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Not sure if this is exactly Culture War, but I think if anybody can tell me what the heck is going on, you lot can š
Okay, so the UK has a new monarch, a new Prime Minister and in the past couple of days, a new budget. And now it looks like a new financial crisis.
Can anybody explain to me, in the manner that Chesterton describes Arnold, with "a smile of heart-broken forbearance, as of the teacher in an idiot school, that was enormously insulting" what has caused this kind of meltdown? I'm cribbing from The Guardian, which is trying to explain what is the problem, but my big difficulty is that I don't understand why the Bank of England had to do this. How did the British economy get to the state that the pound is dropping like a metaphor in Amazon's "The Rings of Power" and the currency apparently would have been worthless?
And why is anybody surprised by the tax cuts? They're a Tory government, the first thing they do when they get into power - or when a new PM is hoping to take over - is announce swingeing tax cuts for the better-off (along with swingeing cuts in public spending). So why is everyone now going "Oooh, that's a bit dodgy"? The only surprise for me is that it's Kwasi Kwarteng who is the guy in charge of the Budget instead of Rishi Sunak, but I suppose Rishi - being disappointed in his expectations to succeed Boris - has decided to spend more time with his family('s billions).
I think Britain's leaders have no idea what they're doing. Dominic Cummings has been screaming about this for the last 8 years, initially in long, well-thought out essays and more recently in angry, over-capitalized tweets full of made-up technical jargon. He strikes me like a Lovecraft protagonist going mad at the true nature of the eldritch horror.
In this case, the pension funds had decided to leverage themselves on government bonds, using them as collateral to buy other things. When Kwasi issued a particularly blase announcement that they'd borrow even more money, investors freaked out. The price of government bonds dropped since the supply increased.
Since the price of the bonds fell, the pension funds started having to sell their assets, including said government bonds. There was a risk of a deadly spiral. But because it's not a real market, the central bank decided to use its own money (that it freely prints) to buy its own bonds and shore up the price, averting disaster for now. The UK economy is now significantly closer to being an 'emerging market', a place where the currency is really just a piece of paper.
This could and should have been predicted. Lee Kuan Yew wouldn't have done things like this - he was all about fiscal prudency, avoiding the accumulation of debt where possible. But the Brits clearly didn't predict the reaction to their tax-less, spend-more plan. I favour Cumming's diagnosis that the UK political elite lives in its own pocket dimension, only tenuously tied to reality by what the newspapers say, rather than any actual world-modelling ability. They didn't know that they couldn't just borrow more money, they didn't imagine that waging proxy war against Russia might raise energy prices in the UK, a part of the European energy/economic system. They don't understand what causes economic growth, they don't know how to make things happen quickly or efficiently. They don't know.
One should be humble before God, but realistic in respect to others.
If Cummings is merely "Like a poster here" he's easily in the top 1% of government officials who have ever held senior office, and by far the most competent person in that cabinet. The stupidity, vacuity and hubris of the senior bereaucracy is almost impossible to internalize...
Its genuinely unbeleivable a man like Cummings penetrated it at all... The elite circles run off socialite style norms related to connections and status games that actively select against the kinds of people who make cohherent mental models and try to make them accord with the world. It the same as career politicans only with more pretense and less charisma, you see this in most academic sub-feilds related to politics as well...
The relationship of the words to actually reality is a 20th or 30th concern... the first concern is its relationship to Taboos and social signaling, and what's worse is all these fields select for people who do it subconsciously and can't tell the difference. People who aren't even capable of being true believers because they don't inherently process their words as being about the world as opposed to their social games.
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Legend of the Galactic Heroes has a great moment:
The enemy out numbers the protagonist's fleet 3 to 2, and everyone's nervous about this... they would like to withdraw in the face of the superior force, but they can't because the enemy has divided into 3 that are able to head them off if they try any retreat...
Well the young High Admiral announces his plan. this is a classic case where defeat in detail is possible, if they strike out hard and fast at one of these enemy fleets they'll outnumber them 2 to 1... and then if they strike quick they can catch another, or worse case merely be outnumber 5-4 taking into account their losses and be able to force a draw... This is a real classic military scenario, Napoleon had a battle that went like this, and something like this is taught in almost every course on strategy.
One of the lesser admirals upon receiving these orders is outraged. "To reach for academic theory at a time like this!? In the midst of BATTLE!?"
so he defies the order tries to disengage his contigent, and he and that contingent die, while the battle turns from a sure defeat to that draw scenario.
The thing is, this lesser admiral who defied the order and died for it... he was the teacher of theory at their military academy! He had taught this theory every year for 20 years. Yet when given a command that directly aligned with the theory he had studied and taught for decades, he not only balked he was outraged!
To him all the theory he taught were polite words and and a social game, they bore no relation to the battlefield, they were related to academic life... he had dedicated his life to repeating the words and social concepts of being a professor of strategic theory, and he wasn't just willing to repeat those theories if they were wrong in fact, so long as they advanced his career... in his mind they only bore relation to his career, the idea they could be right or wrong about real battlefields in the future, as they were happening, was suplurflous or laughable. The theories were social games you played to describe maybe historical battles... And whether his own theories were right or wrong if deployed in the field was a laughable concern relative to how interesting or socially viable they might be...
He regurgitated "Defeat in detail" on tests, then in classrooms as the teacher... he maybe even believed he believed it... but to actually believe it would have meant resisting the thought, putting it under pressure, testing its mettle and how well he could rely on it... looking for contradictory examples, and only being satisfied once he'd concluded it'd held under his harshest scrutiny... And that's not what a "Model Student" who aspires to become a star teacher does. What if you discovered it was wrong? Or rather, in his psychology, that he's wrong and contrary to the social expectation. Is he going to risk placing himself in opposition to the institutional machinery he needs to appease and serve?
So when he received an order based on a theory that happened to be one of the best documented and well theorized realities of warfare ever given a name... one every moderately good strategy gamer should recognize intuitively... he balked and was outraged that some punk was either trying to play a status game to fuck with him, or that he's being lead by some dangerously delusional true believer who thinks these words were meant to constrain expectations about physical reality.
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I've interacted with alot of academics, politicians, bureaucrats, mainline corporate types... everyone that's actively checked-in to the system instead of checked out and disgusted... the kind that will repeat the slogans sincerely... they're almost all like this fictional professor. Our society applies incredible consequences for social faux-pas and almost none for actually being wrong or ineffective. We lack both the scarcity and the high intensity warfare that creates those consequences for being wrong, and are drowning in the centralizing over-socialized morass that makes social norms sting.
Thus the people who get ahead in all but very niche fields are those who spend their lives thinking in relation to the social norms, and feel no compunction about any contradiction with physical reality for any myriad of psychological reasons ("What no I'm not making a probabilistic prediction!? what do I look like a booky! How Low class")... And those who are actually capable of making their ideas commit them to predictions and confine expectations are consistently selected against, or actively punished (Psychologically or socially).
Imagine the reaction if you asked a politician or bureaucrat who'd just made some optimistic statement about education for black kids to actually wager real money about what the test scores would be in 5 years on a consistent test... Naively one would think it'd matter if the politician didn't want to... if we expect the program to fail shouldn't we be doing something different NOW.... but of course they'd be outraged not at the politician who refused the wager with some "I don't wager on matters of morality" bromide... but at you for trying to impose expectations, and worse being willing to bet against black kids (you racist).
The idea these polite statements about opportunities for the future and everyone getting a chance should correspond to realized on the ground reality is laughable in politics, or an actively rude attack... And that casual dishonestly, even in one's own thoughts, that dismissal of the very possibility of a truth value in those words... that casual evil of banality... that's slowly infected everything our government or elite class has touched, and our elite no longer produces people meaningfully able to reach back and relate their linguistic games to reality any more...
they are all that professor of military theory and will intuitively turn and run when their own theories tell them they have the advantage... because that moment will be the first time they have to relate their words games to reality, and they'll immediately know (even if they don't already) that they haven't been doing that, and every cached thought, even one as basic as "Defeat in Detail"... They can't trust.
You're mistaken. The lesser admiral who dies is Erlache. The teacher is Staden, and he dies much later in different circumstances.
Mittermeyer kills Staden, right? I don't even remember Erlache... Time for a rewatch I guess.
Yes, basically. During the Imperial Civil War, Staden sides against Reinhard, which is not much of a surprise, and gets defeated in battle by Mittermeyer. He is evacuated and gets hospitalized due to combat-related stress (I had to look this one up on the interwebz), and his subsequent fate is left unclear. Presumably he was captured or killed.
Erlache is a forgettable character who doesn't do anything else besides dying pointlessly.
Yeah, rewatched a few civil war arc eps, and Erlache really is a blink and miss guy.
Been years since I last watched. Had forgotten just how much Schenkopp wants Yang's dic-tatorship, and how silly everyone's decisions are.
Like literally every single guy in the junta fleet goes full Yukio Mishima and refuses to surrender, even to the super popular hero admiral? Alliance troops were willing to surrender to the empire a few episodes ago!
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Dominic showed significant competence in his running of Project Leave. He helped get Boris a crushing majority and achieve Brexit. That he was unable to turn around the entire structure of the British establishment is an understandable failure. The whole swamp hated him and wanted him gone because he was threatening their power and security. That they could find some trumped up charge to poison his reputation with does not necessarily mean he's a failure, only that they are effective in wielding power from an overwhelmingly stronger position.
I think his predictive capacity is considerable. He warned about the danger of powerful diseases escaping inadequate biosecurity the year before COVID. He warned about the Russian army's deployment around Ukraine back in November 2021. He was instrumental in the shift from COVID 'let it rip' to 'do something' and probably improved the UK's response to COVID from catastrophic to very bad. Obviously, it benefits him to say that but I trust him over the rest of the media-Whitehall mob who turned Britain from the dominant world superpower into a US satellite and bungle seemingly everything they touch. At least he gets things right some of the time and can write convincing, thoughtful essays.
He WANTED to do serious structural reform to improve productivity, Brexit for him was about breaking away from EU regulations that make it hard to do anything. He was trying to escape the fundamental choice you posit, the choice which seems to be inevitable now. His argument was that the bureaucrats were mismanaging huge amounts of state spending (roughly 40-50% of GDP) with their incompetence. This whole crisis was partially caused by their plan for a 200 billion pound subsidy for gas prices, because they totally failed to achieve energy sovereignty before waging a proxy war against a major European energy supplier! How said subsidy will create more gas is unclear. Given the context, I believe his all-consuming hatred and disgust at the British establishment is well-merited.
With this he was clearly wrong. The UK results are very bad, even worse than for countries with less restrictions. Most lockdowns and school closures were pointless because it was elderly people who mostly died. If they had concentrated on protecting the elderly, they would have done better. But overall, even with that most countries overreacted.
The UK didn't introduce vaccine mandates unlike many other countries, so at least they did one thing right. But I doubt it had anything to do with Cummings.
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The choice between taxation and services is not quite a false one, but at the same time, if the national GDP was 20% or more above what it currently is (and there is no reason it couldn't be, because the national GDP hasn't grown over the 2007 level), it would give way more room for maneuver, and we wouldn't see this same lack of confidence from markets.
Maybe not, but the current situation is in part a result of the UK's GDP growth being consistently behind nearly every other developed economy. The United States have managed to grow their economy substantially over the past 15 years. There's no reason we can't too.
And yet, the country consistently punts on those tough questions, and we fall further and further behind. Time and time again the country chooses to consume and consume, and never to invest or to build for the future. The tough choice to make is not whether we increase taxes or cut spending. It's between consumption and investment.
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I feel this is a bit harsh on Cummings; certainly reports on his time at No.10 suggested he largely left matters of the economy to Sunak and his team. And he has always emphasised investments in productivity through science funding, education, etc. His focus is on the civil service because that's where his specialism is, where he can actually influence things.
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It seems like the UK and much of the rest of the west is run by the type of people who lived at Versailles. For them, politics is the debate, not the reality. A war with Russia isn't about tanks and bombs, it is about positioning oneself within the debate and what makes sense within the internal palace politics. Energy politics isn't about watts and power, it is about what works on twitter and what image is projected. The electrical grid is failing not because of Russia but because energy policies have been run by people who know more about PR than energy. They aren't really looking at inflation as an economic issue, they are looking at it as a PR issue.
The background of the people running a lot of the west isn't exactly hope inspiring, they come from media, think tanks and universities with little connection to reality. Politics lacks people who have served in the military, run a company, done engineering or worked in a hospital.
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The chancellorship is Truss's to give, and it would be a little strange for her to pick Rishi. He was her main rival for the leadership, and frequently said he thought her economic vision would be a disaster.
The concern with Truss is not so much that she wants tax cuts, but that she's simultaneously increasing spending, in particular the new energy price guarantee, which could prove very expensive for the government.
The government was already running a large deficit after covid, and Truss was gambling that the markets weren't actually all that concerned about government debt.
It seems like the markets were actually tolerating the debt only because Rishi was promising to eventually pay it back; Truss's more blasƩ attitude has them spooked.
As other commenters have said, the central issue is that the UK political system expects European public services, with American levels of taxation. Truss shares Boris's belief in cakeism, but it turns out that only works for so long.
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My understanding is that the issues with the British economy are structural and go back to the Blair government, which mostly rode a boom in financial services while sowing the seeds of our current issues. Britain is by this point, highly deindustrialized and heavily indebted, with poor infrastructure and an aging population, an economy built on cheap labour and a harsh regulatory environment. This is the result of decades of overconsumption and underinvestment by both the private industry, average people, and government. The longer the fall, the harder the landing, and Liz Truss is simply reaping the result, as much due to animal spirits as any particular decision. Her tax cuts are not particularly radical - they're more or less a return to the taxation levels of Blair. But fiddling with tax levels is only going to shift money between the UK population and the government. It is not going to make the country as a whole (population+government) any richer or poorer, it's pure redistribution.
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Iām going to paste in Matt Levineās newsletter bit because itās so incredibly good.
Here is a simple model of a pension fund. You know you will need to pay out a bunch of moneyĀ 30 years from now, so you buy some 30-year government bonds and hold them to maturity. When the bonds mature in 30 years, you have money, which you give to the pensioners, and youāre done. This model is obviously oversimplified, [1] but itās a good start.
Let me make three points about this model. First, a financial point: Doing a pension fund this way is expensive. Thirty-year UK gilts (government bonds) paid about 2.5% interest this summer. If you want to have Ā£100 in 30 years, and bonds pay 2.5%, youāll need to put aside about Ā£48 now, which will grow at 2.5% over 30 years into Ā£100. [2] Ā If you are a company or government, you might not be jazzed about putting aside almost half the money now to pay pension obligations in 30 years. What if you bought some stocks instead? If stocks return 8% a year on average, you can put aside just Ā£10 now to get back Ā£100 in 30 years. Thatās a much better deal, for you,Ā now.Ā Of course the gilts pay 2.5% guaranteed, while the 8% stock-market return is just a guess; in 30 years, you (and your pension beneficiaries) might regret your riskier choice. But it saves you money now, and itāllĀ probablyĀ work out fine. Or, you know, you do some mix of super-safe gilts and riskier corporate bonds andĀ stocks, etc., still targeting Ā£100 in 30 years but putting less money in now and taking more risk to get there.
Second, aĀ financial-stability point: Structurally, pensionsĀ are about the safest form of investing. Most big investors in financial markets are, to some degree or other, structurally short-term, in ways that make markets fragile. Banks borrow most of their money short-term (from depositors, from capital markets), and if thereās a run on the bank then the bank will need to dump assets to pay back depositors.Ā Mutual funds let their investors take money out every day, and if a lot of investors want out then the funds will have to dump stocks to give them their money back. Hedge funds let investors take money out and also tend to borrow money from prime brokers; if their assets go down then they will get margin calls from brokers and will have to sell assets to meet them. The common theme is:
You buy some assets with other peopleās money.
The assets go down.
The peopleĀ āĀ depositors, investors, prime brokers āĀ callĀ you up and sayĀ āyou used my money to buy assets, and the assets went down, so now I want my money back.ā
They have the right to do that.
You have to sell assets to pay them back.
This makes the price of the assets go down more.
Go to Step 2.
More or less every bad story in financial markets is this story, a ādeleveragingā or ārun on the bank.ā Pensions areĀ immuneĀ to this. Pension funds own assets (gilts, stocks, etc.) with other peopleās money, in the sense that they are ultimately supposed to use those assets to pay benefits to pensioners. But the beneficiaries canāt take their money out if the fund has a bad year. They just have to wait. There are no runs on pensions. The pension has to come up with Ā£100 in 30 years, but thatās it; it canāt be forced to sell early along the way.
This means, for one thing, that if you run a pensionĀ youĀ can confidentlyĀ invest in risky assets like stocks: If stocks go down one year, you can make it up next year; youāre not going to have to shut down your pension fund because investors withdraw money after a year of bad returns. It also means that pensions are not supposed to destabilize financial markets: They are long-term investors and are not forced to sell when markets go down.
Third, an accounting point. Take the simple model of a pension: You buy a bond today to pay Ā£100 in 30 years. I said above āĀ with some simplification āĀ that you pay about Ā£48 for that bond. That is the value of that bond: The value of gettingĀ Ā£100 in 30 years isĀ Ā£48 today. How do you account for that? What does the balance sheet look like? At some conceptual level, the balance sheet looks like āin 30 years I will have pension liabilities ofĀ Ā£100 and assets ofĀ Ā£100,ā so it balances. But in practice accounting doesnāt work that way. In practice you will record the value of the bond as an asset, today, atĀ Ā£48. But by the same logic, you will record the value of yourĀ liabilityĀ atĀ Ā£48: The cost of payingĀ Ā£100 in 30 years isĀ Ā£48 today, so you have assets ofĀ Ā£48 and liabilities ofĀ Ā£48 and it all balances.
What happens if interest rates change? Letās say that the interest rate on 30-year gilts falls to 2%. This means that the market value of your bond goes up, to aboutĀ Ā£55. Do you have a windfall profit? Can you sell a portion of the bond? No, of course not. The market value of your bond has gone up, but you donāt care about that. The bond, for you, is a long-term, hold-to-maturity investment. For you, the bond paysĀ Ā£100 in 30 years; you donāt care about its market price now. But by the same logic, theĀ present value of your liabilitiesĀ goes up: Your obligation to payĀ Ā£100 in 30 years is now āworthāĀ Ā£55, using a 2% discount rate. So your balance sheet still balances.
In the simple case, none of this matters and it is sort of a confusing fiction. You have to payĀ Ā£100 in 30 years, you have an asset that paysĀ Ā£100 in 30 years, youāre done;Ā market fluctuations donāt affect you at all. Accountants will want you to record the value of your asset and the value of your liability at their discounted present value, and that value will fluctuate with market interest rates. As rates go up, the value of your bonds will go down but the discounted cost of future pension benefits will go down; as rates go down, the bonds will go up but your cost will go up too. In the simple case these things will always offset and wonāt trouble you very much.
But once you move beyond the simple case this gets worse. Letās say you have to payĀ Ā£100 of benefits in 30 years, and you plan to pay for that using half bonds (gilts worthĀ Ā£24 today) and half stocks (stocks worthĀ Ā£5 today). If gilts yield 2.5% and stocks return 8% per year for 30 years, that will give youĀ Ā£100 in 30 years, enough to pay those benefits. ButĀ today, you have assets ofĀ Ā£29 (Ā£24 of gilts andĀ Ā£5 of stocks), and liabilities ofĀ Ā£48 (the present value of thatĀ Ā£100 pension obligation in 30 years at a 2.5% discount rate). So your pension is underfunded, by Ā£19. [3] It happens! It might be fine, if you get the returns you want. But it could make you nervous. One way to overcome this nervousness is to invest in evenĀ riskierĀ assets with higher returns, so that next year you have, you know,Ā Ā£33, and are less underfunded.
The bigger problem is what happens when interest rates change. Again,Ā say that the interest rate on 30-year gilts falls to 2%. Now you haveĀ Ā£55 of liabilities (the present value of your pension obligations discounted at 2%). The value of your gilt holdings has gone up to Ā£27.50 as rates fell. The value of yourĀ stockĀ holdings might not have, though; stocks donāt move automatically with interest rates. Still, letās say that your stocksĀ haveĀ gone up, by 20%, toĀ Ā£6. Now you haveĀ Ā£55 of liabilities andĀ Ā£33.50 of assets. You are underfunded byĀ Ā£21.50 instead ofĀ Ā£19, which is worse.Ā You have ālost money,ā in a very accounting-fiction-y sense. Your actual pension obligations (how much you need to pay in 30 years) have stayed the same, and the market value of yourĀ assets has gone up. But your accounting statements show that you have lost money.
Notice that what this means is that, on a reasonable set of assumptions, pensions areĀ short gilts:Ā They lose money (in an accounting sense) whenever interest rates go down (and gilt prices rise), and they make money (in an accounting sense) whenever interest rates go up (and gilt prices go down). [4] Notice also how counterintuitive this is: In its simplest form, a pension fund justĀ is a pile of gilts. The basic default move for a pension manager is to take a bunch of money and put it in gilts. Intuitively, she is long gilts: She has a pile of government bonds, and as rates go down the value of her holdings goes up. But as long as she doesnāt put all of it in gilts, and as long as the pension isĀ underfunded, then she isĀ as an accounting matterĀ short gilts.
I said above that pension funds are unusuallyĀ insensitiveĀ to short-term market moves: Nobody in the pension can ask for their money back for 30 years, so if the pension fund has a bad year it wonāt face withdrawals and have to dump assets. Still, pension managersĀ are sensitive to accounting. If your job is to manage a pension, you want to go to your bosses at the end of the year and say āthis pension is now 5% less underfunded than it was last year.ā And if you have to instead say āthis pension is now 5%Ā moreĀ underfunded than it was last year,ā you are sad and maybe fired; if the pension gets too underfunded your regulator will step in. You want to avoid that.
And so the way you will approach your job is something like:
You will try to beat your benchmark, buying stocks and higher-yielding bonds to try to grow the value of your assets.
You willĀ hedgeĀ the risk of rates goingĀ down. If rates go down, your liabilities will rise (faster than your assets); you are short gilts. You want to do something to minimize this risk.
.. continued below
Part 2ā¦.
The way to do that hedging is basically to get reallyĀ longĀ gilts in a leveraged way. If you haveĀ Ā£29 of assets, you might invest them like this:
Ā£24 in gilts,
Ā£5 in stocks, and
borrow anotherĀ Ā£24 and put that in gilts too. [5]
That way, if rates go down, the value of your portfolio goes up to match the increasing value of your liabilities. So you are hedged. You were short gilts, as an accounting matter, and youāve solved that by borrowing money to buy more gilts.Ā In practice, the way you have borrowed this money is probably not by actually getting a loan and buying gilts but by doing some sort of derivative (interest-rate swap, etc.) with a bank, where the bank pays you if rates go down and you pay the bank if rates go up. And you have posted some collateral with the bank, and as interest rates move up or down you post more or less collateral.
This all makes total sense, in its way. But notice that you nowĀ have borrowed short-term money to buy volatile financial assets. The thing that was so good about pension funds āĀ their structural long-termism, the fact that you canāt have a run on a pension fund:Ā Youāve ruined that! Now, if interest rates go up (gilts go down), your bank will call you up and say āyou used our money to buy assets, and the assets went down, so you need to give us some money back.ā And then you have to sell a bunch of your assets āĀ the gilts and stocks that you own āĀ to pay off those margin calls. Through the magic of derivatives you have transformed your safe boring long-term pension fund into a risky leveraged vehicle that could get blown up by market moves.
I know this is bad but I find something aesthetically beautiful about it. If you have a pot of money that is immune to bank runs, over time, modern finance will find a way to make it vulnerable to bank runs. That isĀ an emergent property of modern finance. No one sits down and says āletās make pension funds vulnerable to bank runs!ā Finance, as an abstract entity, just sort of does that on its own.
Anyway, as I said above, 30-year UK gilt rates were about 2.5% this summer. They got to nearly 5% this week, and were at about 3.9% at 9 a.m. New York time today. You can fill in the rest. HereĀ areĀ Loukia Gyftopoulou and Greg Ritchie at Bloomberg News:
And here is the Financial TimesĀ on the BOEās intervention:
AndĀ FT Alphaville has two very good explainers of the LDI problem, one by Toby Nangle and another by Alex Scaggs and Louis Ashworth, which I have drawn on here. And here is NangleāsĀ prescient LDI explainer from July. Modern finance made UK pensions vulnerable to runs, and then there was a run on those pensions, and the Bank of England had to step in to buy gilts to save them, because thatās what happens in a bank run.
Problem with this analysis and Iām familiar with the pension fund accounting and this formula is itās not a perfect representation of whether you will be able to pay your future liabilities. Itās a good way to estimate your funding levels.
Embedded in all this math is an equity risks premium. When equity risks premiums increase your future returns are higher. Long story short actually hedging out a made up formula for estimating funding made them take a hedging risks that isnāt perfect for telling you if you will actually fund your liabilities.
Hence itās a dumb formula and they hedged something they probably didnāt need to hedge. Also it was hedging nominal rates when one benefit of current markets is a great deal of the change in nominal rates is a change in real rates which means when they roll their current bonds (assume they own a lot of corporate bonds of less duration) they will be getting higher returns on the asset side of the equation.
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Thanks for that, this explains to me why the pension funds were threatened (and yeah, I have noticed that a lot of governments have been really tempted to dip into pension funds because 'well the money is just sitting there and if we invest it or use it for infrastructural funding then we'll magically both spend it and increase it').
Borrow money or cut taxes, not both, seems to be the message. I don't know why Truss and her new Chancellor couldn't foresee that would be a problem, so does this mean "oh dear" for the handling of the British economy for the near future?
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Let me get this straight: Managers want to make equity returns with bond risks. Banks come up with a miracle product that promises just that. They both profit for a few years. Then of course it all goes tits up, and the state 'has no choice' but to bail them out again. They're not illiquid, they're stupid or reckless.
You could say the banks delivered exactly what they promised. Only there was a secret ingredient, the fool who magically takes the risk away from them for free.
That's not quite right. They're saying that bond yields temporarily rose due to illiquidity in the market and were expected to fall shortly, which they did. The Bank of England didn't transfer wealth to the pension fund. They acted as the lender of last resort to tide them over.
Now, if the increase in interest rates had been more permanent, the strategy could have actually failed to the point of insolvency without an actual wealth transfer. Buy that didn't happen.
If my friend acts as a lender of last resort every time I am in danger of getting margin called, that is a valuable service, worth money, even though no money needs to be transferred from his account to mine.
Illiquidity is a red herring, a euphemism for the fact that the yield of those gilts is lower than it should be, propped up by overleverage. Bond yields are rising everywhere. Which is a problem, since they've successfully "hedged" themselves against falling interest rates by making themselves vulnerable to rising interest rates through leverage. Now they're getting margin called, and the state has bought bonds above market rate to keep the charade going, rather than liquidate their positions to let the market find the true, higher, yield.
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Sure, but in exchange for this additional risk, they make it dramatically cheaper to fund pensions. I think to make a principled policy argument against this sort of arrangement, one would have to claim that the NPV of stochastic future government bailouts is less than the NPV of making the pensions much cheaper to fund.
I think I want pension funds to be stodgy, conservative, no-fun, reliable old plodding donkeys, not flashy exciting high-risk high-yield racehorses. 'Way cheaper now' has to be paid for eventually, and it can go sideways just like this did.
That doesnāt exists in the real world of being āstodgy conservativeā. Transferring money from today to the future is always going to have a lot of risks.
Thereās no risks free way of transferring consumption today into consumption tomorrow. It involves some part of society investing surplus today into capital investments that are fruitful tomorrow.
You could say just buy government bonds. But if everyone does that then government bond yields go down (potentially even negative) and someone needs to a credible borrower today that will pay you your capital tomorrow when your pensioners want to consume.
The US government of course does this with social security but that even runs into issues of population pyramids and whether social security will give much real spending power when their are more retirees than young caregivers/workers.
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How much should society be willing to pay for that preference? I don't think your opinion is able to graduate from irritable mental gesture to serious policy preference unless you have some inkling of the relative costs involved.
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You mean itās a legit government subvention of pension funds in the form of an unofficial put, and everyone knows but donāt say. So you agree the claims of illiquidity and 'no choice' are bunk, missing the forest for the trees.
I have a few objections:
Moral hazard: encourages risk-seeking behaviour, causing greater problems than anticipated, currency crisis etc. The best thing for them would be to flip for the money repeatedly, get the most out of that put.
Leakage: the most reckless banks and managers take a larger cut of the profits in good years, sucking up the subvention.
Lack of transparency/uncertainty: Taxpayers are unaware the subvention was in place until the crash. Since itās an unofficial guarantee, Market participants can never be sure of the bailout, leading to uncertainty and malinvestment .
Unfairness: The simple and honest worker-investor who decided to accept the risk of equities for his pension, did everything right, saw through the lies of bankers, doesn't cause systemic risk, has a cheap pension fund. As a reward, he is outcompeted by this chimera of governement subventions and banks.
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There's no reason why the UK can't bounce back. Many of our problems are entirely self-inflicted - the addiction to cheap labor, the highly restrictive planning system, the lack of investment, the total aversion of the government to supporting industry, and moronic environmentalism. Whether we will choose to stop sabotaging our own future is another question entirely. If the previous years are any indicator, the answer is no. Neither political party shows any interest in restricting immigration, investing in infrastructure, reforming the planning system, or supporting industry.
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You know, sometimes you alomost sound patriotic...
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I won't talk on why this caused a potential crash (it's to do with the policy causing a rapid change in the price of government bonds, and I don't really interact with bond markets in my day-to-day), but I can talk about the economic side of things.
The Econ 101 stuff here is that essentially in an anemic economic environment, governments are expected to stimulate demand via tax cuts or spending increases. This environment has been very easy on political parties of both sides, because it just requires borrowing more money (less concering in a low interest-rate environment) to fund your program of choice - or tax cut of choice.
For the last fifteen or so years, the paradigm has been 'we need more demand, right-wing governments cut taxes to try and get more, left-wing governments spend more'.
Now we're in the other side of the macroeconomic cycle - low unemployment and high inflation, and the last time we had inflation this high was around 1990. Governments I suspect simply do not have an institutional culture that tells them to cut back on spending, delay or cancel tax cuts, etc, in this situation. It's been too long.
I don't think the currency would've been worthless, but a good example of what this sort of decision-making would look elsewhen would've been a government drastically cutting spending a little ways in to the Global Financial Crisis and the recession that came with it. That sort of decision would've sent shocks into markets not just because it was a bad decision, but also because the bad decision showed an immense lack of judgement.
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The UK has been in a slow-motion crisis since, arguably, 2008 . It's thing after another: 2008-2010 (such as Greece and Portugal sovereign debt defaults), Brexit, Covid, Russia's invasion of Ukraine, 2022 inflation surge, etc. Dollar-adjusted GDP is unhanged in 13 years https://i.redd.it/ndb3h3pgpyf31.jpg [1]
The problem is, the whatever problems the US faces, such as inflation ,recession, Covid, or banking crisis, ripples to the UK but only worse (50-80% energy inflation for the UK & Germany compared to much less here). Also, a major difference is, the US quickly recovers from its crisis but the UK, Germany, France, etc. do not. So it's one thing piled on top of another. Things never get better.
The UK doesn't have much going for it...it's hard to attract capital, financial or cognitive. Ireland was smart to turn itself into a tax haven, which helped attract capital and raise GDP and standards of living relative to neighboring countries. The difference is stark: https://upload.wikimedia.org/wikipedia/commons/0/0f/Historical_economic_growth_of_Ireland_and_the_UK.jpg
Some of it its own doing , like Germany's dependence on Russian natural gas, which worked well until 2022. But the UK also affected by this.
Regarding tax cuts, this creates a debt-to-currency-collapse spiral, similar to in the situation in Turkey over the past decade. No new wealth is actually being created despite efforts at stimulus or monetary policy, because any growth engendered by said policy is negated by the falling currency. The result is no net creation of wealth. The US in the privileged position of being able to stimulate its economy to get out of recessions fast without losing wealth due to currency decline. Breaking out of this spiral requires net foreign inflows.
[1] https://greyenlightenment.com/2022/09/03/europes-lost-decade-the-crisis-is-overseas-not-here/
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