The perils of linear thinking- UK Steel.

The perils of linear thinking- UK Steel.

Now ask anyone and they’ll tell you the following: I’m a pretty capitalistic guy. I frequently clash on my ideological views with the left.  I adhere to the notion that the individual is, and always has been, the single most important factor in an economy and society- the so-called “rugged individualist“, in my opinion, forms the foundation of our progress as a society. We owe a lot to people like Henry Ford, Albert Einstein, Rene Descartes and Isaac Newton. We are standing on the shoulders of giants.

Where am I going with this you ask? Bear with me, especially if you are on the left of the political spectrum.

I’ve frequently stated that where markets are concerned, there is no single “one strategy fits all” solution. Which is why, of course, any regulatory body, any union, any political group or any central bank simply will fail in their approach at some stage. They tend to be wedded to an ideology* which is only correct in certain situations.  So-called “linear thinking”, the notion that the world is a constant like a linear equation:

y = ax +b

Everything is constant; it lies on a straight line.  You just plug the inputs into the function, get the output out and away we go.  That point is critical to understand some of the biggest policy blunders in history. 

Some people would like to believe that the economy is a simple linear function. In reality there are thousands of variables, even if only a few variables account for the majority of economic output.  The picture above is a 3D contour map- linear models (particularly bivariate linear models) are a primitive mathematical tool in terms of explanatory power, or indeed in terms of policy solutions.

The case for UK Steel tariffs:

My very first blog post was in response to a friend on the left asking how UK Steel could be protected. The first part can be viewed here.  And with that background  I’ll explain, in this instance my reasoning as to, why as a capitalist I view Europe’s (and by proxy the UK’s) inability to tariff cheap Chinese steel as a dangerous thing:

There should be no question in anyone’s mind that we are in trying economic times. The glut of steel coming out of China echoes the aftermath of the previous wave of globalization, where production and consumption was polarized increasingly in specific regions of the world.  China, having a huge overproductive surplus in steel, is now flooding the markets to maintain their industry.

The neo-classical economist would argue that tariffs constrain economic growth and economic development, and this may be true during an economic growth period. This is why, in many ways, Thatcher’s decision to cull the unions was likely to be a good move. It allowed the cost of labour to decrease and for the market to clear- creating renewed prosperity. In many respects the unions were the ones wedded to an ideology back then- the notion that they could extract increasing wages for their labour at expense of the overall society, at a time when real wage increases were not viable based on market characteristics.  This type of thinking can be true in the face of unscrupulous business owners, which I discuss here. Once again, this is not always the case and today it seems the shoe is on the other foot where being unreasonably wedded to ideologies is concerned.

So why would I argue that tariffs are warranted this time? Quite simple really. At some point the probability of and costs borne by social unrest will exceed the costs of implementing a tariff in utility terms. An economy cannot function under mass social unrest or flat-out war. Property rights fall apart (the foundation of capitalism), insurance costs skyrocket, even basic tasks like shifting goods become fraught with danger.  That’s the sort of world which we appear to be heading towards right now and it’s being perpetrated by linear thinkers: people who are focused on one single variable (economic growth) at a time when they should be worried about another (social stability). The economy and markets are neither linear, nor are they bivariate in nature.

*It is worth noting that some things may well be immutable- things like physical observations that follow specific laws that have not changed in all of the time they have been observed. These are the rules that govern our universe; without these physical rules the universe would cease to exist.  Of course, this is not an ideology or a human construct, but rather an adaptive observation based model.


Inflation on the Way?

Inflation on the Way?

Previously I mentioned how it is scary that some governments are offering 25% “low-risk” return on certain investment vehicles going into 2017. Well, that return has now been explained, at least in part, by policy.  As the FT reports:

“Many economists have also changed their views. Economics textbooks used to state that if you raise pay above the value it creates for employers, you reduce demand for labour. In other words, minimum wages cost jobs.

But economists’ opinions are now more nuanced, in large part because of the experience of countries such as the UK, which have so far sustained steady increases in the minimum wage without doing any notable damage to employment.”

The living wage is an attempt to hike the minimum wage on society’s lowest skilled workers, and may coincide with an increase of the monetary base- allowing workers to feel wealthier in nominal price terms while doing little in real price terms.

Why is this justified?

Quite simply, during times where debt accumulation (typically, but not always borne by government) is so high that interest rates extract more from the economy than the economic growth, the only solution is to reduce the debt burden in real terms.

It seems that the UK will be attempting to, at least in part, inflate their debt burden away.  Other solutions lie in stretching debt repayments over a longer time horizon, or forcing haircuts on creditors.

Between Q2 2017 and Q2 2018 (and perhaps moving forward) we might see significant inflation in the United Kingdom which would fit the historical record.  As Ben Bernanke might say, it’s time to start the helicopter engines and get ready for the cash drops.

Of course, there is still the alternative- no stealth jubilee by government and the controlled descent into the abyss of wealth destruction. This would benefit the wealthiest individuals and institutions in society, though neither option is particularly pleasant to consider.

Could this policy be wrong?

Yes, in fact. Historically wealth accumulates in the hands of the few under capitalism. Over time this inherited wealth (or dynasty wealth as I prefer to refer to it) is hoarded and isn’t reinvested (see: Monarchy/Oligarchy etc.)  In the event that most of this wealth is actually being mobilized in useful ways, ie: there is no slack for investment in the productive economy, central bank and government interference will only destroy wealth.

Historically, this has not been the case- there has always been slack, but there are some reasons to think that one day soon, that slack will diminish, making the policy of punishing savers a failed one.  Is it soon? Perhaps.  History will tell, but the stakes are high. We cannot afford to misread the situation.

Gold/Silver Ratio Signals Opportunity.

Gold/Silver Ratio Signals Opportunity.

Recently all of the focus has been on gold, with news that Venezuela shifted reserves to Switzerland, and queues for gold in London, gold has risen substantially.  This has offered up an unusual potential opportunity- the gold/silver ratio.

As of two weeks ago, gold prices had outpriced silver to a ratio of approximately 83- a ratio which was higher than gold’s peak in the height of the financial turmoil during the Financial Crisis (Nov. 2008). It should noted that Gold then fell against Silver to around 32 by 2011.

The gold to silver ratio over the past 10 years (courtesy of 

In fact, taking data going back to the 1980s (silver’s historical peak in real terms) the gold to silver ratio has dropped below the 20 mark.  This suggests a possible market opportunity.

UK Lifetime ISA- Where is the Risk?

UK Lifetime ISA- Where is the Risk?

Upon skimming through the 2016 UK Budget, there are lot of interesting points of discussion (at least to me), however, one of the most interesting on this first read through is the Lifetime ISA, which makes a debut in April 2017.  For anyone who is not from the UK, an ISA is an “individual savings account” and presents the average British saver with a tax-free savings vehicle. Various ISAs are structured in different ways.

The immediate thing that stands out here is that the UK Government is promising British citizens up to 1,000 British Pounds yield on savings of 4,000 Pounds. That’s 25%! This sounds like fantastic news for the average citizen- so why does this yield scare me senseless?

Well, put simply, there is no such thing as arbitrage (risk-free yield). Finance majors with a heavy academic slant, will of course argue the contrary: What about Triangular Arbitrage?  High-Frequency Trading? Put simply, if you think you’ve found an arbitrage opportunity, you either aren’t fully understanding the risks (yet) or you are talking about something with a very low risk to reward ratio- which of course, may not remain in place for very long.

Anyway, armed with this information, it should be obvious to even the most basic investor that sitting on a low-risk investment which returns 25% per annum is quite literally too good to be true.  This sounds like the financial equivalent of the UK Govt. promising everyone an elixir of eternal youth. Or maybe the equivalent of one of those shady web ads. offering an investment strategy which is “guaranteed to turn you into an overnight millionaire!”

So where’s the catch?  It’s easy enough to make make a 37% return swing-trading a volatile asset, over a month or two (and I have), but the explicit understanding is that there are serious risks assumed in doing so and the losses can mount up faster than the gains. Anyway, I’ll discuss the risks and likely aims and risks of this investment scheme below:

What is the purpose of the ISA?

There are likely to be four broad aims with this ISA being floated:

  • Recapitalize the banks at a time when banking is quite a weak sector.
  • Increase savings rates of individuals in a country which is running out of steam as a global consumer.
  • Ween the population off of public pension schemes and ensure they save for their old age (because, like it or not it’s coming and “pensions won’t be there when you get old, pleb.”)
  • Shift under-the-mattress cash savings into the electronic banking system.

These are fairly self-explanatory. Nothing more needs to be said here other than the first and last points being heavily related. (See my writings on the global transition to electronic currency here and here.)

So where is the risk?

Well the first two points above highlight potential risks, one directly and one indirectly. Banking is weak, and in any market which is in systematic decline, it stands to reason that not all market participants will emerge unscathed.  There is a risk of failure and loss of wealth. This is just a normal function of fractional reserve banking which is an inherently unstable system from a mathematical perspective.  To put this into real world context  I know a guy who receives a 15% interest rate on several corporate bonds he holds with a local bank. The caveat of course is he is from Argentina, and the bonds were floated (with a short time horizon to buy into them- about 48 hours) during a banking crisis.

The second point is a little more nuanced. The UK has tremendous debts, borne out of its overconsumption (trade deficit) for many years. It is therefore, not outside the real of possibility, that the GBP will face significant devaluation, and perhaps high inflation rates soon.  If the rate of inflation post 2017 was to exceed 25% then the real yield on this scheme would be negative. (See here for discussion of sovereign default trajectories and how they relate to inflation.)  In short, if the inflation rate per annum (and thus, increase in the basic cost of living) is 26%, then the real yield will be approximately -1%, despite a 25% nominal yield.  In other words you are less wealthy at the end of the year despite a 25% yield on that investment!

Far be it from me to question the actuaries and financiers who put this scheme together, but I have to say: the notion of a 25% return for supposedly little work/risk terrifies me. I’ll be looking to protect what little wealth I have before this ISA comes out.



Fifteen Rules for Successful Investment.

Fifteen Rules for Successful Investment.
  1. There is no single strategy which will succeed all the time: Markets are not static, they are not in equilibrium. They move to find equilibrium (and may reach it for a fleeting point in time) but they will fluctuate.
  2. Timing is more important than pricing: Frequently you will hear “buy low, sell high”, inferring price is the variable to watch. Price is just one variable- market timing is more critical than the price. A poorly timed trade will lose you money, regardless of whether you understand the overall trend.
  3. Understand the table that you are sitting at: Trading currencies, or equities is different to trading flowers in a market stall. The participants on the other side of the trade have different skill levels, better (or worse) knowledge. They may have more sophisticated tools or strategies.
  4. Every seller needs a buyer, every buyer needs a seller: this is important when reading financial advice. The more an asset is shilled, the more likely it is that your purchase of the underlying asset is closing another trader’s position.
  5. Good advice doesn’t come for free, or in a bestselling book: This one should be self-explanatory- if you cannot understand why, you have no business being in the market.
  6. Limiting risk is more important than capturing gains: eating losses erodes your capital. It is much easier to lose than to win, in general, given the overall configuration in markets.
  7. There are diminishing returns on capital: The more capital that is being invested, the harder it is to source real yield. Fees become harder to overcome, taking and exiting positions take more time.
  8. Markets and profitability is not a moral crusade: Markets move irrespective of morality (generally speaking). Taking a moral stand on a position imposes a personal bias, which can lead to losses.
  9. Very few things are impossible: Every time I hear an individual voice that something is an “impossibility”, it is worry. The possibility for most outcomes is always there, however remote. In fact, the more impossible something seems, the more likely the market is to shock and/or surprise participants.
  10. Fundamentals are important, but markets mostly trade on expectations: Every now and again, fundamentals show through when the market breaks, but most of the time market prices respond to expectations about the future prospects of the asset.
  11. Access to information is critical: Information on current affairs, market news and access to information as it breaks provides an asymmetric advantage over other traders.
  12. There is no such thing as an easy profit (long term): All pursuits in life, be it market trading, investing, building a business, or building a house require hard work and graft. If you want to become an overnight millionaire, gamble on the lottery. Successful investment requires time, energy, and research.
  13. Risk and Reward will not wait for you: You do not get an option to opt out of risk in life, it is everywhere. Similarly, reward will not wait.  If an opportunity presents itself, it needs to be seized as soon as possible.
  14. Don’t enter or exit positions based on emotion: These types of actions almost always lead to losses.
  15. Don’t take punts on investments you do not understand: Risk becomes very difficult to spot in these scenarios.


ECB Announcement, JGB Flash Crashes and Sold Canadian Gold Reserves: What Do They Have in Common?

ECB Announcement, JGB Flash Crashes and Sold Canadian Gold Reserves: What Do They Have in Common?

Canadian Gold Reserves.

Firstly let’s look at the now non-existant Bank of Canada gold reserves. As of last month the Bank of Canada sold off its gold and now has a zero balance forgold reserves.  This is a situation which has purportedly not occurred since 1935.

On the face of things, this isn’t a huge issue. Canada has ample gold mines and can dig up and purify more gold dust into bullion if they wish to but the behavior behind selling the reserves off hints at something else.  Quite simply, this hints at an inability (or unwillingness) on behalf of the central bank to auction debt to foreign holders.

If faced with a choice in the face of tricky financial headwinds, they can: issue more debt to  creditors (sell debt for cash), or sell assets for cash.  It seems, for whatever reason, the Bank of Canada elected to do the latter. More on this later.

Japanese Flash Crashes.

There have allegedly been two flash crashes this week in futures contracts trading on Japanese Government Bonds (JGBs). In fact, as Zero Hedge reports, circuit breakers kicked in and halted market trading for a number of seconds  just this week.

This hints at decreasing liquidity issues in markets, especially those linked to debt.  This lack of liquidity seems to be on the buy side of the market- suggesting market participants are extremely wary of this asset class.

The ECB Announcement.

This week the ECB announced an interest rate cut to zero percent as well as further monetization of debt through scaling up their QE program by 33% from 60 billion Euros to 80 billion Euros a month.  The Euro initially dropped against other floating currencies, but then reversed, strengthening.  The reverse was seen in European stocks- an initial strengthening, followed by a drop. This volatility is an unusual response for such an announcement and hints that faith in central banks, particularly in Europe, may be wearing thin.

Interest rates reached their previous peak in the 1980s, and have declined ever since- a positive thing for debt issuance. The face value of debt is inversely related to the interest rate.  Textbook finance would report that as as rates decline, previously issued debt with higher yield is more valuable. (Please be aware, that there is likely to be an inflection point at some stage, where market participants simply will not buy new debt issued despite lower interest rates because repayment becomes unlikely.)

So what is going on?…

In general the lack of liquidity, volatility on central bank announcements and sale of low-yielding assets by some banks suggest that the Sovereign Debt Crisis is not far away. It is becoming increasingly hard for governments and central banks to issue debt- buyers are not present in the market on the other side of the trade. Furthermore, what goes up must come down- the 30 year bull run in fixed income (part of a larger 70 year cycle) is coming to an end.

…And why the picture of the black hole?

What Just like a black hole, forcing the creation of more outstanding debt, without first letting the market clear, will destroy liquidity, destroy savings and destroy the overall markets.  Forcing the creation of debt on market participants (as central banks and their allies have been doing) without any underlying real economic growth, sucks increasing amounts of liquidity out of the markets through extracting increasing interest.  Therefore, without defaults on the debt, this acts very much like a black hole, sucking more and more capital in as it grows.

This might go some way to explain why German Banks were told to hoard cash.

Donald Trump- Hitler, or someone else?

Donald Trump- Hitler, or someone else?

Donald Trump has been likened in the past to Adolf Hitler, especially in the mainstream media.  So how accurate is this portrayal of the businessman turned politician?

Is Donald Trump a new Adolf Hitler?

There are some parallels- Donald Trump does indeed approach politics from the direction of a nationalist.  This is demonstrated in many of his speeches, as well as his campaign slogan: “Make America Great Again.”  However, seizing on nationalism at a time of general dissatisfaction with a largely out-of-touch establishment, and general economic decline is not a new tactic, nor is it one exclusively attributed to Adolf Hitler.

Donald Trump also advocates for some aggressive foreign policy maneuvers, such as the use of scorched-earth tactics against radical groups like ISIS. This type of political rhetoric also seems like something that might be used by Adolf Hitler in 1938.

It is also fair to say that both Trump and Hitler had a disdain for the establishment politics of the day.  This is also a characteristic which hints at both of the men having authoritarian leanings.

Adolf Hitler was not a businessman, nor was he a successful general. Hitler was a fine arts student, a laborer and a war hero (World War One) turned politician.  Adolf Hitler had few notable exploits prior to the horrific conditions faced by young men in the trenches and his world view, anger, and general disposition was melded by witnessing years of economic, political and military fumbles by the German State.

While it’s impossible to say where Trump’s true intentions are, I would argue that this is where the similarities end. In fact, I believe that Trump is more likely to be the modern day version of another famous historical figure: Gaius Julius Caesar.

What similarities are there between Trump and Julius Caesar?

It is probably fair to say that the United States was built upon the experiences of the Roman Empire when it was first assembled, including the use of a Republic.  Both the United States and the Roman Republic made use of eagles in their iconography (although unsurprisingly, so did Nazi Germany.)

Unlike Adolf Hitler, both Julius Caesar and Donald Trump sprung out of aristocratic class. Both men were broadly successful in their youth.  While Donald Trump had financial backing from his father (see the “small loan of one million dollars” debacle), Julius Caesar was financed by one of the wealthiest men in human history, Marcus Crassus.

From a young age, Julius Caesar was walking a tightrope between existing within the establishment and skirting it. Caesar grew up during a time of political unrest within Rome. His uncle and powerful political figure, Gaius Marius was in a bloody political war with an opponent during Caesar’s youth. To this day I have yet to meet a businessman who does not view the political authorities with some modicum of skepticism. This springs from the political pursuit of power and the nature of government in seizing and redistributing wealth.  It is likely to say that both men learned early how to navigate the nebulus void of the political seat of power.

Both Trump and Caesar were successful in their respective national pursuits: Caesar was a decorated general who pacified and conquered Gaul, and Trump is a billionaire who built a business empire. Rome’s predominant expansion was borne through military conquest, whereas the United States favors trade.

Both were respected by the populace broadly for their strength and leadership abilities and each figure was a unifier of men.  Furthermore, both men were benevolent to their friends and allies (see Trump’s inclination to extend an olive branch to political allies- evidenced by his early praise for Ted Cruz, and for his support of Ben Carson when Cruz undermined him), but both were ruthless with enemies.  Julius Caesar exhibited this trait when he forgave Brutus when he turned on Caesar during the war for control of the Roman Republic between Pompey and Caesar. Brutus later proved to the be catalyst for Caesar’s assassination.

The largest similarity, however, is the direct conflict with establishment politicians that both men faced when running for political office.  Caesar was brought into direct conflict by figures in Rome who were fearful of his power- a host of senators and his prime political opponent Pompey. Indeed, the fight for the leadership of the Roman Republic was so fierce that it fractured the Republic down the center.  Based upon the rhetoric and the fierce criticism coming out of both the GOP and the Democratic party, it seems that history may well repeat.

Caesar was assassinated upon the floor of the Roman Senate- murdered by some of the men he had previously forgiven for supporting his political opponent, Pompey.

If I am correct in my assertions and the parallels continue to hold then turbulent times are ahead.  Caesar defended himself and destroyed his opponents when the Roman Senate fragmented, brought his enemies back into the Senate after Pompey’s death in Egypt. He bribed the population who broadly loved him, and named himself as the dictator. This power grab ended in assassination and a second bloody civil war which led to the rise of Caesar’s  great nephew, Octavian (his named heir), who later became known as Augustus and was arguably the greatest political leader in Roman history.

If we do see a historical repeat, expect wholesale rebellion and odd political alliances forming behind closed doors, we might even see partisan alliances forming between established Republicans and Democrats.  Mitt Romney, could play the Pompey type figure in the battle for power at a brokered convention for the Republican nominee.  Trump would likely run as an independent in such an event, which would make for a very interesting presidential race.