monetary policy

Perhaps more surprising than the results itself was the market’s reaction to Britain’s exit from the European Union: for such a momentous event, it was very mild, not getting materially out of recent trading ranges, and with the FTSE100 (though a poor proxy for the British economy) back where it was before the vote at the time of writing, with only the rather modest GBP re-rating remaining material.

Portfolios almost unchanged

I couldn’t find any noticeable distressed prices in my watchlist(s) and only sold Panmure Gordon, in the Stamp collection, on the grounds that being a small broker focussed on the London small cap market may not be very promising, as business is delayed or shifts to other places. Companies I hold are are biased towards exporters and  otherwise not UK-centric stocks, which has worked reasonably well despite the London listing bias.

Is the market right?

Is the market dominated by trading noise, or is it successfully predicting that Brexit will have little negative impact? Uncertainty will certainly be there but the outcome is hard to predict. Negative scenarios are all other the press, but one can imagine a few positive ones as well:

  • On consumer confidence, ex-UK consumers will probably ignore it, or plan holidays to the UK. UK consumers might prove stoic, optimists perhaps balancing pessimists. It’s hard to imagine that it wouldn’t at least slow down the housing market (in transaction volumes if perhaps not prices).
  • Business investment should be down, from some plans being frozen or moving elsewhere, though the outlook seemed pretty positive before the vote, down a bit from there may remain positive.
  • Sterling devaluation, if it persists, which is not a given, may help a bit. It could also remain at a sweet spot: big enough to help but small enough not to trigger enough inflation for the Bank of England to have to tighten monetary policy. Indeed, business investment slowing down may be all the tightening that’s needed.
  • Last but not least, there may be positive impact from EU re-focussing (see below).
Doc Marteens with Union Jack toe

Britain kicks arse? (credit: I Ransley via Flickr)

The European Union becomes the Eurozone

A potential positive side-effect of Brexit is that it might help refocus the European Union on improving its institutions, in particular finishing off building the Eurozone.

The United Kingdom was perpetually only half-way in, making the whole system an unwieldy variable geometry construction, both adding complexity and slowing down integration as exceptions piled up, and other member states had a strong incentive to get their own special case deals. When membership was irreversible this made sense, but if it turns out leaving has a precedent, that is not an unmitigated disaster, then there’s a way out. Then, variable geometry need not be inside the EU but between EU membership and the various forms of association around it (e.g. Norway or Switzerland style deals).

This enables the EU to become the Eurozone: the Eastern European states are committed to join; Denmark is de-facto in economically as they operate a fixed exchange rate system with the Euro; Sweden entry seems permanently suspended due to a failed referendum, but then they, or other reluctant members, could choose to either come in or leave and get a UK style deal.

So we have both a simpler and clearer framework institutionally, and an incentive to escape the current deadlock on Eurozone construction, as the choice between further integration or dismantlement becomes clearer and clearer. If this works out, it could be of great benefit to everybody, including the UK, which would be (much) better off with prosperous partners.

As a short term little bonus, if some business, financial or otherwise, moves from London to the continental financial centres, it’s a mini-Keyneysian stimulus programme for the Eurozone, which may help accelerate the recovery process.

Maybe the whole world will in the end need to thank UK voters for their selfless, if unwitting, sacrifice.

The recent discussion about high denomination banknotes has extended into the merit of paper cash.

In so far as paper cash is needed, does it need to be done the old school way? For buying goods in legal market, probably not, an alternative would be to use “bearer numbers” (implemented as QR-code or barcode) that could be printed on paper if people want that.

The way it would work would be something like:

  • ATMs are replaced by an online banking facility that debits the client’s account, credits the bank’s account at the central bank (or whoever is the barcode cash clearer), which in response issues a new random number associated with the amount. The number is printed in computer readable form on a ticker the punter puts in their wallet.
  • In a shop the punter shows the number (the ticket) which the cash register redeems with the central bank computer. A new number is issued for change and printed on the receipt. These numbers can then be spent at other shops.
  • People can also simply give away the printout to others, as long as the recipient trusts the giver not to spend a copy before them.
  • Splitting a ticket would require an online app similar to the shop’s cash register.

This reproduces something similar to paper cash but without the need for actual ATMs with a stock of high value banknotes, or a banknote printing and processing infrastructure.

The principal disadvantage is that it requires all non-trusted-parties transactions to be online, to check the value and validity of the number with the centralised issuer/redeemer computer system.

The issuer could be a Bitcoin-like system — you can indeed do all of the above with Bitcoin — though current blockchain technologies add a delay to transaction authorisation that’s impractical for most shop-style settings.

It could be argued this is less anonymous than paper-cash because all redeeming transactions are logged (like in Bitcoin).  Technically that could be done with current cash as well: banknotes have serial numbers that could be tracked to produce interesting meta-data — a government could easily mandate the use of some scanner widget in the cash registers of all legal businesses.

Monetary policy’s impact is made relevant by sticky prices. The stickier nominal salaries and fixed prices for products and services are, the greater the impact of changes in nominal money quantity.

Thing is, prices are getting less and less sticky.

Long gone is the time where the price of flights was printed in a paper catalogue updated once a year. Dynamically priced flight can include changes in fuel cost, or demand and supply pressures, every few minutes, and people got used to it. You have a ballpark idea of what a flight cost, but known that the exact price will only be known at the time of booking.

Anyone who buys tech gadgets and shops around using internet comparison engines will end up paying the producer country price, as lean distributors with little stock and tight margins pass through currency impact, and this model dominates — sticky price competitors are structurally more expensive because they need  to add a buffer to both hedge currency risk, and to prevent adverse selection (people buying from them only when the exchange rate has moved favourably since the last sticky price was set). Even supermarkets now have dynamic price labels that can be updated in seconds.

What’s left of sticky prices? Wages and property are perhaps the main markets where stickiness still applies, though this too is challenged by short term rental contracts and short term employment (be it old school or gig-economy style), or variable compensation (bonus or commission based long term employment) where the net wage becomes decoupled from the notional sticky base salary. This is still a strong force, but for how long? I suspect the writing is on the wall: prices will get less and less sticky.

A possible danger for monetary policy is that backward-looking simulations use datasets from olden times, when prices were stickier than they are today, and thus unless a gradual decrease of stickiness is embedded in the model, will make increasing false predictions. More generally, monetary policy may become less and less important as nominal effects reduce, as changes to nominal quantities get absorbed by reality faster. Another reason to give fiscal policy a greater role in macro-economic management.

The current models used to fund digital media are not very satisfactory.

Old Newspaper likes firewalls, with content behind a monthly subscription. Like in the good old dead tree times. While those with a conservative ageing demographic can sometimes get a sizeable subscriber base, it does not seem to be the future when it’s so easy to move elsewhere in a world of plenty of free content. Attention seekers and new entrants will always be happy to produce free content when the cost of publishing itself is so close to zero.

Digital Natives like the advertising funded model, free to access at the expense of privacy, degraded user experience and an incentive to produce “Social Media leaders’ 25 ways to produce Click Bait headlines” content.

I hereby propose a new model: charge for comments. There are lot of trolls in the world who have a lot of rage, seem very motivated, and produce a lot of low quality and oft duplicated content that would be nice to see less of.

Several models can be envisaged:

  • Charge per comment: each post is charged a small fixed amount.
  • Deposit system: the user pays a fixed amount, once, that gives a right to a number of daily comments. The amount, or some of it, is forfeited if one or more posts are moderated away. Users who do not post objectionable content can get their deposit refunded when they decide to stop posting – for them posting remains close to free.
  • Attention auction: for popular articles with many comments, you could auction the most visible places in the comment page. Surely some people would pay a penny to lift their pearl of wisdom to comment page 1. This can be combined with the deposit idea.

This should help deal with spam as well as trolls incidentally. Payment in digital currency can preserve anonymity if so desired.

I think the latest Super Mario move is genius, again, notwithstanding the apparently negative trader reaction.

Not only does a subtle move with tricks that have a potential real effect is probably the best to do domestically for the eurozone (balancing monetary firing power and political capital), but it avoids too strong a move being equivalent to a monetary tightening in the dollar zone, which would make it harder for the Fed to finally do a token rate increase — which is long overdue, if only for signalling purposes and to take that  uncertainty out of the system.

Super Mario and star CGI

Super Mario at work (credit: phobus on Flickr)

What are we going to do when he’s gone?

Funny news about a granny who shred her cash stash to annoy her heirs. The local central bank will replace the banknotes!

Mattress safety

This bring interesting potential applications. How to make cash under the mattress safer? Just cut it in two and hide it under TWO mattresses in different locations. If you need to spend it, rejoin the two parts and redeem it for spendable currency at the central bank. (This doesn’t though cover the somehow unlikely scenario where the central bank ceases to operate but the banknotes still have some value.)

Paper multi-sig

This could also be used by a group of people who want to share a stash and only spend it when they all agree: cut each banknote in N-pieces where each party takes one. To spend, the parties must collaborate to reunite the parts and redeem them at the central bank. This is pretty similar to multi-sig addresses in Bitcoin — indeed it could be used to explain multi-sig to people who don’t get the explanation in cryptographic terms.

Shredded will

Back to the granny, a central bank representative is quoted as saying that “If we didn’t pay out the money then we would be punishing the wrong people.” I think it is the wrong attitude. Destroying a banknote is equivalent to making a donation to society, as the value of everyone’s remaining currency increases (there are fewer of them going around). From an accounting viewpoint it decreases the central bank, thus the state, liabilities as there are fewer banknotes to redeem (paper money in circulation show up as a liability on the issuer’s balance sheet). So, the act of shredding the notes was obviously a wilful act of spending on the granny’s side. She could have equivalently bought an expensive object and destroyed it so as to destroy its value.


The ECB says that they do not redeem banknotes damaged intentionally. The Bank of England seems more tolerant. Arguable if people started to use the procedure for mattress safety and paper multi-sig en masse, central banks’ damaged notes redeeming service could be overwhelmed, though economically or morally I don’t see a problem with operating the service, perhaps with a fee to cover direct costs.

Much has already been said about the Greek “deal”, most of it unsurprisingly negative. No question it’s a sorry deal in many ways, but I’ll skip that today and try to cover some of the positives.

The Eurozone’s future is now on the table

It has been long known that the euro can be seen as two very different projects: one is a building block on the way to some kind of Federal Europe, the other is a purely technical shared currency, which is doomed to be a form of synthetic gold, because the strength of such a currency is the binding factor — otherwise the stronger members will leave.

Deciding where to go has been procrastinated since 1999 and absent any crises looked like it would be forever. But this crisis has put the debate back on the table. It could still simmer for a while, but I think the debate has advanced more in the past few months than in the last decade.

The historical track record of loose currency unions is abysmal, so if federalism doesn’t progress, we’re probably in for an implosion, if possibly a slow one. I would still bet on (some form of) federalism winning the day in due course.

The Greek debt sustainability debate is over

Today’s Draghi comment that a Greek debt write-off or some kind or other is “not controversial” reflects the speed at which the official consensus has changed. It’s striking that everybody, from the IMF to Schäuble, now agrees on that, despite being a total taboo at least in official speech a few short months ago. Varoufakis has at least comprehensively won the argument here, if not yet a solution.

Defaulting on the IMF was very useful

The catalyst for the above may have been the default on the IMF. Funny how now that the option is full default or a write off by other official creditors, the latter has become their top priority.

Also the silly long term GDP extrapolation modelling methodology has flipped to Greece’s advantage. Now they extrapolate 2 weeks of capital controls to an exhaustive disaster for the next umpteen years.

As such I don’t think a few weeks of capital controls are that bad. No actual production capacity is destroyed, people can go back to work doing whatever they were doing before when it’s over. It could push a few marginal businesses to bankruptcy but I don’t think you can project much out of that. Out-of-model factors will surely have an order of magnitude greater influence on the final outcome. The good thing is IMF models will now probably tend to underestimate Greek recovery, pushing for a better (than otherwise would be) deal.

The deal is technically pretty open

The deal is actually quite open. Everybody seems to expect Greece to get smashed, and it could, but if the politics follow it’s also possible for the deal to produce a reasonable outcome, e.g. the open-end negotiation on debt rescheduling going somewhere decent.

The deal does buy time

As a 3-year deal, if it doesn’t fall on some technical hurdle or outright sabotage, it does leave time for European politics to mature. It would get a bit easier if Tsipras’ Greece wasn’t the only unorthodox (in being of a Keyneysian and somewhat federalist inclination) government in power. In a positive scenario you could imagine both a shift in PIGS and greater tolerance in the Northern countries. It is still pretend and extend, but if we can pretend and extend until the next treaty, and that’s in 2 rather than 20 years, good.

Here and in its open-ended character, it is better than the “referendum question” deal.

Merkel has still not spent any political capital on this

Merkel’s approval rating hasn’t been dented at all and she has effectively not used any of her large stock of political capital, indeed may have again increased it. That can be seen negatively — reward for being tough — but also positively — the “kick the Greeks out of the Euro” constituency may be losing out in Germany.

It also means she’s got capital left for an actual compromise and or federalist steps. Not a given she will use it, but the outlook could be worse.

Benefits of capital controls

As a parting shot I’ve noticed a few positive side effects of capital controls:

  • people with some savings allegedly accelerated paying off debts or taxes, as a bail-in risk mitigation, thereby improving the position of the state and banks, contributing to offsetting some of the negative impact
  • nearly everybody in Greece now has an ATM card (some bank branches were open for that issuing cards) and greater access to online banking
  • it shows how an emergency (semi-)exit could work in a currency union: keep the union currency for paper cash, and use trapped banking currency as a new digital-only currency, by just replacing the exit/ATM limits with an auction system, aka a forex rate between the trapped digital deposits and the union currency