for the euro’s stability, as it makes it hard to argue it is completely controlled by crazy inflationists, thus killing most opposition before it can even start.

Is Jens Weidmann under an explicit brief of being a useful idiot? I doubt that, but it is convenient for everybody. I would be more inclined to think that whoever ends up head of the Bundesbank is going to face institutional existential angst. The current clunky setup where the national central banks are notionally members of a network but operationally branch offices is doomed to normalise into more centralisation — unless the euro doesn’t survive. Most branch office functions should sooner or later (if you think decades) be subsumed into the central core. The direction of travel is clear. Banking union takes away one of the few remaining relatively independent responsibilities national central banks still have. The Target-2 non-problem, if it at some point it was to surface as a political issue, can quickly be resolved by consolidating the accounts centrally once and for all, and taking the NCBs out of the equation.

So what is the future of the Bundesbank once stripped from its ECB branch office functions? Hard to see apart from being the custodian of (pointless) German gold. Maybe that’s why they’re repatriating some of which was stored elsewhere: to have something to do.

So going forward, the Bundesbank will probably not be notionally abolished, but will functionally disappear in all but name. That might explain slightly queasy management.

Bitcoin has gone mainstream, boomed and crashed, in just a few short weeks. If you want to understand how it works, the self-evident blog has a brilliant introductory series which goes in just enough depth to be interesting and yet capture the subtleties of the technology.

What interests me however is to try and think of ways in which it could fail. It’s based on a clever technology, but like computer security it’s very hard to design software systems or algorithms that correctly anticipate every possible misuse. It’s been surprisingly resilient so far and a remarkable success story. It’s nowhere near becoming a real alternative currency for what existing mainstream currencies are used for, but just getting considered for that role is a remarkable achievement for something created by one lonesome and anonymous hacker.

There’s probably a myriad of ways in which it could fail, so I’ll just throw a few random ideas. It is also worth noting that currently most people involved in Bitcoin seem to genuinely want it to succeed, for various ideological or aesthetic reasons. It feels like the naive Usenet of the 80s and early 90s before wilful spam was introduced into it by unrepentant green card lawyers.

The blockchain as a data store

The core of Bitcoin is a distributed ledger of all transactions ever conducted, which may “metastasise”. The obvious risk is what happens if it becomes too big, although it’s also hard to overwhelm modern computers with mere transaction information (a modern smartphone has more computing power and storage than a major bank had when bank accounting moved to electronic processing), but it may face tangential attacks or misuses.

Through steganography any data store can be used to store anything else. People may start to use the Bitcoin blockchain as a store for information they want to publicise anonymously or hold for a a long time, by generating sequences of special dummy transactions. This might cost transaction fees (to get included in the blockchain) but for that you get perpetual public distributed storage, which is a good deal! It doesn’t need cost actual Bitcoins beyond transaction costs, because the encoding transactions can be conducted between Bitcoin addresses all belonging to the entity writing the data.

Here are some applications I can think of:

  • Way to publish illegal content like child porn
  • Way to publish secret information, like wikileaks
  • Back up device for small data as a substitute for a paid for data store
  • Underground social network using the blockchain as the transport and storage mechanism for status updates
  • Anything you can do with a public more or less anonymous data store…

This is a bit limited in size, if people start backing up their HD porn collection encoded as Bitcoin transactions the network would probably be overwhelmed fast enough to require remedial action.

For small controversial content though it might attract the ire of authorities which are used to be able to take such content down… the obvious answer would be for a way to “delete” the offending “transaction” but this is totally at odds with the core design principles of Bitcoin…

Jamming the network with a penny auction

Another idea is that an hostile force which has managed to acquire some Bitcoins could try and jam the network. For instance they could offer a prize to the Bitcoin address which posts the most transactions in a given block, which would push third parties to devise inventive ways to maximise pointless transactions. The logic is that of a penny auction, which leverages greatly the impact of the prize — a lot of people may compete for a single prize, collectively loosing more in effort and transaction cost than the nominal prize is worth. If it worked well the price of transaction may go up with increased competition to be included in the blockchain, perhaps making some genuine transactions uneconomic.

Becoming an ordinary currency

Bitcoin is effectively a software monoculture — nearly every actual node in the network uses the reference implementation — so there’s some scope for the people managing this code to act, de facto, like central bankers for regular fiat currencies. As long as they can get the community to upgrade and not fork the code — arguably a protection — they control all the rules that are encoded in the algorithm as code. This can also be seen in the highly concentrated mining syndicates, who intermediate the mining process, although again the members could switch if they disagree and manage to overcome institutional inertia. One could make a parallel between them and how the network of regional Federal Reserve banks compose the Fed…

Reinventing the existing would not be a particularly unusual phenomenon. Some institutional forces are so strong that alternatives tend to gravitate back to something close to what was originally rejected, if you let them marinate long enough.

Scarcity is not scarce

This would not be a technical failure, but it could also fall into disuse because of being drowned by competitors doing the same thing — Bitcoin is a form of synthetic scarcity which is itself not scarce: anyone can start a new Bitcoin clone, either as a new root with the same code, or by creating something similar based on a different protocol. Seen as synthetic gold, the problem is shared with actual precious metals. Gold supplies may be limited, but people who see it as a store of value could move on en masse to platinum or any other rare material, or alternative sources of scarcity, and thus whatever value it has depends on ebb and flow of fashion.