Interesting Times?

‘May you live in interesting times’ – Chinese curse

The credit crunch may yet have a silver lining. The oncoming recession could well cause us pain, but the unwinding of toxic risk and firmer regulations will carry long-term benefits. Lessons are to be learned. Short-selling, souped-up derivatives , hollow ratings and 125% mortgages are all excesses of a Regan-Thatcher market gone berserk. Post-Enron, we saw accountancy reform. Investment banking is due for a similar audit.

Still “reform” is a funny word – like a host of other positive sounding terms (think “progressive”), the word comes straight out of the Tony Blair lexicon – all spin and no substance. Two parties, never averse to a little band-wagoneering, are using it a lot to lampoon a third. Hacks and politicians have joined forces to tut tut at the money men. Now, for sure, there is intelligent, intelligible discussion taking place in the corridors of power. There is also a lot of incisive commentary sharpening up the content of the business pages. Nevertheless the central tenet of our economy is not up for question. Whatever happens, interest, the lubricant for the borrowing-lending relationship, will remain indispensible to modern finance. Cheap credit will continue to be easily obtainable. Not only is the transaction recognised as efficient but also as clean and amoral. Yet it is worth remembering that it wasn’t always so. It took the Medici family to bank for the Vatican before the Church shook off its abhorrence to the practice. Nor was Christianity alone in its condemnation. Judaism, its Semitic sister, shared the moral revulsion. If Jesus confronted the extortion of the currency changers at the Temple, then Ezekiel’s revelation was more direct in its denunciation of usury.

It is an old truth that if theology is how the world should work, then economics is the way it does. True, the transaction in the time of the Prophets took on the form of loan sharking – while today rates are more affordable and less extortionate. Nevertheless it was pragmatism, far over ethical considerations, which succeeded in eroding away the question mark that hung over the practice. Yet pragmatism, itself, may cause us to revisit the issue. Given that the credit crunch could never have developed in an interest-free world, here is a question worth war-gaming. What it would be like in a world without interest?

Let us remember at the outset that zero interest and infinite interest are almost the same – borrowing becomes so prohibitive that either the lender or the borrower has no incentive to enter the transaction. A low stable interest rate however provides the key inducement – a 0% interest rate and a 0.5% interest rate will have radically different effects. At a low rate, the market comes to life as multiple borrowers and lenders engage in multiple one-to-one transactions at their negotiated convenience. Capital can flow through the system and the benefits are obvious. To abolish interest, today, would freeze borrowing-lending transactions, causing a sharp and prolonged contraction forcing the economy straight into recession.

Nevertheless the vitality that interest brings, comes at a price. Take the credit card. Consumer aspirations have swelled as wares have become so much more obtainable. Producers have been able to translate that raised aspiration to command a higher price. Flat screen televisions, designer shopping and Swedish furniture are luxuries only directly obtainable by the well-to-do. The less well off are left with two choices: to do without or to use their credit card. Too often the latter choice wins. Yet borrowing against tomorrow’s potential necessities for the luxuries of today must be among the greatest follies of modern consumerism. It is a reasonable presumption that if credit cards were snapped up, people would be forced to live within their means.

Still there may be longer term, more entrenched, consequences. The credit card market makes up only a small segment of the global economy and is only of real significance in the West. Despite this, the size of the credit card market in revenue terms, belies its importance. The average citizen of the West has a far higher quality of life because credit enables him to have options regarding the choicest merchandise. The credit card is a vital window which gives access to our end buyer – but also has the large scale implication of realigning world produce. To remove the credit card would be traumatic for manufacturers abroad, as the First World’s demand for imported luxuries would wane. This realignment would see a whole economic infrastructure dismantled. Foreign manufacturers might well turn to providing bread-and-butter goods to their national internal markets – but they would be cut off from a lucrative avenue. In the end, consumerism as an ideology would be drastically questioned.

Our hypothetical world would also shock the housing market. Naturally, house prices would plummet as mortgages would no longer provide the means of purchase. Currently prices stand at the better part of a lifetime’s net earnings for the breadwinner. No longer. In contrast to the luxury sector, the housing market need not be destroyed. Instead, affordability would become the watchword of the sector. Under such a system, the subprime crisis would have never come to be, since the risk floating around on house buying would have been minimised.

Structurally however, perhaps it would be financing which would have to change the most. We have to think in world terms. As long as investors have the choice they will always re-route their money into locations where they can pick up the guaranteed returns that interest brings. Only a closed system can remedy that. Now history has shown us that the only viable closed system is the world itself. Therefore the abolition of interest can only be viable at a global level. The hope is that forced to use their investing nous, investors would take up Foreign Direct Investments. New forms of development loans farmed out on the basis of profits and equity may evolve. Finance might shift to being less about speculation and more about development. This would be especially the case with banks, which, whilst retaining depositors, would have to shift their operations entirely to maximising the benefit out of the liquidity in their coffers. Given that trade is not zero-sum growth – the key beneficiary would be an efficient manufacturing industry, to whom our finances would be rewired.

A discussion on this topic would not be complete without considering the inflation-interest nexus. It remains an irony that the highest banker in the land, Mervyn King, seems to be reduced to the Homer Simpson of the banking world, moving the interest lever up and down to check inflation while encouraging growth. True, higher interest rates curb price inflation by slowing down borrowing. Yet as argued earlier, a no-interest world is intuitively parallel to an infinite interest world. We might just as well need to think in terms of deflation instead. In any case a system of capital controls should do just as well to address conceivable issues. Remember, borrowing will transform, not die. In our hypothetical world those transformations will need to be addressed, as and when they arise.

So should we look forward to zero-interest world? The question revolves around sustainability. Unsurprisingly there are a lot of unknowns lurking in unchartered waters. Yet one thing remains certain. Easy credit will have to be rethought. After all, whatever the pros and cons of free interest, there is no such thing as free money.

Robin Hood Medicine

Nye Bevan, the Welsh Labour Minister was a through and through socialist when he founded the NHS. His argument that “no society can legitimately call itself civilized if a sick person is denied medical aid because of lack of means” struck a chord and became the constitutional principle for the institution. With its 60th birthday this year, we are left to ponder upon its respective merits and flaws, and as ever the arguments revolve around resources, human capital and management. Criticism, being what it is, is easy to mete out, while praise is considerably harder. It took the Guardian journalist Will Hutton to put the brakes on and remind us not to flood ourselves with never-ending tabloid hysteria. A more sober appraisal is necessary. Let’s engage in some historical analysis.

Free healthcare, even within modern fields such as psychiatry, is not as new as one may initially presume. In the Middle Ages the Sultan Saladin ensured that Cairo had a functioning state mental hospital, something which the traveller Ibn Jubayr marvelled at, finding it staggeringly farsighted. Saladin, of course, is most famously known in the West for his battling against the valiant Richard the Lionheart while the big bad King John was crushing the mythical Robin Hood. The Sultan had his own system of take from the rich to give to the poor, he was using the Islamicate tax systems (as well as, arguably, the proceeds of a war-state) to cover his costs. Hospitals were not the only charitable institution that Saladin took an interest in, his endowments of educational establishments are especially well noted. Yet those had an obvious motive, they could act as centre of dissemination for his propaganda. His healthcare policy is more intriguing.

What does that Cairene hospital tell us which can inform us about today? I think we can legitimately derive a few things. Firstly free healthcare at the point of delivery, or at least at nominal cost, was a feat performed by the nation state long ago (purists will be upset that I took up the 12th Century when I could have gone back to Haroun al-Rashid’s Baghdad hospital, built some twenty-score years earlier). Granted, hospitals would have, at best, provided coverage to the city population, whilst today the West expects nothing less than full nationwide coverage, yet it should be remembered that the maintenance of the hospital was historically thought of as the (surplus) duty of the sovereign power. Within living memory, Reagan used lingering anti-Communist sentiment to convince his people of the imbalance of allowing healthcare into the hands of Government. Yet, somewhat ironically, the Sultan’s endowment shows us that “socialist medicine” predates socialism. Secondly, healthcare was emerging as a right. To be sure, at the time, the people of Cairo must have regarded it as a favour and not as the Sultan’s obligation. However one only need consider the how the discussion about basic rights has developed. King John’s Magna Carter was extracted at the point of the barons’ blades – but habeas corpus is now enshrined as law. By now we should have matured into accepting the right of healthcare as a basic premise. If not, we are being put to shame by our ancestors.

Nothing brings into sharper relief the difference between British and US domestic policy than healthcare. Citizens west of the Atlantic have difficulty comprehending the rationing out of goods that government administration demands. Drugs not being supplied on the basis of quotas, waiting-lists ever extended, these are intolerable by the standards of the market. Yet is health to be treated as a consumer good? A pill or a potion which offers an immediate cure may well be, but the problems associated with chronic long-term illness cannot be so easily resolved by market forces. After all, ethical issues begin to intrude. Is it morally right to hinge a patient’s cancer treatment on the number of his credit card or the small print of his insurance policy?

For long-term illnesses, good healthcare at the point of absolute need may be virtually perfectly inelastic (a man dying of heart disease is not going to quibble about the numbers). However consumers may still gamble that the point of need will never arise. Not being insured is common as millions (47 as of 2006) leave their health on hold. Whatever the merits of the finite legislation introduced by the Bush administration to attend to immediate healthcare, it is obvious that it is the poor and disenfranchised who suffer the worst.

Yet we should not rush into easy exaggerations. Health indicators in the US are still very good. The key statistic, life expectancy, according to the WHO’s 2006 figures was 78, only five years short of the top figure. Further, the lucrative rewards on offer, which is made available by its peculiar system of healthcare funding, means that the States possesses the best doctors. As a result it also possesses the best training facilities, Harvard and John Hopkins being acknowledged as the world leaders. Meanwhile, in the UK, Blair’s reforms of the NHS (erratic doctors’ pay, over-management but decentralisation) have placed it under such strain that we may well be witnessing the beginning of the end game for Nye Bevan’s vision. What then? Perhaps, in the end, we will have to cede to the American way. Perhaps, but I hope not. After all the NHS is an established equilibrium. It would be foolhardy to increasingly work towards it privatisation. Do we really wish to open it to the forces of creative destruction?

The Benefits of Bootlegging Vodka

For those who are interested in a fast buck, here is a quick tip - the UK black market vodka business is a nice little earner. Rewards are so lucrative that bootleggers are not just interested in smuggling: they are willing to brew the stuff on home-soil. In May last year a lab technician, Mrydul Das was found guilty of having run an illegal industrial-scale distillery for two years. Considering that the venture was found to have netted seven million pound sterling, it is perhaps not so hard to see what Das’s motive was. Yet the market still remains something of an enigma – Britain isn’t Saudi Arabia – alcohol is neither illegal nor scarce. In Russia, where the consumption of counterfeit vodka kills five people an hour, the issue is price. Yet here for the cheaper brands, prices are near rock bottom. Why, then, are the bootleggers so successful?

To answer the question, we need to look a little deeper at the market strategy of the bootleggers. It cannot be sheer chance that they have targeted the vodka sector. Vodka production is relatively easy while its high ethanol content means that it especially addictive, ensuring repeat customers. Low production costs mean that, after plant installation and bottling, the bootleggers’ mark-up can be fairly high. The bootleggers favour targeting the bottom sector of the market. Das was manufacturing low-key supermarket brands such as Aldi’s Tamova Vodka and Nisa Today’s Kommisar Vodka. It seems that the plan was to gain legitimisation whilst capitalising on low consumer brand loyalty and quality expectations, helping the fraud remain discreet.

Das’s strategy of counterfeiting supermarket brands has proved popular with subsequent bootleggers. At the end of last month the Food Safety Authority (FSA) issued a warning about counterfeit bottles of SPAR’s Imperial Vodka being sold in non-affiliate stores. Das had also targeted the low-priced Scottish manufactured Glen’s Vodka, and it has since remained a favourite target of the black market.  Another development last month saw a woman admitted to hospital in Cambridgeshire after having drunk from a counterfeit bottle of Glen’s.

Though supermarket chains are not implicated, being the victims of the fraud, smaller retailers do stock the counterfeit products. At a guess, if a retailer is selling 20 70cl bottles a week of a £7-99 product with a £3-99 mark-up he is an odd four thousand pounds richer by the end of the year. That perceived profit may be offset by the fines that the FSA can mete out, running into hundreds per bottle. Yet it is clearly not enough. To challenge the network, the oxygen of distribution needs to be cut off. In cash terms, the consumer barely benefits – one counterfeit brand was found to sell only a penny less than the price of the genuine article. If we want to defeat the market, it’s the bootlegger-retailer link that needs to be smashed.

No doubt the FSA and the lawmakers will take royal exception to this, but they need to remind themselves that counterfeit vodka can result in the loss of life. In 2003 a 42 year old woman died in Scotland after having drunk from a beverage called Vodka Russia. Even if that is a rare occurrence, injury is not unheard of. The counterfeited SPAR products contain such an excessive amount of methanol that it could blind. A small-time shopkeeper, who should have been more suspicious about his back-of-a-lorry delivery, is selling on potential poison. He hasn’t tasted the product and is wholly ignorant of the health consequences of the bottle he is stocking. It might not be malicious but it is exceptionally reckless. If prison sentences are automatically meted out for any counterfeit bottle found, you can bet your bottom dollar that there will be a lot less van-men walking through the shop-door.