January 2, 2009 | posted by Michael Baxter in risk | comments (0) |

Article first published November 17 

You may have heard this one before, but supposedly around 16 million men alive today are descended from Genghis Khan. What has that got to do with the credit crunch? – well, actually, quite a lot.

The great Khan conquered more than half the world. And that was good news, not just for Tamujin himself (Genghis’s real name) but for his brothers, his cousins, and even his second and third cousins, even the ones that died before the great Mongolian empire was created. At least it was good for their genes.

The great evolutionary scientist Bill Hamilton from Oxford was supposedly in a pub on one occasion, when he was asked if he would jump into a river to save someone from drowning. It is said he grabbed a napkin, for jotting down some quick calculations, and announced: “No, but I would do it for two brothers or eight cousins.”

According to some scientists from the Royal Society B: Biological Sciences, it appears males have an incentive to be especially brave, and indeed aggressive, even if this usually results in failure.

The rare occasions when this strategy succeeds, yields benefits, in terms of reproductive success, that can be enormous. Not only is the gene relating to the successful individual then passed on, this also means that most of the DNA relating to that individual’s relatives are passed on, too.

If the purpose of evolution is the successful reproduction of DNA, then it makes sense to die childless, if that sacrifice ensures a close relative is unusually successful at reproducing.

Now reconsider this in view of research reported in the previous day’s FT.

Scientists from Cambridge reckon they have found evidence that entrepreneurs have enhanced activity in the “medial and orbital sectors of the prefrontal cortex”.

They found that entrepreneurs react to risk, such as in a gambling environment, in a different way from the rest of us. In short, risk taking seems to be hardwired into them.

From an evolutionary point of view, you can see why this is so.

Now see that in the context of bankers with their crazy risk taking in recent years. You can see where the gene that motivates them comes from.

It has all gone horribly wrong, of course.

But in the previous cycle, their madness funded technology. Bust followed, but the benefits of that boom could underpin growth for the next century.

And when you see it from the point of view of Genghis Khan, it all makes sense.

November 17, 2008 | posted by Michael Baxter in risk | comments (0) |

It is not generally known that this weekend’s meeting of the great and the good, designed to save the world, was all down to a communication error between the Brits and the French.

Gordon Brown and nearly headless Nick Sarkozy were trawling through the newspapers together, and in between reading about the X Factor, noticed that there was this thing called the Credit Crunch. “We have got to do summat about this,” said Gordon. To which his French counterpart replied “D’accord!, that’s a good idea”, and then started talking about the need for an economic summit.

Well, there was good news this weekend. The world’s leaders agreed to do nothing.

And, in this era when good news is so rare, let us celebrate this for a moment, and consider why the summit was such a resounding success.

Take the 1930s. Policy makers had lots of ideas for solving that crisis. First there was the Smoot-Hawley Tariff Act. You see, the poor beleaguered US manufacturers were suffering at the hands of vicious and unfair foreign competition. So, in its wisdom, the US government passed the Smoot-Hawley Act, designed to protect US businesses with the imposition of tariffs on 20,000 goods. What a sensible idea – as a result, of course, US businesses found they were able to sell more into the domestic market – until, that is, other countries across the world rather selfishly responded with similar measures. International trade dried up, US exporters found there was no market for their goods and services – and unemployment rather exploded.

Back then, of course, banks were allowed to fail. The US treasury secretary at the time, Andrew Mellon, was a great believer in letting businesses go bust. “Liquidate labor, liquidate stocks, liquidate farmers,” he said. “It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.”

That’s why, this time around, the Fed and Co. decided that allowing banks to go bust is a bad thing – learn from Mellon’s error. But not everyone believes Keynes’s idea of pumping up the economy with government spending was the solution to 1930s depression. Milton Friedman once famously said: “Inflation is always a monetary phenomenon.” And this works both ways – it means deflation is caused by not enough money – he believed the 1930s depression was as bad as it was because not enough money was in circulation. That, by the way, is a flaw in the gold standard. Those who say a return to the gold standard would bring stability to the economy, ignore innovation. What happens if the money supply is fixed and our ability to produce rises? – answer: deflation, and the stifling of further innovation.

The big problem you have with the economy is that overreaction can make things worse. In the US, the reaction to WorldCom and Enron was the Sarbanes Oxley Act. It led to an exodus of business from the US to the UK, such that when Ken Livingstone was in New York a couple of years ago, and he was asked why is London so successful, he said: “Two words, Sarbanes Oxley.”

This time around, the big ideas for change came from the French. They want to see a kind of global financial police force – let the regulator make sure banks never take risks again. Of course, a side effect of that may be less funding for business, but that won’t matter. After all, the state is far better equipped to decide which businesses should enjoy loans.

And yet, although Mr Sarkozy’s ideas were rejected, he was still able to present victory. “Never before have Anglo-Saxons agreed to subject rating agencies to oversight and regulation.”

He went on with one of those ‘but’ comments. You know, when someone gives you a compliment and then says… ‘but’. “I’m a friend of the US,” he said “but… it wasn’t always easy. We had to convince. It was a long night, there were misunderstandings to overcome, but that’s what dialogue is about,” said the French president.

Well, it appears the rest of the world are not too keen on the idea of a worldwide financial straight jacket.

But the danger still remains. Risk is not a bad thing. The credit crisis was caused because banks and investors thought property was a zero-risk way to riches. The truth is, you get nowt for nowt, and the property dream was only ever going to be that, a dream.

It wasn’t lack of regulation that let the world down – the causes of this crisis are far more complex than that. If regulation needs improving, then it needs to be willing to pay more to those who work in the regulation industry, and attract those who understand the financial markets more fully. But more regulation in the way the French are demanding can make things a whole lot worse.

We are left with one worry, however; this weekend’s summit did agree one thing. They agreed to meet again in April, and talk some more. Let’s hope they are not more successful, next time.

November 14, 2008 | posted by Michael Baxter in risk | comments (2) |

One of the big mistakes economists and politicians make is to assume we live in a more-certain world than we actually do.

Most of the big innovations, the Internet, computers, lasers, and even penicillin, were accidents. The Internet was originally designed as a method for protecting US data in the event of a nuclear attack. The innovation of the laser occurred when two researchers at Bell Labs were attempting to create a method for studying molecular structures. Penicillin was discovered after Alexander Fleming accidentally left a dish of staphylococcus bacteria uncovered – as you do – for a few days.

The key to innovation is doing.

Consumer spending can promote innovation, because the frenzy of activity that results can throw up all kinds of results by accident.

In the US during the 1990s, Wal-Mart seemed to lead US growth. At least, studies have shown that many of the changes in productivity that occurred during that time were led by the giant retailer and the new practices it introduced.

But, as a general rule of thumb, innovation comes via research. The innovation that occurs may not have been the thing its inventors were aiming for, but they are normally aiming for something.

And that tells us something. If the big ideas come by mistake, progress comes in the form of a kind of blindfolded stumble forward. Ask a politician what will happen next, and if he or she says “I don’t know,” their standing in opinion polls will sink like a stone. But the truth is, they don’t know that will happen next.

That is why economists so totally failed to call this crisis. They had no way of knowing. They are only any good at predicting the future, if it will be just like the past. Usually if you say next year will be like this year, you will be right. This can fool people into believing forecasters have some kind of prescience. The reality is that their ability to forecast is only accurate when not much is happening. (This of course begs the question, do we really need forecasters?)

The baby boomers are set to retire soon. The first of that generation will reach 65 in 2011.

These people can not eat money, or use it as fuel. Money is only effective if it is matched by production. Today, one of the arguments many are making against crashing interest rates is that it is unfair on savers.

But this argument misses the point. Saving itself does not create future wealth. What creates wealth is how the money that is saved is used.

If it is used to invest in property – pushing up house prices – then the final result is nothing. The country’s ability to produce hasn’t been affected one iota. For years, the baby boomers thought they could fund their retirement through the value locked away in their property. If some individuals are doing this, then for them that strategy may work. But if this becomes a national pastime, then since the country’s capacity to produce is unaffected, no one will be any better off. Savings would have been wasted.

But if, instead, the fall in sterling teaches the UK to focus its energy on producing goods and services that people abroad want – the result will be innovation in the way these goods and services are produced. And down the line, that means the UK will be able to fund its retiring baby boomer generation.

The snag is, we can’t say what form that innovation will take. All we can be fairly sure of is that innovation will occur. And that, of course, means risk.

But the commodity called risk is going out of fashion faster than anything else – even oil.

Here is the real irony. The last few years have seen two bubbles in the West. The first bubble changed the world, but it happened too fast, that is why dotcoms crashed. But many of the big changes we see today can be traced back to the investment craze of the late 1990s. The dotcom boom, in as much as it provided the framework for a new interconnected world – which helped create globalization, lower prices, and improved communications between scientific researchers – was a good thing. It was, if you like, a good bubble.

The bubble that followed it has no redeeming features whatsoever.

In a way, the property bubble occurred because people had reacted against risk. All that money quite literally went into the ether, and people said: No more, let’s invest in something solid, that we can see and touch, so property took over from dotcom as the new big thing. That was a mistake.

The biggest risk you can take in the modern world, is not to take a risk. The property boom and crash shows this to be true. Quite simply, investors were told there was no risk in investing in property. Banks funded the boom, because they believed investment backed by bricks and mortar was as safe as well, as safe as houses.

But to understand the factors that are really powering risk, we need to look into our own minds and something odd about human nature – and for that, read the next article.

October 31, 2008 | posted by Michael Baxter in risk | comments (1) |

Okay, so what has the Jonathan Ross–Russell Brand affair got to do with economics and the credit crunch? Answer, well actually, quite a lot. No doubt you are sick of reading about it, but perhaps this slightly different twist on the affair can shine some light on the big danger the economy faces right now.

Let’s get this bit out of the way first. The BBC messed up, so did its stars. But, equally, we would argue the media backlash, and indeed the backlash from politicians, has not only been out of all proportion, it has been scary too.

One of the comments made as criticism of the BEEB is that neither of the stars in question are funny. This is a ridiculous and, frankly, irrelevant comment. Humour is subjective, millions of people think they are funny, and in a democracy that should count for something.

What we are seeing is an example of the demographic shift. Baby boomers, brought up on a diet of Monty Python and Pete and Dud, have become all moral in their old age. The kids like their humour to be on the edge, they always do. But these days, as the population ages, marketing is being geared more and more to an older audience. When the baby boomers retire, who do you think will pay their pension? Answer, the next generation. They won’t able to afford to do so, but that is too bad, for they will pay it nonetheless. And they will for this reason. There will be too many baby boomers, forming far too high a slice of the electorate, to allow it to be any different. The power balance in the UK is moving from the youth to older citizens.

The furore over the Ross and Brand affair is an example of this. We have seen a clear generation divide in opinion.

Another interesting development of recent years has been the rise in the power of the press.   These days, our leading politicians dance to a tune played by the media. Gordon Brown’s first year as premier was characterized by U-turn after U-turn, whenever the media disagreed with him. It was as if our prime minister had said: “To those waiting with bated breath for that favourite media catchphrase, the U-turn, I have only one thing to say, you turn and I will follow.”

But then, this week, both Gordon and David Cameron made statements on the Ross–Brand matter. Can you believe that? We are in the time of an economic crisis – and our two leading politicians jostle with each other over who can sidle up the closest to the tabloids.

But the key issue is this. Risk is the building block of progress. Without risk we would never have left the trees. Not all risks come off. But history tells us that the benefits from the small number of risks that do come off, easily make up for all the failures.

The same argument applies to comedy. For every Monty Python, Black Adder and Fawlty Towers, there was a mountain of dross.

Comedy is not a science. You don’t really know what will work, and what won’t. Comedians take their cue from their audience. They are funny if their audience think they are.

The BBC should have acted quicker.

But we live in a world where those who take risks that don’t work are being pummelled like never before.

The media won‘t forgive risks that go wrong. But you can’t have innovation without failure. If we move into a world in which no one does anything unless they are sure it will work, we will find ourselves living in a world of decline, and a backwards march to a new Stone Age.

Risk is the building block of progress, and we are living in a world of politically correct dictatorship – a world ruled by media that have no intention of providing balance to any debate.

The backlash we are seeing today against risk is the single-biggest threat to future economic prosperity.