Too big to jail?

Why should bankers be different?

One of the most frustrating phenomena thrown up by the unending list of banking scandals was highlighted this week by the fine handed out to Scottish and Southern Energy (SSE) for misselling and misleading advertising. The fine was not directed at the board, who would be ultimately responsible for the running of the business and overall strategy, but at the company, thus impacting shareholders who will have been completely unaware of the corporate culture of greed and lack of oversight.

Here is a list of actual criminal activities conducted by banks. Let’s see what the same offence would have resulted in if conducted by a small regulated company (SRC)…

Example – Laundering money for Mexican Drug Cartels
Bank’s Penalty – Fine of $1.9 billion. Directors unaffected. Shareholders impacted.
SRC – Directors individually prosecuted with potential prison term of up to two years.

Example – Misselling Insurance
Bank – Substantial fines. Directors unaffected. Shareholders impacted.
SRC – Regulator bans directors for life and revokes company licence.

Example – Contravening International Sanctions
Bank – Fine of $298M. Directors unaffected. Shareholders impacted.
SRC – Directors liable for up to $1M fine and up to 20 years imprisonment.

Example – Intentionally manipulating financial markets
Bank – Fined between £400M and $1.5 billion. Chairman resigns. Directors personally unaffected. Shareholders impacted.
SRC – Company closed. Directors fined up to $1M. Criminal prosecution.

Example – Intentionally manipulating electricity and power markets
Bank – Fined between $470 and $1,500 million. Directors unaffected. Shareholders impacted.
SRC – Company closed. Directors fined up to $1M. Criminal prosecution.

Violating Antitrust laws
Bank – fined EUR385 million. Directors unaffected. Shareholders impacted
SRC – Directors fined $350,000 personally and up to 3 years imprisonment. Company closed down.

Time to think again?

Guest Post: Patrick Barron on Gold vs The Dollar

Is Gold or the Dollar Overvalued?

by Patrick Barron

A recent bulletin from a major Swiss Bank argues that the price of gold has never been higher, that its price has peaked, that the run up was driven by fear, that fear is now waning and it is time to sell gold.

The problem with comparing the price of gold in dollar terms today and its price in the past is that it ignores dollar inflation.  The price of gold today is around $1,600 per ounce.  It peaked in dollar terms roughly a year ago at just under $2,000 per ounce.  Prior to the recent run up, the peak price of gold at year-end occurred in 1980 at $612 per ounce.  So, let’s look at the price of gold today, taking into account dollar inflation since 1980.

First let’s look at the government’s own Consumer Price Index.  In December 1980 the CPI stood at 86.3.  In January 2013 it was 230.3. (This is hardly believable; i.e., that prices have gone up only 2.7 times since 1980.)  Nevertheless, adjusting for the CPI increase since 1980, the price of gold today should be $1,633…about where it is right now.

But now let’s look at inflation of the money supply.  In 1980 M1 was $.420 trillion and M2 was $1.605 trillion.  As of January 2013, M1 is $2.470 trillion and M2 is $10.445 trillion.  So, taking into account the great inflation in M1 and M2, the price of gold should be either $3,600 per ounce (M1 equivalence) or $3,983 per ounce (M2 equivalence) for the price of gold, IN DOLLAR TERMS, to match its price at year-end 1980.

Another way to look at the relationship between the dollar price of gold and dollar inflation is to calculate gold’s dollar coverage price; i.e., for the Fed, which owns 262 million ounces of gold, to back the dollar in gold and make it truly redeemable, it would be forced to set the price at either $9,427 per ounce (M1) or $39,866 per ounce (M2).  In other words, any lower price the Fed would not be able to redeem all of its dollars.

One last thing.  In 1980, Paul Volcker was clamping down on the US money supply and would drive interest rates to over 20%.  Ronald Reagan continued the Carter deregulation policies, and he reduced taxes and slowed government spending.  The forces that drove the price of gold to $612 in 1980 were arrested by the policies of Paul Volcker, Ronald Reagan, and, to some extent, by Jimmy Carter.  But today government is pursuing the opposite of all four of these beneficial policies.  It is pursuing the same policies that drove the price of gold to its previous peak in 1980, but there are no politically powerful voices advising monetary restraint.

So, which is overvalued today–gold or the dollar?

Guest Post: Emile Woolf on EU Membership

EU membership, in or out? Think it through but tread warily

“Expert” is defined as a  person whose research, knowledge and experience accords them the respect of  their peers in a well-distinguished domain.

Economics is just such a domain, yet the degree of diversity in the views of  so-called experts can be astonishing. Take one of today’s most topical issues: will a UK exit from the EU be a blessing or a disaster? Those who take the former position point to a saving for the exchequer of some £8 billion each year; a return to sovereign integrity and the restoration of democratic self-determination in all areas of national life.

At the other extreme are experts who cite, with equal relish, UK/ EU trading statistics, concluding that the loss of trade following a UK exit would induce a spiral of decline and years of irremedial economic gloom.

Who should we trust? Since criteria defining an expert include “experience”, and since unilateral exit from the EU has never been experienced, reliance on basic common sense may be preferred to any feigned expert opinion.

What does common sense tell you about the following opinion of a leading EU motor industry chief? “All trading countries should have their sovereignty, but don’t even discuss leaving a trading partner to whom 50% of your exports go. That would be devastating for the UK economy.”

This expert’s assertion is widely shared, but it is flawed. “Trading countries” is a contradiction in terms. Nations do not trade. People and businesses trade.  A trade in goods or services occurs when, and only when, the most that a buyer is prepared to pay exceeds the least that a seller will accept. In such circumstance a price will be struck.

The buyer expects the goods to be of merchantable quality, and the seller expects to be paid in a currency whose purchasing power can be trusted to endure. Thus it is and always will be. Free trade is human nature, and the only thing  governments do is get in the way, either by imposing quotas and embargos, or by debasing the currency.

Free trade – that’s what really matters

There is nothing EU membership can bestow that free trade does not already guarantee. But currency debasement, now so prevalent that it passes as policy, will hinder free trade as surely as any embargo. Actions now pursued by central banks everywhere rely on the impossible notion that a weak currency is a good thing because it will induce an export-led revival, ignoring the corollary that there must always be an importer at the other end.

This ludicrous race-to-the-bottom is self-defeating. Everyone else is also flooding the bond markets with newly-printed fiat money, carrying the inescapable consequences of inflation and higher production costs. This internal transfer of wealth is a theft suffered by each country’s own citizens.

The endgame being played out in many troubled EU states  is closing in. Germany is the exception, but for how long will a thriving economy allow a bunch of blunderers control its currency? Berlusconi’s come-back plea to the European Central Bank is “to act like a real central bank and therefore print money – or we shall be forced to leave the euro and return to our own currency!”

And Spain? Right now the only buyers of its government’s debt are the pension funds of its own state workers. Talk about the snake eating its own tail.

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Emile Woolf: teacher, lecturer, best-selling author of professional texts, practising accountant, forensic expert witness and, throughout this period, one of the profession’s most widely read columnists and magazine journalists. His subject range includes the wider spectrum of economics, taxation and any related developments that have a financial dimension, always seeking to identify the principle that lies behind the dilemma.

www.emilewoolfwrites.co.uk

History Repeats Itself

I recommend to commodity friends a book by Anthony Capella called “The Various Flavours of Coffee“.

The book is a novel set around the turn of the 20th century in the coffee industry as the coffee market was transformed from a luxury product drunk in coffee houses and upper income households to a drink available to every family, packaged ground in packets and vacuum tins.

The resultant huge demand led to a massive increase in planting in Brazil and other countries in South America, leading to enormous investment in infrastructure, railways and roads to transport the coffee to ports. Prices soared, stimulating ever more cultivation and production until by the Great War coffee was in huge surplus. The market was flooded with coffee that was produced on plantations where the decision to plant was taken 3-4 years earlier. Brazil tried to control production by paying farmers to destroy bushes and buying up surplus beans to dump at sea, but corruption led to the coffee being taken out of sight of land, loaded onto freighters and shipped to Arabia, where it was relabelled as Mocca and shipped to Europe. It was cheap for Mocca but a higher price than Brazilian.

Which leads me to Copper and other metals where the decision to produce more was taken at a time of high prices some years before the global recession. It is difficult to stop or reduce production, and indeed why would producers want to stop when prices are maintained at artificially high levels by vested interests storing over-production and making it unavailable to the market?

No such intervention has ever succeeded. Have a cup of coffee and think about it…

Guest Post: Patrick Barron on Junk Bonds

How many Fed economists does it take to screw in a lightbulb?

Re: Fed Governor Raises the Spectre of a Bubble in Junk Bonds (New York Times 7 February 2103)

So the Fed thinks that it just might be possible that its unprecedented bond buying programs will cause a bubble in junk bonds.

How many Fed economists does it take to screw in a light bulb?  And will the light actually come back on with a new bulb installed?  If you are a Fed economist, these things must be tested and tested and tested and….

When the Fed finds evidence of such a bubble, of course it will be too late.  And if it takes regulatory action to prevent its base money production from going into junk bonds, the money just will go somewhere else.  It must go somewhere!  Isn’t that the point?

The Fed has no idea what it is doing or what the consequences will be.  Nevertheless, when the markets crash, the Fed will blame everyone but themselves.

Cost of the EU dream: who pays? – Guest Post by Emile Woolf

Relentless pursuit of a fallacious idea is surely a sign of madness. It may begin with a laudable objective, such as a pan-European vision of free trade between nations whose history of animosity threatens to boil over into military warfare. Who would not willingly subscribe to membership of such an association?

The irony of the insidious journey from sensible origins to the EU behemoth with which we are now saddled, is that the nations affected are all democracies. How can free-thinking electorates finish up where none of them actually want to be? Nor ever wanted to be?

What Britain gets out of it is a matter for debate, but the annual monetary cost to UK taxpayers is not: well over £8 billion a year.

Spending our money

The primacy of Parliament’s right to determine how UK taxes are raised and spent was established over 100 years ago. In 1909 Lloyd-George’s “people’s budget” was passed by the Commons, only to be vetoed in the Lords. The Parliament Act of 1911 removed the right of the House of Lords to veto money bills completely, on the grounds that it is not an elected Chamber .

Although members of the European Parliament are “elected” by the voters who turn up, their perceived remoteness from everyday life has resulted in an accountability gulf so wide that “European democracy” has become a contradiction in terms. But there are signs that the default position, of just putting up with spending priorities inflicted by Brussels and Strasbourg, will no longer be tolerated.

The undignified budgetary skirmishes currently being staged have put a spotlight on where taxpayers’ money actually goes. While domestic budgets throughout Europe are being squeezed, EU officials, inhabiting a parallel reality, enjoy immunity without accountability.

Given the chance, who would vote to earmark 40% of the entire budget for a Common Agricultural Policy designed to support farmers, primarily in France? Who would sanction the allocation of half the budget for something called “Smart and inclusive growth”? Unravel the euphemism and you find that these funds support the EU’s poorer regions, including poorer regions of the richest countries. For example, Brussels has poured billions into the Calabria region of Southern Italy, much of which now seems to have found its way into the pockets of the mafia.

And what do the 3,325 eurocrats, whose salaries exceed that of our Prime Minister, actually do? Could European taxpayers survive without them?

The big question

How did the EU become an autonomous hegemony in its own right? Why do national leaders repeatedly submerge their own countries’ independence with cries for “solidarity” behind the European cause, when pursuit of that cause is so ruinous?

When President Hollande urges Chancellor Merkel to subordinate her domestic concerns and “put Europe’s interests first” he is merely deflecting attention away from his own crippling ineptitude. Would a sane leader tackle his country’s deficit by lowering retirement age and raising the top tax rate to 75%?

And Italy’s Monti: “It’s not important to have a limit on the total budget because things are produced more efficiently at the EU level”. Not surprisingly, the main man in Belgium echoes the sentiment: “For me, Europe means more solidarity and prosperity for all Europeans.”

All these puffed up egos are  handsomely remunerated – out of  other people’s taxes. Only the recognition of that fact will terminate the dream.

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Emile Woolf is a director of Hyperion Insurance Group

emilewoolfwrites.co.uk

Simon Hunt: Letter to the Editor (FT)

Simon Hunt writes:

We read with indifferent interest the piece in yesterday’s FT about miners cancelling/postponing mega-projects. The article gave the impression that this development will lead to future shortages and higher prices a view that the FT’s commodity editor seems to hold.

We thus sent this letter to the editor to balance the views expressed in that article, which has not and probably will not be published for obvious reasons since reality is quite different to the views of the paper

The Editor

The Financial Times

5^th November 2012

Dear Sir

I refer to your article on “Miners are digging a big hole by delaying mega-projects” written by your Commodities Editor.

Whilst not exactly saying so, the impression given is that because of delaying or cancelling mega-projects there will be a shortage of future global metal supplies to meet consumption.

This is very unlikely to be the case for the following reasons and I refer particularly to copper.

Future global growth will be slower than in the past twenty years. This will be because the Western World’s baby-boomers, who were the large spenders, have mostly passed the age of 55 when they begin to save more for their impending retirement. It will be also because post credit crises’ growth slows sharply, as the OECD, BIS, Rogoff/Reinhardt and others have shown.

China’s economic growth has benefited from a labour force which grew by 8.4% in the last ten years but will start falling next year (some Chinese demographers say it began falling this year) and should decline by 5.4% in the coming ten years according to well-regarded demographers like Dr Clint Laurent of Global demographics, supported by senior demographers in China. Using the classic matrix of working age of a population, propensity to employ and productivity, China’s trend growth over the coming ten years should about halve compared with the reported 10% or so of the last ten years.

Not only will China’s growth rate slow appreciably, but its GDP mix should change from dependence on exports and investment towards consumption. This will mean a greater focus on light industry than on heavy, thus one that will be less metals’ intensive.

Your correspondent follows the line given by analysts and others when talking about “demand”. There are, in fact, two forms of demand, material which goes into a furnace and material which is bought by the financial community, mostly warehoused outside the reporting system. Stripping out the latter, world refined consumption has grown by an average of 2.1% a year from 2000 to 2010. This compares with a growth of 2.4% a year in the 1990s.

Copper’s intensity of use is falling because of substitution in its broadest sense – this is not just the replacement of one material by another, but by ‘making more with less’ through improved fabrication techniques and better designs, using lower copper containing alloys and the introduction of new technologies. And it is the latter which will become increasingly important over the coming decade. Thus, world refined copper consumption is very likely to grow even slower than it has done over the past twenty years. In sum, there will be no shortage of copper for many, many years.

The activities of the financial community and others in acquiring copper for whatever purpose will not be a permanent feature of the financial landscape. The day will come when the financial community will want cash in return for their investments just as they did in the early 1980s. It is then that the immutable law of supply and demand will prevail on prices, not, as is the current dynamic, of copper being used as part of the money game.

For those who believe that prices always revert to the mean it is worth remembering that the average copper price since 1900 to 2010 in 2010 US dollar terms was $5100 and  from 1990-2010 was $4100. History shows too that when prices explode above the mean they collapse below it before reverting back to the mean.

These are powerful reasons why miners should be cancelling or postponing mega-projects and are wholly within the interests of their shareholders.  Without the support of the financial community in buying up most of the global surpluses of copper, prices would be nowhere where they are today, which makes many projects that have been considered recently unattractive.

Simon Hunt

A News Article from the Future

LME Week 2018

HONG KONG The first LME week in the exchange’s new home has been a spectacular affair with the highest attendance in recent memory!

In his address to guests at the LME dinner at The Hong Kong Jockey Club, the Chief Executive of the LME, Duncan Quek, strongly defended the somewhat controversial decision to move the exchange from its 140 year home in London to new premises in Hong Kong, (six years after the LME was taken over by the Hong Kong Stock Exchange).

“ The LME was established in 1877 to act as a mechanism to allow the British manufacturing industry to source and efficiently price the metals that were the life blood of the British economy.  As the industrial might of Europe and North America developed, along with advances in communication, the LME became an Atlantic centric market in the 19^th and 20^th Centuries.

Now, in the second decade of the 21^st century, it is the Pacific economic area which is in a modern Industrial revolution. Today, most of the metals the LME trades are produced and consumed in the Pacific area: Australia, Chile, China, Indonesia, Japan and Korea (to name a few).

 It is the Pacific area that requires a mechanism to price and allocate metals efficiently and it is vital that the market should be close to its main users.

No longer will the metal trader, purchasing manager or smelter operator have to be a nocturnal creature, (having to wait until London opens and the LME rings to begin), to enable sufficient liquidity for them to hedge. 

Now the LME is Pacific orientated, our stakeholders can hedge whenever they want to,  with enough liquidity for them to do so without them burning the midnight oil.

Some say I have destroyed a 140 year institution. I say the institution is still the same, as it continues to perform the function it was designed for. You could say that we have brought the market back to its true roots through servicing the needs and requirements of the manufacturing and mining industries.

All we have done is moved to a new home with a more agreeable climate.”

 The climax of the historic evening was a spectacular fireworks display, broadcasting the old and revered institution to its new location.

Guest Post: Godfrey Bloom on Regulation

One of the great regulatory myths is there was not enough of it.  Only someone who has not worked in financial services for some time in a senior appointment could possibly believe this.  There are 4 million words in the regulatory hand book.

I tried to explain to Francis Maude in 1986 that his concept of regulation was doomed to failure because it was prescriptive and therefore backward looking – doomed in the fast moving world of financial services.  It was, in the main, a political knee jerk reaction to the Barlow Clowes scandal, which was a criminal scam.  No amount of regulation would have prevented it.

There has, of course, been scandal after scandal, from Equitable Life to the 2008 banking crisis.  The UK Financial Services Authority (previous authorities being IMRO, PIA, LAUTRO, FIMBRA) was destined to fail.  Staffed by incompetents and led by people with no serious experience in the field of financial services, the most recent being Lord Turner as chairman.  The current CEO is a lawyer and most staff have no financial qualifications at all.  The whole concept is devolved by an enabling act, the principles of English Law have been abandoned for a box ticking exercise – a fast track to disaster – and now Brussels want to give us more boxes to tick.  Yes, those people who gave us the Common Agricultural and Fishing Policy, not to mention the obviously suicidal energy policy!

The point is that no regulation of any market is possible without perfect knowledge.  This is, of course, impossible.  So best practice, common law and caveat emptor are the only possible ways to regulate financial services.  I explained this patiently to Francis Maude, but being a politician the urge to “do something, anything, and be seen to do so” was too strong.

Yet none of this is even relevant.  We have a banking system known as fractional reserve, which means banks can lend money they do not have, backed by a central bank with political masters which can print money and ultimately lay the responsibility on the tax payer.  None of this is being addressed.  Until we return to redeemable money, or hard money if you will, with artificial interest rates controlled by central banks the next disaster will not be far down the road.  Indeed it is already formulating.

The Economic and Monetary Affairs Committee members mean well and work very hard, but they are trying to perfect a ‘concrete aeroplane’. No amount of hard work or goodwill can make up for the fact the venture will again end in tears.

Guest Post: Simon Hunt on China

ECONOMIC & COPPER ADVISORY SERVICES

VISIT REPORT TO CHINA: Our main conclusions.

 The good news is that consumption is holding up quite well especially the services sector. The latter is able to absorb the layoffs from manufacturing and the heavy industries’ sectors. The State Council has just announced measures to prioritise the sector’s development, an indication of how their advisors see the importance of this sector to future growth.

 Middle class urban consumers are spending more on leisure activities and travel than on buying goods like appliances. For instance, it is virtually impossible to get a ticket to travel within China during the holiday period.

 The bad news is that there are no signs of recovery in either heavy industry or manufacturing. Current production for many sectors is down 20-30% YoY with capacity utilisation below 50% in many cases.

 Surplus capacity is endemic and getting worse. Restructuring will be a primary focus for the new leadership. Meanwhile, margins are under pressure; production is low and inventories are at extraordinary high levels for most.

 In fact, inventories have become a heavy burden to company cash flows, to the economy and solvency issues. Take one simple example. We visited a power cable with an experienced international cable executive. Stocks of drummed cable were everywhere. Other sources indicated that this was germane to the sector and not an isolated case. We calculated that cable makers were financing some US$5bn of cable, or in other words, the banks were. And this is just one example.

 Many companies both in the SOE and SME sectors are being kept alive by banks rolling over loans and extending even more credit to them. This is part and parcel of a policy to put the bad news into a back drawer until the months of political transition are over – the second quarter of 2013.

 In an earlier note we stated that steel traders in Fujian province would default on some RMB200bn of loans. Banks have been instructed to roll them over, another example of putting bad news in a back drawer.

 Real GDP will continue to be weaker than the reported data will show. The latter will probably show that third quarter GDP grew by around 7.8% and fourth quarter 8%, whilst the former should be around 5% and 6% respectively.

 There is unlikely to be any measures announced over the holiday period to stimulate the economy. Enough has been done to stabilise growth mostly on consumption.

 The PBOC continues to operate a prudent monetary policy. Its credit injections are designed to support banks which have to roll over non-performing loans – which have become significant – and not to stimulate the economy and to meet households cash demands for the holiday week. Moreover, sane banks don’t want to borrow short and lend long.

 Many companies are using any means they can to take high inventories off their balance sheets, such as by pushing their surplus stocks into the distribution channels with the offer of 180/360 day credits – which will probably be rolled over if necessary.

 Slower growth has relieved some of the shortage in the labour force; it is not as tight as it was at the end of last year. This will only be a temporary reprieve since the labour force starts falling next year.

 FAI projects which have been announced have clear objectives – to add real value to the economy and to assist in restructuring industry. Local governments are trying to get their own pet projects off the ground but will probably fail because they won’t be able to finance them.

 The leadership transition is difficult and messy. All of the pieces on the chessboard are not yet in place.

 Driving future growth are the changing demographics. These have acted as a bonus to growth, but have now become a penalty. Forget 10% a growth; think more like 4-5% and then think of the implications for imports of raw materials etc.

 In short, the incoming leadership will have a full hand of important problems to deal with at a time when global growth will be slow if at all.

 A critical turning point has arrived in modern Chinese history, dictated by changing demographics. Not only is the labour force starting to fall – by over 16% over the next twenty years – but it is a society which is aging rapidly. The old cliché that China will grow old before it becomes rich will probably be right.

 This is why the incoming leadership has critical challenges to face. We believe that they are prepared to so do and to “bear the pain” if necessary.

 How their international relationships play out is difficult to envisage. The PLA, for instance, have been trained to fight. As they have no battles to face, they have become a frustrated fighting force.