Category Archives: finance

Direct Action

It has been a very long time since there has been a post here on the Stubborn Mule. Even now, I have not started writing again myself but have the benefit of a return of regular guest poster, James Glover.

This is a post to explain the Australian Government’s policy called “Direct Action”. I will spare you the usual political diatribe. So here is how it works. The government has $3bn to spend on reducing carbon emissions. At a nominal cost of $15/tonne that could be 200m tonnes of Carbon.

Okay so how does it work? The government conducts a “reverse auction” in which bidders say: “I can reduce carbon emissions by X tonnes at a cost of $Y per tonne”. You work out what is the biggest reduction for the least cost. You apportion that $3bn based on the highest amount of carbon reduction. Easy peasy. That $3bn comes from government spending so ultimately from taxpayers. [Editor’s note: while not directly relevant to the direct action versus trading scheme/tax discussion, I would argue in true Modern Monetary Theory style that the Australian government is not subject to a budget constraint, beyond a self-imposed political one, and funding does not come from tax payers].

As our new PM Malcolm Turnbull says why should you have a problem with this? There is a cost and there is a reduction in carbon emissions. There will always be a cost associated with carbon reduction regardless of the method so what does it matter if this method isn’t quite the same as a Carbon Pricing systems previously advocated by the PM and his Environment Minister Greg Hunt? As long as there is a definite amount, Xm tonnes reduced.

Well here are a few thoughts:

1. if a company is currently making a profit of, say, $500m a year, producing electricity using coal fired power stations then why would they participate in this process? There is no downside. Maybe.

2. Okay it is a bit more subtle than that. Suppose the difference between the cost of producing electricity using coal or renewables works out at $15 a tonne. You might reasonably bid at $16/tonne. In reality there is a large upfront cost of converting. There is a possibility that an alternative energy provider takes that $15/tonne and uses it to subsidise their electricity cost. That could work. That encourages a coal based provider to move to renewables. But so might a coal based electricity provider at $14/tonne to undermine them. What we call a “race to the bottom”.

3. It seems to be an argument about who exactly pays for carbon pollution. Well here is the simple answer: you pay. Who else would? And you pay because, well, you use the electricity.

4. There is no easy answer to this. Which approach encourages more electricity providers to move to renewables? That is hard to say. Every solution has its downside. I decided while writing this I don’t actually care who pays. As long as carbon is reduced.

I started out thinking Turnbull was just using the excuse “as long as it works who cares?” but I have moved to the view that it doesn’t matter. All carbon reduction schemes move the cost onto the users (of course). There are many subtleties in this argument. I personally think a Cap and Trade system is the best because in a lot of ways it is more transparent. But in the end, as PM Turnbull says who cares, as long as carbon is reduced. Presumably as long as that is what really happens, eh?

Getting Australia Post out of the red

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John Carmody returns to the Mule in his promised second guest post and takes a close look at Australia Post’s profitability with some (ahem) back-of-the-envelope calculations.

There are many forms of communication which underpin the function and productivity of a modern society like Australia. Despite the Cassandra-commentary from Mr Ahmed Fahour (the well-paid CEO of Australia Post), regular mail delivery certainly remains one of them.

In making his tendentious, but opaque, points, he has not been entirely frank with the community. He has, for instance, claimed that 99% of our mail is electronic. That assertion is meaningless because so much e-mail is advertising, brief inter- or intra-office memos and notices, or quick substitutes for telephone calls. When these are removed from the calculation, the importance of “hard mail” becomes more obvious

The data which the Herald has published (for instance, “Please Mr Postman: snail mail doomed to disappear“, 14 June) also show how shallow or formulaic Mr Fahour’s thinking seems to be. In 2012-13 Australia Post made an after-tax profit of $312 million and if there had been no losses on the handling of letters, that would have been $530 million. Do Australians really want a profit of that magnitude from such a vital national service?

But when one looks at that “letter-loss” a little more closely and at the figure of 3.6 billion letters delivered that year, it is clear that the loss per letter was 6.5 cents. In other words, if instead of recently increasing the cost of a standard letter to 70 cents, this had been to 75 cents, the losses would have been comprehensively dealt with.

Some comparisons might be informative. The British Royal Mail currently charges about $A1.10 for delivery of a standard (20g) letter for next-day delivery within the UK (its “aim”) and $A0.95 if you’re happy for delivery within 3 days. The Deutsche Post charges the equivalent of 86 Australian cents for delivery within Germany but about $A1.08 cents to adjacent France. Given that we currently pay only 70 cents for delivery across a far larger area, my suggested price of 75 cents seems reasonable and justified.

Government spending

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Before, during and after this month’s budget, Treasurer Joe Hockey sounded dire warnings about Australia’s “budget emergency”. Amidst this fear-mongering, it was a pleasant relief to come across a dissenting view. In a recent interview on 2SER Dr Stephanie Kelton (Department of Economics at the University of Missouri in Kansas City) argued that the government budget is very different from a household budget, however appealing that analogy might be. Governments like the Australian government, with its own free-floating currency can spend more than they take in taxation without worrying about running out of money. While the economy is weak, the government can comfortably run a deficit. The constraint to worry about is the risk of inflation, which means curbing spending once the economy heats up.

I posted a link to Facebook, and immediately drew comment from a more ~~conservatively~~ libertarian-minded friend: “of course a deficit is a bad thing!”. Pressed for an explanation, he argued that government spending was inefficient and “crowded out” more productive private sector investment. This did not surprise me. Deep down, the primary concern of many fiscal conservatives is government spending itself, not a deficit. This is easy to test: ask them whether they would be happy to see the deficit closed by increased taxes rather than decreased spending. The answer is generally no, and helps explain why so many more traditional conservatives are horrified by the prospect of the Coalition’s planned tax on higher income earners….sorry, “deficit levy”.

From there, the debate deteriorated. North Korea was compared to South Korea as evidence of the proposition that government spending was harmful, while a left-leaning supporter asked whether this meant Somalia’s economy should be preferred to Sweden’s. Perhaps foolishly, I proffered a link to an academic paper (on the website of that bastion of left-wing thought, the St.Louis Fed) which presented a theoretical argument to the “crowding out” thesis. My sparring partner then rightly asked whether the thread was simply becoming a rehash of the decades old Keynes vs Hayek feud, a feud best illustrated by Planet Money’s inimitable music video.

Macroeconomic theory was never going to get us anywhere (as I should have known only too well). Instead, the answer lay in the data, with more sensible examples than North Korea and Somalia. Aiming to keep the process fair, avoiding the perils of mining data until I found an answer that suited me, here was my proposal:

I’m going to grab a broad cross-section of countries over a range of years and compare a measure of government expenditure (as % of GDP to be comparable across countries) to a measure of economic success (I’m thinking GDP per capita in constant prices).

If indeed government spending is inherently bad for an economy, we should see a negative correlation: more spending, weaker economy and vice versa. My own expectation was to see no real relationship at all. In a period of economic weakness, I do think that government spending can provide an important stimulus, but I do not think that overall government spending is inherently good or bad.

The chart below illustrates the relationship for 32 countries taken from the IMF’s data eLibrary. To eliminate short-term cyclical effects, government spending and GDP per capita (in US$ converted using purchasing power-parity) was averaged over the period 2002-2012.

The countries in this IMF data set are all relatively wealthy, with stable political structures and institutions. All but one is classified as a “democracy” by the Polity Project (the exception is Singapore, which is classified as an “anocracy” due to an assessment of a high autocracy rating). This helps to eliminate more extreme structural variances between the countries in the study, providing a better test of the impact of government spending. Even so, there are two outliers in this data set. Luxembourg has by far the highest GDP per capita and Mexico quite low GDP per capita, with the lowest rate of government spending.

The chart below removes these outliers. There is no clear pattern to the data. There is no doubt that government spending can be well-directed or wasted, but for me this chart convincingly debunks a simple hypothesis that overall government spending is necessarily bad for the economy.

Now look for the cross (+) on the chart: it is Australia (IMF does not include data for New Zealand and we are the sole representative of Oceania). Despite Hockey’s concerns about a budget emergency, Australia is a wealthy country with a relatively low rate of government spending. Among these 30 countries, only Switzerland and South Korea spend less. These figures are long run averages, so perhaps the “age of entitlement” has pushed up spending in recent years? Hardly. Spending for 2012 was 35.7% compared to the 2002-2012 average of 35.3%. The shift in the balance of government spending from surplus to deficit is the result of declining taxation revenues rather than increased spending. Mining tax anyone?

Can I trust MtGox with my passport?

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In March 2013, the US Financial Crimes Enforcement Network (“FinCen”) published a statement saying that companies which facilitate buying and selling of “virtual” currencies like Bitcoin constitute “money service businesses” and are subject to reporting obligations designed to prevent money laundering and other financial crimes.

A couple of months later, the seizure by US authorities of Liberty Reserve has shaken money service businesses around the world, whether they deal in “real” or “virtual” currencies.

Two days later, the largest Bitcoin exchange, MtGox, tightened their anti-money laundering (AML) controls, posting the following statement on its website:

Attention Users: From May 30th 2013 all withdrawals and deposits in fiat [real] currency will require account verification. However withdrawals and deposits in Bitcoin (BTC) do not require verification.

What MtGox is attempting to do here is meet one of the most fundamental requirements of AML legislation around the world: know your customer. It is so fundamental that it too earns its own three-letter abbreviation, KYC.

So, how does an online business like MtGox verify the identity of its customers? After all, you can’t walk into the local MtGox branch with a fist full of paperwork. Instead, you must upload a scan of “proof of identity” (passport, national ID card or driver’s licence) and “proof of residency” (a utility bill or tax return).

MtGox are not alone in this approach. More and more online money service businesses are attempting to get on the right side of AML rules by performing verification in this way.

Here in Australia, there are still some Bitcoin brokers which do no verification whatsoever, including BitInnovate (who helped me buy my first Bitcoin) and OmniCoins. Australia’s AML regulator, AUSTRAC publishes a list of “designated services”, which make business subject to reporting obligations including customer verification. The list includes

exchanging one currency (whether Australian or not) for another (whether Australian or not), where the exchange is provided in the course of carrying on a currency exchange business

So I strongly suspect that all local Bitcoin brokers too will soon be demanding scans of your driving licence and electricity bill.

But is the MtGox approach to customer verification a good idea? I don’t think so. I believe it is a bad idea for MtGox and a bad idea for their customers.

It is a bad idea for MtGox because scans of fake identity documents are very easy to come by. For example, one vendor at the online black market Silk Road offers custom UK passport scans with the name and photo of your choice, complete with a scan of a matching utility bill.

It’s a bad idea for the customer too, because it exposes them to increased risk of identity theft. Although my intentions were not criminal, I chose BitInnovate when I bought Bitcoin precisely because I did not have to provide any personal documents. How well do you know MtGox or any other online money service? How confident are you that they will be able to keep their copies of your documents secure? Securing data is hard. Every other week it seems that there are stories of hackers gaining access to supposedly secure password databases. I have no doubt that scans of identity documents will also find their way into the wrong hands.

So what is the alternative?

Third party identity management.

Using a passport or driver’s licence scan is effectively outsourcing identity verification to the passport office or motor registry respectively. Before the days of high quality scanning and printing, these documents were difficult to forge. A better solution is to retain the idea of outsourcing, but adapt the mechanism to today’s technology.

Here’s how it could work.

A number of organisations would establish themselves as third party identity managers. These organisations should be widely trusted and, ideally, have existing experience in identity verification. Obvious examples are banks and government agencies such as the passport office.

Then if I wanted to open an account with MtGox, its website would provide a list of identity managers it trusted. Scrolling through the list, I may discover that my bank is on the list. Perfect! When I first opened an account with my bank I went through an identity verification (IDV) check (ideally, this would have been done in person and, even better, the bank would have some way to authenticate my passport or driver’s licence*), so my bank can vouch for my identity. I can then click on the “verify” link and I am redirected to my bank’s website. Being a cautious fellow, I check the extended validation certificate, so I know it really is my bank. I then log into my bank using multi-factor authentication. My bank now knows it’s really me and it presents me with a screen saying that MtGox has asked for my identity to be validated and, in the process, has requested some of the personal data my bank has on file. The page lists the requested item: name, address, email address and nationality. I click “authorise” and find myself redirected to MtGox and a screen saying “identity successfully verified”.

MtGox is now more confident of my true identity than they would be with scanned documents and I have kept to a minimum the amount of information I need to provide to MtGox: no more than is required to meet their AML obligations.

This authentication protocol is a relatively straightforward enhancement to the “OAuth” protocol used by sites like Twitter and Facebook today. OAuth itself is subject to some controversy, and it may be better to create a new standard specifically for high trust identity management applications like this, but the tools exist to put identity management on a much safer footing.

* Today, unfortunately, banks and other private sector entities are not readily able to authenticate passports or driver’s licences. Once government agencies are able to provide this service, the options for third party identity management will be even greater.

Unfounded liability

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Today a tweet from “Australia’s most idiosyncratic economist” Christopher Joye caught my eye. I followed the link and found a scaremongering article trying to whip up concerns about Australia’s levels of government debt.

A key part of Joye’s argument is to accuse the government of creative accounting by including Future Fund assets in the calculation of net debt. Carving out these assets, along with some other tactics, leads him to assert that the true size of the government’s debt is around 40% not 11% of GDP. But it is Joye’s accounting that is flawed, not the government’s.

Joye’s argument centres on the notion that government pension obligations to public sector employees constitute an “unfunded liability”. Unlike other liabilities, i.e. government bonds, this liability is not included in the calculation of the government’s debt, thereby understating it. To remedy this, Joye argues that the calculation can be corrected by noting that the Future Fund was created with the precise purpose of funding these liabilities, so excluding them from the net debt calculation addresses the omission of the unfunded pension liabilities.

Superficially, this argument can sound plausible. But, closer scrutiny shows that Joye is cherry-picking to distort the numbers.

Analogies between government and household finances can be dangerous, but I will cautiously draw one here to illustrate the point. Imagine a family with a $300,000 house financed with a $200,000 mortgage, a net asset position of $100,000. Over time, the family works to save and pay down the mortgage. But they also want their daughter to attend a private high school and have been putting money aside into a saving fund to be able to afford the fees. A few years later, the debt has been paid down to $175,000 and they have put $25,000 into the school fund. So how does the family balance sheet look now? Assuming that property prices are unchanged, the family has assets of $325,000 (house and saving fund) and a debt of $175,00, so net assets of $150,000.

Not so fast, Christopher would argue! Those school fees are an unfunded liability! Since the school fund is there solely to fund that liability, it should be excluded, so the family only has assets of $125,000.

It’s nonsense of course. A commitment to pay pensions (or school fees) is a liability of sorts, in that in entails a commitment to making payments in the future. But why stop there? The government is also committed to making welfare payments, so there’s another unfunded liability. We can ignore the baby bonus, as that’s likely to be eliminated, but the government has a whole range of commitments for future payments.

But that ignores all the sources of future receipts for the government. If public pensions are an unfunded liability, what about the unfunded asset represented by all future income tax receipts? Corporate taxes provide another solid income stream, not factored into the governments assets.

The family’s school fees are a liability of sorts, but their capacity to earn income into the future effectively provides an even greater asset. Both are uncertain, which is why accountants stick to financial assets, like loans, bonds and deposits or even stocks, land or houses, all of which have a relatively clear value today and, more importantly, can be bought or sold for figures very close to those assessed values.

Christopher Joye drastically overstated the government’s net debt position by factoring in future government payments and ignoring future government receipts. As the less “idiosyncratic” economist Stephen Koukoulas eloquently put it:

This is like painting a red dot on a daddy long legs and telling people it is a redback spider.

Bitcoin: what is it good for?

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Bitcoin has been a hot topic in the news over the last few weeks.

The digital currency has its adherents. The Winklevoss twins, made famous by the movie Social Network after suing Mark Zuckerberg for allegedly stealing the concept of Facebook, now purportedly own millions of dollars worth of Bitcoins.

It also has its detractors. Paul Krugman has argued that the whole enterprise is misguided. Bitcoin aficionados are, he writes, “misled by the desire to divorce the value of money from the society it serves”.

Still others cannot seem to make up their mind. Digital advocacy group, Electronic Frontier Foundation (EFF) accepted Bitcoin donations for a time, but became uncomfortable with its ambiguous legal status and shady associations, such as with the online black market Silk Road, and decided to stop accepting Bitcoin in 2011. A couple of years on and the EFF’s activism director is speaking at a conference on Bitcoin 2013: The Future of Payments.

Recent media interest has been fuelled by the extraordinary roller-coaster ride that is the Bitcoin price. In early April, online trading saw Bitcoins changing hands for over US$200. At the time of writing, prices are back below US$100. As with many markets, it’s hard to say exactly what is driving the price. Speculators, like the Winklevoss twins, buying Bitcoins will have helped push up prices, while reports that Silk Road has suffered both a deflation-driven collapse in activity and hacking attacks may have contributed to the down-swings.

Although not obvious on the chart above, dramatic price movements are nothing new for Bitcoin. Switching to a logarithmic scale makes the picture clearer. After all, a $2 fall from a price of $10 is just as significant as a $40 fall from a price of $200. The 60% fall from $230 to $91 over April has certainly been dramatic. But back in June 2011, after reaching peak of almost $30, the price fell by 90% within a few months.

The volatility of Bitcoin prices is orders of magnitude higher than traditional currencies. Since the start of the year the price of gold has been tumbling, with a consequent spike in its price volatility. Even so, Bitcoin’s volatility is almost ten times higher. The chart below compares the volatilities of Bitcoin, gold and the Australian dollar (AUD).

A week or so ago, armed with this data, I was well advanced in my plans for a blog post taking Bitcoin as the basis for a reflection on the nature of money. I would start with some of the traditional, text-book characteristics of money. A medium of exchange? Bitcoin ticks this box, with a growing range of online businesses accepting payment in Bitcoin (including WordPress, so not just underground drug sites). A store of value? That’s more dubious, given the extremely high volatility. It may appeal to speculators, but with daily volatility of around 15%, it’s hard to argue that it is a low risk place to park your cash. A unit of account? Again, the volatility gets in the way.

That was the plan, until a conversation with a colleague propelled me in a different direction.

She asked me what this whole Bitcoin business was all about. Breezily, I claimed to know all about it, having first written about Bitcoin two years ago and then again a year later. I launched into a description of the cryptographic basis for the operation of Bitcoin and went on to talk about its extreme volatility.

I then remarked that when I first wrote about it, it was only worth about $1, but had since risen to over $200.

“So,” she asked, “did you buy any back then?”

That shut me up for a moment.

Of course I hadn’t bought any. What gave me pause was not that I had missed an investment opportunity that would have returned 20,000%, but that I was so caught up in the theory of Bitcoin that it had not occurred to me to see what transacting in Bitcoin was actually like in practice. So I resolved to buy some.

This turned out not to be so easy. While there are many Bitcoin exchanges, paying for Bitcoins means jumping through a few hoops. Perhaps because the whole philosophy of Bitcoin is to bypass the traditional banking system. Perhaps because banks don’t like the look of most of them and will not provide them with credit card services. Whatever the reason, your typical Bitcoin exchange will not accept credit card payments. Many insist on copies of a passport or driver’s licence before allowing wire transactions, neither of which I would be prepared to provide.

Eventually I found BitInnovate, which allows the purchase of Bitcoin through Australian bank branches. Even so, the process was an elaborate one. After placing an order on the site, payment must be made in person (no online transfers), in cash, at a branch within four hours of placing the order. If payment is not made, the order is cancelled. Elaborate, but manageable, and no identification is required.

But before I could proceed, I had to set myself up with a Bitcoin wallet. As a novice, I chose the standard Bitcoin-Qt application. I downloaded and installed the software, and then it began to “synchronise transactions”. This gets to the heart of how bitcoins work. As a purely digital currency, they are based on “public key cryptography”, which is also the basis for all electronic commerce across the internet. The way I make a Bitcoin payment to, say, Bob is to electronically sign it over to him using my secret “private key”. Anyone with access to my “public key” can then verify that the Bitcoin now belongs to Bob not me. Likewise, the way I get a Bitcoin in the first place is to have it signed over to me from someone else. In case you are wondering what one of these Bitcoin public keys looks like, mine is 1Q31t2vdeC8XFdbTc2J26EsrPrsL1DKfzr. Feel free to make Bitcoin donations to the Mule using that code!

In this way, rather than relying on a trusted third party (such as a bank), to keep track of transactions, the ownership of every one of the approximately 11 million Bitcoins is established by the historical trail of transactions going back to when each one was first “mined”. Actually, it’s worse than that, because Bitcoin transactions can involve fractions of a Bitcoin as well.

So, when my Bitcoin wallet told me it needed to “synchronise transactions”, what it meant was that it was about to download a history of every single Bitcoin transaction ever. No problem, I thought. Two days and 9 gigabytes (!) later, I was ready for action. Now I could have avoided this huge download by using an online Bitcoin wallet instead, but then I would have been back to trusting a third party, which rather defeats the purpose.

The cryptographic transaction trail may be the brilliant insight that makes Bitcoin work and I knew all about in it theory. But in practice, it may well also be Bitcoin’s fatal flaw. Today, a new wallet will download around 10 gigabytes of data to get started, and that figure will only grow over time. The more successful Bitcoin is, the higher the barrier to entry for new users will become. I suspect that means Bitcoin will either fail completely or simply remain a niche novelty.

Still, it is an interesting novelty, and despite the challenges, I decided to continue with my investigations and managed to buy a couple of Bitcoins. The seller’s commission was $20 and falling prices have since cost me another $20 or so. So, I am down on the deal, but, as I have been telling myself, I bought these Bitcoins on scientific rather than investment grounds.

Of course, if the price goes for another run, I reserve the right to change my explanation.

NDIS and how many disabled people are there anyway?

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Regular guest writer, James Glover, returns to the Mule today to look at the figures behind the proposed NDIS.

The National Disability Insurance Scheme (NDIS) is in the news again. A welcome development for people with disability and their carers and families…and friends and pretty much anyone else who cares about their fellow humans. It is not a platitude to say that disability can strike anyone at any time in their life and the stories of these people are truly moving and shaming, especially as we live in one of the richest countries in the world. Adults who are only provided with two assisted showers a week and parents providing 24/7 care to profoundly disabled children but who cannot afford a new specialised wheelchair because there is limited funding for such things (wheelchairs cost from $500 for the basic models, of which I have two, and range up to $20,000 or more). In August 2011 The Productivity Commission reported on and recommended the NDIS and since then pretty much everyone agrees it is a good idea if we could only agree how to fund it.

So what does it replace? Currently most people with serious disabilities that prevent them from, inter alia, working, can receive the disability support pension (DSP). A small number will have insurance payouts if they were “lucky” enough to to have someone else to blame for their disability. In addition, anyone can receive a rebate on medications in excess of about $1,200 a year and, of course, access to (not quite free) public health care. On top of that, there are concession cards for public transport and a taxi card system which provides half-price taxi fares to partially make up for many disabled peoples inability to use public transport. The DSP does not depend on a specific disability and for a single adult over 21 with no children it is about $19,000 a year. For child under 18 who is living at home it is about $9,000 a year. While this would appear enough to live on (forgetting overseas holidays or a mortgage) most such people rely on additional support services for everything from basic medical equipment to respite for carers. There are currently 820,000 people, about 4% of the population, on the DSP. The Productivity Commission estimates 440,000 people on the NDIS so most of these will not be eligible for the NDIS but may still receive the DSP. People 65 and over of pensionable age are not eligible for the DSP and will not be eligible for the NDIS.

The purpose of the NDIS is to provide funding for care in line with the specific requirements of the recipients, and will mean additional support to the DSP for some. You can read more about it at ndis.gov.au. Unlike the DSP, it isn’t a fortnightly stipend or, like standard disability or employment insurance, a lump sum. The government is planning to roll out pilot programs in many regions in the next few years, aiming for a complete national program by 2018-19. I won’t go into the politics but it seems even politicians can feel shame and bipartisan support for the NDIS is emerging with a good chance of a bill through this parliament in the next few weeks. The total cost of the NDIS is often quoted as $18bn a year. Some funding is proposed from an additional 0.5% to the Medicare levy. Other funding wil come jointly from the federal government and the states. The proposed levy will raise about $3.8bn a year, so nowhere near enough for the full cost. If you subsume the half the DSP cost of $11bn a year that (only) leaves an outstanding amount of $8-10bn a year to be funded even with the Medicare Levy. Hopefully with bipartisan support the full NDIS will be implemented sooner rather than later.

So that’s the background on the NDIS. The real purpose of this article though is to consider the question “How many disabled people are there in Australia anyway?”.

Well that’s easy, just read any article on disability–for instance this one by disability advocate and media personality Stella Young–and you’ll be told the answer: 20%. 20%. 20%! I am a huge admirer of Stella Young’s work, so don’t get me wrong if I choose to disagree with her on this. The 20% figure gets quoted so frequently it must be true. Well maybe. People questioning this figure are directed to the 2009 ABS Census report on disability where the self-reported disability figure is 18.1% (+/-1.3%). So a round 20% is not too bad, right? Well like all statistics, the details are important. Firstly this includes people of all ages and, not surprisingly, many more older people have disabilites. From 40% at 65-69 to 88% at 90+. For those under 65 the figure is 13.2%. It increases with age and, in the 45-54 age group, is about the average 18%. Anyway why does it matter if the true figure is overstated? Well one reason is that while there is widespread support for the NDIS, the one concern that keeps coming up is who is eligible.

According to the Productivity Commission report they estimate 440,000 people on the NDIS of whom 330,000 would be disabled, and the rest made up of carers and people on preventative programs.

This report has a deeper analysis, which takes the figures at face value. It also includes breakdowns by disabling condition. I have paraphrased these in the following table based on some of the major causes of disability. And look, there are those perennial favourites of those who think all disabled people are really bludgers: back problems,stress and depression, making up about 18% of the total. Not quite bankrupting the country then.

But what constitutes disability? It is basically a lack of normal activity rather than a set of diseases per se. The ABS report has 5 activity based categories, four of which are based on “restrictions on core activities: communication, mobility, self care”. There are “profound”, “severe”, “moderate” and “mild” levels of disability. A fifth category is “schooling or employment restriction”, but overlaps with the first four. Here is a table with the breakdown by category and age group. Combining those with a core activity limitation with employment/school limitations the figure is 15.3%. The difference between this and the higher self-reported 18% figure I suspect comes from peope who feel a bit crap a lot of the time, but aren’t signficiantly prevented from their activities. So I would estimate the number of disabled people to be more like 15% than 20%. For those under 65 this is 11%. The NDIS has a similar definition but includes social activities as well, but don’t yet provide any breakdowns.

So much for the figures from the ABS, which I think we can all agree are definitive, right? Looking at the ABS figures for this group (under 65) they total 345,000. But wait! The figure of 15.3% is based on a total number of respondents to the census of only 9.5 million people. If the reportage rate was the same as the general population of 22m then there would be about 700,000 severe or profoundly disabled people. But the Productivity Commission only estimates 330,000 or half this number on the NDIS! The alternative to the unlikely event that less than 50% of profoundly or severely disabled people will end up on the NDIS is that the reported ABS figure for people in this category is correct but the rate is wrong. While the overall reportage rate is about 50% it looks like the reportage rate for disabled people in the severe and profound category is closer to 100%. If this was also true for the other categories of disabled people then that suggests that the real rate of disability is less than 9% and maybe as low as 7%. Assuming the reportage rate is the same as the rest of the population, ie 50%, for the other categories then the disability rate might be as high as 13%. So lets split it and say 10%. In any event the widely reported figure of 20% is well above the highest estimates based on the ABS and Productivity Commission data. The real rate of disability is closer to 10% than 20%.

Does it matter? Maybe. If you claim that 20% of the population are disabled, people start quickly calculating that the cost is unsupportable if all of those people are on the NDIS! Which of course they won’t be. Fewer than half of disabled people are already on the DSP. Less than half of those will transfer to the NDIS. Overstating the percentage of disabled people isn’t necessarily a good argument for the NDIS if it reduces support from otherwise sympathetic people.

A final thought: in the large Australian organisation I work for, there are a fair few disabled people, some of whom I think would be categorised as severe. With proper support many disabled people can gain suitable education or training and hence employment and support themselves and contribute to the economic activity of the nation. The more people with disability who are employed the fewer on the DSP or NDIS, the more money for those who really have no choice. Supporting people with disability into employment is as important, in my opinion, as supporting them in living and care through the NDIS.

[This article was rewritten following some comments and some further research. In line with all my articles on Stubbornmule this article is about estimating rough numbers from scarce data “back of the beercoaster” style rather than disability politics, it just happens I have a personal interest in this subject]

Quandl

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I spend a lot of time trawling the internet for data, particularly economic and financial data. Yahoo Finance and Google Finance are handy for market data and “FRED”, the St. Louis Fed is an excellent, albeit US-centric, resource for a broad range of financial aggregates. While these sites make it very easy to automate data downloads, most sites (including, unfortunately, the Australian Bureau of Statistics) provide data in Excel format or other inconvenient forms. At times this has become sufficiently frustrating that I have periodically entertained vague plans to build my own time-series data web-site that would source data from across the world and the web, making it available in consistent, useful way.

Needless to say, I never got around to it, but it seems that someone else has. Today I stumbled across Quandl, which aggregates and re-publishes over 5 million time-series. The data can be presented as charts on their website, downloaded or accessed programmatically through their application programming interface (API). There is even an R package available to make it easy to load data directly into my favourite statistical package, R.

Here is an example of how it all works. Quandl has data on the Australian All Ordinaries index. To read this data into R, you will first need to register with Quandl and obtain an authentication key for the API. This key is a random string, which looks something like this jEGfHz9HF7C3zTus6ZuK (this one is not a real key!). Once you have your key, you can fire up R and install and load the R package by entering the following commands:

install.packages("Quandl") library(Quandl)

Once this is done, you will need to find the Quandl code for the data you are interested in. Near the bottom of the Quandl page, there is a pane showing the data-set information, including the provenance of the data.

Armed with the text labelled “Quandl Code”, in this case “YAHOO/INDEX_AORD”, you now have everything you need. I will assume you already have the ggplot2 and scales packages installed. To plot the history of the All Ordinaries, simply enter the following code (replacing the string in the third line with your own authentication key).

library(ggplot2) library(scales) Quandl.auth("jEGfHz9HF7C3zTus6ZuK") aord ggplot(aord, aes(x=Date, y=Close)) + geom_line() + labs(x="")

I can see I am going to have fun with Quandl. It even has Bitcoin price history. But that is a subject for another post.

Wall of Liquidity

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Once again a misconception is gaining currency. There is increased talk of a build up of cash just waiting to be converted into equities or other assets. I wrote about this years ago in cash on the sidelines, but apparently the financial commentariat did not read the post, so it is time to revisit the subject.

I believe that the reason the misconception is so widespread is that the subject is not discussed in technical terms, but in metaphors. Some of you have heard the phrase “the great rotation”, which refers to the idea that investors will shift en masse from cash and bonds to shares. It’s a compelling phrase, but it leaves one question unanswered: who will sell the shares to these rotating investors and, given that these sellers will be paid for their shares, what happens to the money they receive? It’s still cash after all. Likewise, if these rotators are selling their bonds, someone has to buy them. Post-rotation, there is still just as much cash in the system and just as many bonds. Cash and bonds don’t just magically turn into shares. Reality is messy…why spoil a good metaphor?

A simpler, more dramatic and more vacuous metaphor that has also made a reappearance is the “wall of liquidity”.

No one using this compelling phrase would be so crass as to explain what it means. Such is its power, it is assumed that we all know what it means. So, let’s have a look at “wall of liquidity” out in the wild. In an article about rising bank share prices, Michael Bennet wrote in The Australian:

But pump-priming by global central banks has created a so-called wall of liquidity looking for income that is flowing out of cash and into high-dividend-paying stocks, with banks attractive due to their fully franked dividends.

Here it certainly sounds as though “wall of liquidity” is just “cash on the sidelines” in a fancy suit. But let’s zero in for a moment on the other metaphor in this sentence, “pump-priming”. Doubtless, the author has the US Federal Reserve (Fed) in mind. The standard line runs something like this: with low interest rates and purchases of securities through the “QE” (quantitative easing) programs, the Fed has flooded the banks with liquidity. More prosaically, reserve balances (i.e. the accounts banks have with the Fed) have grown. So far so good, as the chart below shows.

The next step in this line of thinking is that as this cash builds, it is a “wall of liquidity” desperate to find somewhere to go and, in the quest for investments, it will push up asset prices.

But before we can accept this reasoning, there is an important point to note. Reserves with the Fed are assets of banks only. Contrary to a common misconception, these reserves cannot be lent, they can only be shuffled around from bank to bank. Nevertheless, there is a theory that, because in the US and some other countries, a certain percentage of bank deposits must be backed by reserve balances, there is a “money multiplier” which determines a fixed relationship between reserve balances and bank deposits*. If this theory is correct, bank deposits should have grown as dramatically as reserve balances. They have not.

M1 money

Taking the same chart and displaying it on a log scale shows that growth in deposit balances has been very steady over the last 20 years.

M2 - log scale

Whatever is going on in financial markets, it has nothing to do with a dramatic build up of cash which is poised to be converted into “risk assets”.

Yet another way to see this is to think about what is going on in Australian banks at the moment. Credit growth is slow in Australia. This is not because banks are reluctant to lend. Quite the contrary. Banks are looking at the slow credit growth and fretting about their ability to deliver the earnings growth that their shareholders have come to expect. The problem is that there is a lack of demand for credit as households and businesses continue to save and pay down debts. In response, banks have begun to compete aggressively on price and, in some cases, on terms to attempt to grow the size of their slice of a pie that is not growing. And yet these very same banks continue to compete for customer deposits. Australian banks are not sitting on vast cash reserves that are compelling them to lend. Rather it is simply renewed risk appetite that is driving banks to compete for lending.

The same is true around the world. Looking at cash balances as a sign that yields will fall and asset prices will rise is a pointless exercise. What is happening is much simpler. Animal spirits are emerging once more. Low interest rates (not cash balances) will help, but fundamentally it is risk appetite that drives markets.

The last time I heard people talking in terms of walls of liquidity was in 2005-2006 in the lead-up to the global financial crisis. These putative piles of cash were used to support a change of paradigm in which the returns for risk could stay low indefinitely. Of course this turned out to be dramatically wrong. The cash didn’t disappear, but risk appetite did. I am not predicting another crash yet, but I do foresee this nonsense being used to justify more risk-taking for lower returns. If that happens for long enough, then there will be another crash.

* As an aside, given that Australia has no minimum reserve requirements, if the money multiplier theory was valid, there should be an infinite amount of deposits in the Australian banking system. For the record, this is not the case.

Photo credit: AP

Cypriot sovereignty surrendered

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Here is a rant about events in Cyprus. Normal dispassionate service will resume here at the Mule in the next post.

Over the weekend, the European crisis took a sickening new twist in Cyprus. The government of Cyprus announced a “levy” on Cypriot depositors as part of a deal to secure a bailout of its ailing banks by international lenders. In doing so, it has dramatically demonstrated how completely Cyprus and other eurozone nations have surrendered their sovereignty to the technocrats of the European Commission, the European Central Bank (ECB) and the IMF.

The president of Cyprus Nicos Anastasiades has told his citizens, subject to getting the numbers in parliament, his government is about renege on past promises and appropriate the savings of pensioners to make good the failings of others. This is not the first time that the global financial crisis has claimed innocent victims, but it is perhaps the most striking example of this phenomenon.

Cyprus’s financial woes stem from the fact that their banks had significant investments in Greek government bonds. Back in March 2012, as part of the bailout of Greece, investors in these bonds suffered a “haircut” of 53.5%. Somewhat less euphemistically, holders of these bonds lost more than half of their investment. This left Cyprus’s banks in deep trouble and, while negotiations with Europe for a bailout continued, the ECB kept them afloat with emergency funding. The threat of suspending that ECB support was the gun to Anastasiades’s head that led him to agree to the disgraceful bailout scheme.

As the European crisis has rolled on, the European technocrats have become increasingly committed to “private sector involvement” (PSI). At face value, the principle is sound. The use of public money to rescue private sector banks leads to moral hazard. If lenders to banks expect to be bailed out, they may be tempted to allow banks to be ever more reckless in their risk-taking.

When a bank suffers losses, there is a hierarchy that determines who will suffer losses. The hierarchy typically works like this: investors in the bank’s shares are the first lose their investment; next to lose are investors in so-called “hybrid debt” (not quite lending, not quite equity, this includes things like preference shares); if the bank has issued “subordinated debt”, investors in these securities come next, followed by “senior debt” providers (typically in the form of bank-issued bonds). Depositors are the last to lose money and retail depositors with small balances typically have additional protection in the form of deposit protection provided by the government or a government agency*.

Depositor protection is extremely important. Despite being private companies, banks provide a critical role for the smooth running of an economy and so cannot be left at the mercy of the “creative destruction” of capitalism. In today’s society it is not really possible to opt out of the banking system and simply being paid a wage requires a bank account. It would be impractical, inefficient and unreasonable to expect every retail depositor to analyse the financial health of their bank before choosing where to deposit their money. When a bank collapses, shareholders should lose money. Wholesale investors should lose money. Retail depositors should be protected.

This reality is not lost on the lawmakers of Cyprus and for over 10 years, Cyprus depositors have supposedly been provided with deposit protection on balances under €100,000. The details of the levy have not yet been finalised, but the initial proposal involves a levy of 9.9% on all deposit balances over €100,000 and 6.5% on all deposits below €100,000. Anastasiades has effectively said, Oh, that deposit protection scheme? Well we had our fingers crossed when we made that promise. That explains the weasel word “levy” or “tax”. Of course your deposits are still protected against losses. You will not suffer a loss, it’s just that there’s a new tax we’re bringing in…

As if this dramatic breach of faith was not enough, there is no moral justice here either. Like Ireland before it (and indeed Australia), Cyprus did see rapid growth of private sector debt in the lead up to the crisis. So why not levy the tax on reckless borrowers not prudent savers?

Cyprus should rue the day that it surrendered its sovereignty by joining the euro zone in 2008. Cyprus would still be facing economic challenges today, but it would be free to determine its own fiscal policy, stimulate the economy (if it managed to keep politically-motivated deficit hawks at bay) and, of course, it would be able to honour its promise to protect retail depositors.

* Before the financial crisis, Australian depositors had no deposit protection. The assumption was that prudential oversight of banks provided sufficient protection for depositors. That changed after the crisis and now deposits below $250,000 are protected.