Archive for February 2012
How Many Years Purchase
From William Shakespeare to Jane Austin
It seems there were times when people better understood the relation between capital and income. In past times when people had stable money and more importantly stable interest rates and their mathematical faculties were neither suitable for fractions nor large numbers they cleverly converted income to capital and vice versa.
SEBASTIAN
I prithee, foolish Greek, depart from me: There’s
money for thee: if you tarry longer, I shall give
worse payment.Clown
By my troth, thou hast an open hand. These wise men
that give fools money get themselves a good
report—after fourteen years’ purchase.—Twelfth Night – Act IV
Land was seen as an infinite stream of income (the landlord would lease it to tenants, so the only cost was the purchase price) similar to a perpetuity that can be easily capitalised by dividing the yearly income on the prevalent interest rate. The purchase price divided on the income would give a multiple dependent only on the interest rate. If the interest rate was about 7% then the multiple would be about fourteen, a land would sell for fourteen times its yearly income or put more succinctly: “fourteen years’ purchase.” (today this is called Capital Cost)
“He is a man of very large property in Derbyshire, I understand.”
“Yes,” replied Mr. Wickham; “his estate there is a noble one. A clear ten thousand per annum.”
—Pride and Prejudice Chapter 16
Landowners, on the other hand, who owned vast estates did not really care about the price of their lands for two reasons: they had no intention of ever selling their land and the price was almost constant over long periods of time. They were basically living on fixed income or a perpetuity. The price of their estates can double or half without affecting their life, because their income is fixed. So a gentleman would not be known for his net worth but for his yearly income, for example: “his estate there is a noble one. A clear ten thousand per annum.”
From Francis Bacon to Bill Gross
Now I come to the subject at hand: Francis Bacon’s essay on usury. In my previous thrashing I skipped the part about setting up a primitive central bank to manage usury; today I handle it in detail. Here is the paragraph I skipped:
To serve both intentions, the way would be briefly thus. That there be two rates of usury: the one free, and general for all; the other under license only, to certain persons, and in certain places of merchandizing. First, therefore, let usury in general, be reduced to five in the hundred; and let that rate be proclaimed, to be free and current; and let the state shut itself out, to take any penalty for the same. This will preserve borrowing, from any general stop or dryness. This will ease infinite borrowers in the country. This will, in good part, raise the price of land, because land purchased at sixteen years’ purchase will yield six in the hundred, and somewhat more; whereas this rate of interest, yields but five. This by like reason will encourage, and edge, industrious and profitable improvements; because many will rather venture in that kind, than take five in the hundred, especially having been used to greater profit. Secondly, let there be certain persons licensed, to lend to known merchants, upon usury at a higher rate; and let it be with the cautions following. Let the rate be, even with the merchant himself, somewhat more easy than that he used formerly to pay; for by that means, all borrowers, shall have some ease by this reformation, be he merchant, or whosoever. Let it be no bank or common stock, but every man be master of his own money. Not that I altogether mislike banks, but they will hardly be brooked, in regard of certain suspicions. Let the state be answered some small matter for the license, and the rest left to the lender; for if the abatement be but small, it will no whit discourage the lender. For he, for example, that took before ten or nine in the hundred, will sooner descend to eight in the hundred than give over his trade of usury, and go from certain gains, to gains of hazard. Let these licensed lenders be in number indefinite, but restrained to certain principal cities and towns of merchandizing; for then they will be hardly able to color other men’s moneys in the country: so as the license of nine will not suck away the current rate of five; for no man will send his moneys far off, nor put them into unknown hands.
—Essays, by Francis Bacon: Of Usury [my emphasis]
Bacon advocate low interest rate for two reasons: asset price inflation and increased risk apatite leading to economic growth. He also wants to give a monopoly to lenders who would only lend to merchants, at a lower interest rate than what prevailed before. I will discuss each point below and then comment about Bacon’s brooking (enduring or tolerating) of banks.
If the prevalent interest rate is 6% and it is cut by one percentage point then the value of an asset will rise from sixteen to twenty years’ purchase, but why stop there why not cut it by one more point and assets rises to twenty-five years’ purchase; cutting the interest to 3% makes assets worth about thirty-three years’ purchase. Thus halving the interest rate doubles the asset price. Only big speculators would benefit, those living on the income of assets (e.g. gentlemen, widows, pensioners) would gain no benefit and suffer from the inflation brought about by declining interest rates. The speculation in the price of tulips came after chartered banking spread in the Netherlands (see Chronology of Money below).
If interest rates are cut capital will indeed shy away from investments that pay less and that might lead to increasing productivity or seeking new avenues that pay higher. In reality technological (“industrious and profitable”) improvements takes long time to bear fruit and carries with it potential risk. Money would more likely seek profit in asset price speculation aided by falling interest rates. Again society would not benefit but only speculators. Capital would flow from industry to property and speculation, destroying the industrial base of the country.
The monopoly Bacon suggest is nothing but government chartered banks run by a central bank. Both the Federal Reserve and the Reichstag (of the Weimer inflation) were limited to discounting commercial notes with duration not longer than three months. Both were allowed, by hook or by crook, to first discount government notes and then government bonds. Both ended up as money-printing machines for the benefit of the government and financial elite. The commercial banks follow the central bank like ducklings following their mother into the path of traffic.
Now I solve the riddle of the banks: Bacon does not “mislike” them and yet he clearly is trying to put them out of business. Francis Bacon is the creature of big money oligarchy that formed around Elizabeth and flourished under the Stewarts. Banks at the time were goldsmith shops that had cash (gold & silver coins) accounts and lent money at interest—England oldest private bank C. Hoare & Co started like that—he wanted to expropriate their role to the benefit of others. As I showed elsewhere Bacon had the interest of big money oligarchy at heart, not the merchants or the small landowners. His fall would be at their hands, lead by Sir Lionel Cranfield an MP for Sussex and the son of a mercer. Twenty years after Bacon’s downfall merchants and small landowners would break six hundred years of tradition and behead the king. Bacon’s essay provides an economic insight into that monumental struggle. This essay was not idle philosophising, The Act Against Usury which reduced rates to 8% was enacted in 1621, the year of Bacon’s disgrace (see Chronology of Money below).
The reason I skipped this paragraph, despite its importance, was because Bacon’s plan has become our reality for the last thirty years. The following graph gives an idea of the prevailing interest rates for the last thirty years, it is the 30-years treasury yield from its peak in January 1982 to January 2012 (with a linear trend-line):
30-Year Treasury Constant Maturity Rate 1982-2012
(Data source: St. Louis Fed. Graph made with LibreOffice. Image created with GIMP)
Long-term interest rates went from about 11% to 3% in thirty years, the value of assets tripled as a result; thus Chinese officials who put earned dollars into long-term Treasury bonds saw the value of their bonds tripling from 40% to 120% of face value; coupled with constant exchange rate they earned huge profits. Everyone who speculated in assets got awarded thanks to the falling interest rate. Over the last thirty years the world has seen one bubble after another: the Japanese bubble, the Asian bubble, the Tech bubble, the housing bubble. Here is the view from the head of the world’s largest mutual fund:
Still, the primary way to coin money over the past 30 years has been to use money to make money. Although the price of it started in 1981 at a rather exorbitantly high yield of 15% for long-term Treasuries, 20% for the prime, and real interest rates at an almost unbelievable 7-8%, the gradual decline of yields over the past three decades has allowed P/E ratios, real estate prices and bond fund NAVs to expand on a seemingly endless virtuous timeline.
—Defense by Bill Gross.
The price of assets that speculators buy rises because of falling interest rate and not because of any intrinsic improvement done by the speculators; money makes money bypassing useful productive activity.
At the same time industry and small business has been destroyed. In countries like Spain and Greece the process happened much faster: falling rates after joining the Euro caused a bubble in properties and financial assets, that ended in a bust with small business bankrupt and cut-off from credit and unemployment at all-times record high (up to fifty-percent for the youth).
Some commentator repeat that there is little room to cut interest rates any more, but to obtain the same result (tripling of price) the long term rates has to be cut from 3% to 1%. After cutting the short-term rates to zero the Federal Reserve has moved to longer-term treasuries; today 93.6% of the treasuries it is holding will mature in over a year compared to 47.9% in January 2007 (I cover operation twist in Will the Fed ever Get Paid Back). The Fed recently announced a 2% inflation target, leaving the real rate of a 30-year treasury at 1%. There is no upward limit on inflation.
Bill Gross sees the abyss lying ahead and is preparing for it, those at the helm seem oblivious to the dangers ahead. Business, industry, employment, pensioners, savings, the dollar, the whole lot will be thrown into the abyss to save system.
See also:
- Chronology of Money: 1600-1699, spread of banks in the Netherlands and England.
- Professor Antal E. Fekete, covering the destructive effect of rising and falling interest rates on industry and finance.
- Bacon on Usury, refuting Bacon’s arguments in favour of usury.
- Bagehot on Money, a monumental five part series about finance and how banks works.
- Liquidating the Debt of the United States, graphs of falling interest rate and a numerical example about asset price and interest rate.
The Weight of the Net
Continuing with the idea of the last post, today we look at the ratio between social benefits to persons paid by the US government to Federal receipts.
Social benefits to persons as ratio of government receipts
Again this is the view from 1500 Pennsylvania Avenue (i.e. Department of the Treasury). While debt service is taking only one in ten dollars they receive, social benefits are taking almost the whole lot. Here is the FRED graph I used.
The Cost of Debt
The burden of public debt is usually measured compared to GDP, but that is an economist concept; I wanted to use a real tangible number.
I decided to look at the debt burden of the US federal government the way an accountant in the Treasury would. I divided the the government outlays on interest on two numbers: the government receipts and the total debt. Dividing on the receipts gives us the percentage of income that goes to servicing the debt. Dividing on the total debt gives us the effective interest rate.
The following graph shows the two ratios from the end of the sixties. Both government receipts and outlays are annual (fiscal year), while the the total debt is the amount at the end of the year.
Interest burden and effective interest rate 1967-2011
The total debt has tripled since the Clinton administration, but the effective interest rate has collapsed since then:
Effective interest rate 1998-2010
This is the view from 1500 Pennsylvania Avenue and there is nothing here that says “too much debt”. If you want to adapt the graph you can use this FRED graph to get you started.
See also:
The Catholic International State
In the Catholic Empire 950-1350 I wrote:
The history of the world knows many past empires, some are still visible others quite forgotten, but only one has been to a successful degree concealed from history and a veil drawn on its existence and the role it played in the history of mankind; a role that still echoes in our present life.
Once we view the medieval age in Europe as the age of a specific empire then we can understand the reason behind many events and see them as parts of a whole pattern, rather than just a series of random events. As a modest contribution I list here some of the most important dates in the history of the Catholic Empire
I have found an article by August Krey published in The American Historical Review in 1922 that exactly discuss what I would almost ninety years later independently discover. The author however uses the term “International State” to describe the empire, this might be to relate the empire to the then current discussion about setting up an international body to prevent another world war. Despite the difference in our nomenclature we both agree, as I will show, about the origin, function and demise of the empire.
I date the germination of the empire with the monastery of Cluny rise in 950 A.D., Krey writes:
Perhaps the first advance in this direction was the rehabilitation of monasticism through the founding of Cluny. That Cluny became an international force was the result of circumstances, not the least of which was its remarkable series of abbots. But there were others as well. Its location on one of the main highways to Rome advertised its virtues more widely than was the usual lot even of good monasteries. Most of all, however, Cluny represented a general desire. As requests came for its monks to establish similar houses elsewhere or to reform existing monasteries, the abbots laid down certain stipulations to guard against the relapses so general among religious communities. Related monasteries were to be subsidiary- their heads, priors trained at Cluny and subject to annual inspection- in short, the “congregation” of Cluny. Every house added to the Congregation meant just that much more subtracted from the mailed fist of feudalism and private warfare.
I marked the effective rise of the empire with the election of pope Gregory VII, Krey writes:
Of the various attempts to achieve international control in the Middle Ages only one need receive our serious attention, however high the hopes and ambitions of the others. This is the one headed by the papacy in the days from Gregory VII. to Boniface VIII.
I date the zenith at 1150, Krey describe it at that time so:
By the time of Innocent [III] the Church with the papacy at its head had become an international state. It had everything that a state has-and more. It could raise funds by direct taxation and raise armies equally directly. It could bring offenders to the courts of justice, and it had the means of executing its judgments. It applied its laws equally to peasant and king and it executed judgments against both. It controlled education, controlled the agencies of publicity, and controlled the courts. The social cares of charity and public health were in its hands. And on top of all this, it wielded the awful power of eternal life or death.
I describe the kings of England and France as warlords, Krey writes how they dismantled the empire from within:
Papal revenues for the maintenance of the international organization were attacked as unwarranted exactions for which society had no return and even the appeals to papal courts were denounced as venal devices. The kings contended that they maintained the peace, that they could offer impartial and speedy justice to all, and that there was no need to pay both papacy and kings for this service. This contention was supported in France and England before the end of the thirteenth century by the financial aid of the greater business interests and by the moral support of many of the local clergy. The Model Parliament of I296 and the Estates-General of 1302 will serve as concrete examples. And when, after I305, the Babylonish Captivity of the papacy made it seemingly subservient to the French crown, the international control by the papacy was practically gone and the era of unrestrained national warfare begun
The source for all quotes is:
August C. Krey
The American Historical Review , Vol. 28, No. 1 (Oct., 1922), pp. 1-12
Published by: The University of Chicago Press on behalf of the American Historical Association
Article Stable URL: http://www.jstor.org/stable/1835972
Jeremy Warner and the War Loan
In How to Honour your Financial Obligations I discussed the UK War Loan. Jeremy Warner of The Telegraph writes on his blog:
In their best selling book, This Time is Different: Eight Centuries of Financial Folly, Carmen M. Reinhart and Kenneth Rogoff describe the cut – from 5pc to 3.5pc – as a default, which actually it wasn’t, either technically or in any other regard.
The prospectus for the original war loan gave the Treasury the right to redeem the stock at any time. Given that interest rates had at that time sunk significantly below the original rate, all the Debt Management Office was doing was exercising its right to refinance the debt at a lower rate. There was nothing new about this exercise. The same thing had been done with a number of other government debts in the 1880s. These were swapped into “consols”, which like the 1932 War Loan, are still around to this day.
—Britain has never defaulted – or has it? (technical) [my emphasis]
Bond face value paying 5% interest at different interest rates
The terms of the War Loan was to repay the bond in 1947 and the Treasury had the right to redeem it at face value at any time. I have already explained in Liquidating the Debt of the United States that when the interest rate declines the value of a bond rises. The terms protected the Treasury, because declining interest rates means that deflation increases the purchasing power of money. The Treasury did not pay the face value of the whole War Loan, it swapped them for other bonds; the new bonds had a lower coupon and no redemption date. Here is the historical context from the Bond Vigilantes blog:
Another event that I would classify as a default was the changing coupon on the gilt known as War Loan. Issued in 1917 (“If you cannot fight, you can help your country by investing all you can in 5 percent Exchequer bonds. Unlike the soldier, the investor runs no risk”, the adverts said), the bond’s coupon was reduced from 5% to 3.5% in 1932. You can read Chancellor Neville Chamberlain’s speech announcing his plan in Hansard, here. This was a voluntary conversion – you could have had your money back – but the moral screws were on. Chamberlain ends his speech saying “For the response we must trust, and I am certain we shall not trust in vain, to the good sense and patriotism of the 3,000,000 holders to whom we shall appeal”. 92% of holders accepted the new, lower coupon (probably not just for patriotic reason, but because 3.5% was still a better rate of interest than was available elsewhere in those deflationary times). Today, we have seen the ratings agencies classify similar events as defaults, even if such disadvantageous changes were consensual.
—What happened the last time the UK defaulted? [my emphasis]
Contrary to what Mr. Warner states it was a voluntary restructuring with 92% of the holders agreeing. If the terms gave the Treasury the right to exchange the debt with another debt, there would have been no need to consult the holders. As the link between gold and the pound was severed in 1931 the value of the loan declined drastically.
We’ve written about War Loan before it was issued during World War I with the 1917 advert stating “if you cannot fight, invest all you can in 5% bonds. Unlike the soldier the investor runs no risk.” The “no risk” bit wasn’t strictly true. In 1932 its coupon was “voluntarily” reduced from the original 5% to 3 1/2% – I’ve argued before that this should be viewed a default event for the UK Government . Additionally, because inflation has at times been way above 3 1/2% in the intervening decades, the real returns have therefore been sharply negative, and as recently as 1990 the bond traded at a price below 30 pence in the £.
—Will the Debt Management Office redeem War Loan? [my emphasis]
Jeremy Warner himself confess that: “Since 1932, [inflation] has utterly destroyed the value of of the £1.94bn of war loan outstanding.” Today the total notional value of the War Loan would buy less than one half of one percent of the gold that it would have bought a hundred years ago.
Lost value against gold between 1900 and 2012
Coins in Hyperinflation
The three most clicked links on my blog are:
Click for a better view
Two of the first three are images in the post Metallic value in Euro coins published only 14 months ago. Despite coming three years after the start of the blog it grabbed the first and third places; traffic is driven by search engines. Clearly people are wondering, just like I did, what is the real value of a coin. I designed the worksheet so that I can update the prices and get new ratio’s, but, unfortunately, I don not have access to it presently.
The interest, and problem of rising intrinsic values, is also present in the US. A recent CNN article gives valuable information about the situation in the US (the article is worth reading, I am only quoting the part about intrinsic values):
The raw material cost of the metals used in a current penny is only about 0.6 cents per coin, according to prices quoted on the London Metal Exchange, and a breakdown of a penny’s composition from the mint. The mint paid 1.1 cents on average for the metal used in a penny in 2011, but that is the cost of ready-to-stamp blanks from the supplier, not raw material traded on commodity markets.
There have been times in recent years when a run-up in zinc and copper prices has taken the raw material value of a penny above one cent.
That’s the case for a nickel today. Its more expensive metal mix means the raw materials in each are worth almost 6 cents per coin, based on current market prices.
—Obama wants cheaper pennies and nickels [my emphasis]
A penny (1 cent) has 60% ratio, while a nickel (5 cents) has 120% ratio. Before you rush out to get nickels you should be aware of the law:
The US Mint specifies that this coin weigh 5.000 g and be composed of 25% nickel (1.250 g) and the balance of copper (3.750 grams). On June 13, 2008, the value of the metal in a United States nickel coin reached $0.06013, a 20.3% premium over its face value. This was due to the rising price of copper and nickel and the decline in value of the United States dollar. In an attempt to avoid losing large quantities of circulating nickels to melting, the United States Mint had earlier introduced new interim rules on December 14, 2006 which criminalized the melting and export of cents and nickels. Violators of these rules can be punished with a fine of up to $10,000, five years imprisonment, or both. See Title 31, United States Code Section 5111(d). The rules were finalized on April 17, 2007.
—Nickel (United States coin): Metal value [my emphasis]
Think about it for a second: the government uses force to make you accept pieces of metals for more of their intrinsic value and the same government uses force to prevent you profiting from the same pieces of metals. This law will hold as long as the punishment is greater than the reward, as the ratio rises the coins will have to be withdrawn (see Metal Theft in the United States at Wikipedia for more information).
I wrote it once and I will write it again: all persistent inflation is hyperinflation! When inflation is followed by deflation that restores the lost value and then some, one can talk about ‘inflation’. Inflation that is never balanced by deflation and accumulated lost value that consumes 99% of the currency is hyperinflation, regardless of the time-scale. When prices doubles every month and you live from pay-check to pay-check, everybody can see the ‘hyper-’, when prices double every twenty years such things are not mentioned in polite society. If, however, your time-scale is measured in decades you will be suffering from all the ills of hyperinflation without even realising (or daring to mention) why.
Governments cannot change the composition of coins every decade, because all vending machines, counting machines, fraud detection machines would have to be changed. Sometime a solution could be found, like after the inflation of the seventies, when all-copper pennies were replaced with copper-coated coins, but this is not the norm.
The US Dollar has lost 98% of its value against gold. The British Pound has lost 99% of its value against gold. This happened in the eighty years since the Great Depression. The Euro have lost about 75% of its value against gold during its 13 years of existence. At the end I can only repeat what I have already written: Coins are problematic in an inflationary environment due to their substantial intrinsic value compared to paper money, sooner or later their intrinsic value will exceed their face value.
See also:
- Beware the Boom! discussion of hyperinflation.
- Defining Inflation long-term graphs of the dollar.
- Zimbabwe’s Monetary Policy instead of learning from it the West made fun of Zimbabwe’s plight.
Old Britannia Fades Away
Two years ago to the month I wrote a post titled Will Britain Commit Naval Suicide? in which I posed the following question regarding the Falkland issue: “Are the British mad enough to send their fleet to its destruction in the south Atlantic? Only time will tell.” in response I got one comment from a reader who violently disagreed with my basic framework, he wrote:
William Dyce — Neptune Resigning To Britannia the Empire of the Sea (1847)
The fact of the matter is Brition stays on the island because the islanders want the british, if it were the other way around the British would of left years ago.
1. Study the war futher. The conflict was a counter opertaion to an invasion by a failing tyrannical dictator. A one off.
2. Study the history further Royal Naval history further before making any assumptions. The Argetine navy was sent packing early in the war.
3. Its accepted in Argentina that She benefited more from defeat than Britain did from victory. The country was returned to democratic rule only a year later
4. “Are the British mad enough to send their fleet to its destruction in the south Atlantic?”
The oldest, most experienced and one of the most advanced blue water navies in the world? Operated by a country that has no need/want to invade South America
5. The US served as a go-between in the diplomatic talks while Britian was rasing the fleet. This was not your war and downright shameful that you could conduct that it was somehow your victory. In fact, the US Navy stated the counter attack had no chance of succeeding.
Im sorry, Your pride disgusts me.—Ash writing on March the second 2010 [my emphasis]
After two years the subject of the Falkland Islands is heating up again, coinciding with the thirty years anniversary of the Falklands War. The trends for ‘falkland’ and ‘falklands’ are going upward on Google Trends, this is not only because of the anniversary, but a reflection of growing tensions concerning the islands:
Google Trends: falklands, falkland
The UK insists that current military operations in the Falklands, including the inclusion of Prince William as part of an RAF search and rescue mission and the deployment of a Royal Navy destroyer to the region, are “entirely routine”.
Argentina has made much of Prince William’s presence on the islands, with one government official comparing him to a “conquistador”.
While Buenos Aires has long claimed sovereignty over the Falkland Islands, the impetus appears to have returned along with the 30th anniversary last month of the failed invasion.
Tensions over the Falklands – which Argentina refer to as Las Malvinas – have been further fuelled by the discovery of possible oil fields in its territorial waters.
—UK and Argentina must stop ‘escalating’ conflict over Falklands, says Ban Ki-moon [my emphasis]
The past two years have provided more information, events have transpired, and now we can discuss the Falkland Islands constructively. I will answer all six points made by Ash. I am, of course, two years late to win a point against an anonymous commentator who probably never returned to my blog again, the reason I am finally answering his points is to better show my position and further our (my and the readers’) understanding of this situation, in particular, and the world around us, in general.
I have emphasised the six points I am going to answer in the quote above, I will number my answers and give them summarising titles.
1. British Intentions
It would be highly naive to ascribe good-intentions to any country’s foreign policy, let alone to an old empire like the UK. The British would not risk blood and treasure to satisfy the wishes of islanders on the other side of the globe. Their actions must have root in British material interests and a consistent British foreign policy. This is not a cynical or anti-British stance, it is simply realpolitik.
Britannia
There are many problems with the position that the Falkland Island sovereignty should be decided by the islanders, chiefly that the islanders are British colonists settling not earlier than 1840, today 90% of the islanders are of British descent. The other major problem is that about 3000 people are claiming rights over 12,000 square kilometres of land and sea, an area about third of the Netherlands which has a population of over 16 million.
In reality the islanders are British by citizenship (according to Wikipedia) and if they want to stay with Britain, they can easily relocate to it. Any good book about the Falklands war would give a more realistic view on the British intentions than “the islanders want the british”; the Argentinians seem to have an idea about Britain motives themselves:
Hector Timerman, Argentina’s foreign minister, accused the United Kingdom of using the wishes of the 2,500 citizens of the Falklands to remain under British sovereignty as an excuse to set up military bases in the south Atlantic.
His lodged an official protest at the UN in New York over the dispatching by Britain of state-of-the-art warships, war planes and, he claimed, a nuclear submarine.
—Argentina: Falkands are Britain’s ‘last refuge of declining empire’
2. Argentinian Intentions
There was certainly a “tyrannical” dictatorship in Argentina, that might have started the war to elevate certain local pressure, but Argentinian claims to the islands are very old and precede the British colonisation of the islands in 1840:
- 1945: Formation of the United Nations, Argentina states its claim to the islands in its opening address.
- 1946: Britain includes the Falkland Islands among the non-autonomous territories subject to its administration, under Chapter XI of the UN charter.
- 1947: Britain first offers to take the sovereignty dispute to the ICJ. Argentina does not accept.
- 1948: Britain again offers to take the sovereignty dispute to the ICJ. Argentina declines.
- 1955: Britain unilaterally refers the sovereignty dispute to the ICJ. Argentina indicates that it will not accept any judgement.
A long way to the other side of the world
The military coup was in 1976. It is exactly because the Falkland Islands are such a sensitive issue for the Argentinian national spirit that they chose to reclaim it thirty years ago. The notion that the Argentinian will forget about 12,000 square kilometres right in front of their shores and leave it in the hands of Britain is optimistic to say the least. The recent exploration of the Falkland waters for oil has only helped to crystallise the importance of regaining the islands for the Argentinian people.
Although patriotic fervor over Malvinas has remained high since the war, even intensified with the new diplomatic confrontation, a few Argentines are starting to question their country’s traditional hard-line attitude regarding the islands’ inhabitants. In the past this has ranged from affirming that they are actually Argentines to suggestions they should be evicted post-haste to Britain. “We have to move away from the old sloganeering,” says Gustavo Arballo, 36, a law professor at the University of La Pampa in central Argentina who recently penned a column in the left-wing daily Pagina/12 suggesting the islands should be granted wide autonomy in any future arrangement. “We’re a nation of 40 million against islands with only a few thousand inhabitants, that’s like an 18-wheeler bearing down on a bicycle.”
—Argentina and Britain’s Unfinished War: Hate E-Mail, Harassing Calls and Prince William
What has become different is the way Argentina approaching this subject, the crude military approach is gone and now there is a systematic approach: on the diplomatic front, the media front, the UN, the economic front, even the possibility of autonomy for the islanders. This time the Argentinians are playing to win.
3. Past Victory
The third point is sadly not a point in an argument at all. What is the point of stating that the Argentinian navy was sent packing thirty years ago? The comentator only provided another example to the English Empirical philosophy that I stated in the post itself: “[T]he English philosophy of Empiricism: What worked the first time must work the second time.” I really could not have asked for a better comment than the one Ash wrote, demonstrating my point.
Let us delve into the claim further: indeed the Argentinian navy was crippled after the sinking of the General Belgrano, but it was never the navy that constitued the major threat against the British:
The retaking of the Falkland Islands was considered extremely difficult: the main constraint being the disparity in deployable air cover. The British had total of 28 Sea Harriers and 14 Harrier GR.3s available for air combat operations, against approximately 122 serviceable jet fighters, of which about 50 were employed as air superiority fighters and the remainder as strike aircraft, in Argentina’s air forces during the war. The U.S. Navy considered a successful counter-invasion by the British to be ‘a military impossibility’.
Different types of Royal Navy warships since 1980
The Sheffield was sunk by a modern air-launched anti-ship missile. Both the Ardent and the Coventry were sunk by twenty-years old A-4 skyhawks dropping unguided bombs, despite those ships having the most modern anti-aircraft defences. Of course the times are not the times and a lot of things have changed in the past thirty years, mainly the decline of the Royal Navy. The biggest difference from thirty years ago is the loss of air cover:
The Royal Navy flagship aircraft carrier, HMS Ark Royal, will be decommissioned “almost immediately” rather than in 2014. The Joint Force Harrier aircraft will be retired. Both of these measures will save money for the purchase of the Queen Elizabeth class aircraft carriers.
The Sea Harrier flew almost three-quarters of the sorties in the Falklands War (see Air Campaign). Without the Harriers the last aircraft carrier the Royal Navy (the Illustrious) is used as helicopter carrier instead. Of course the UK has plans to build two bigger and modern aircraft carriers, the first will be introduced in 2020. The promise of a modern ship might not be fulfilled, this was clearly seen in the Falklands War when old aircraft’s sunk modern ships (the British should know this better than anyone, they crippled the Italian fleet with biplanes in WWII). A bigger question is whether the promised ships themselves will materialise, the financial crisis has cast doubt on the second and a sudden economic downturn might scuttle the whole project:
Construction stopped by 1992, with the ship structurally complete but without electronics. With the dissolution of the Soviet Union, ownership was transferred to Ukraine; the ship was laid up, unmaintained, then stripped. In early 1998, she lacked engines, a rudder, and much of her operating systems, and was put up for auction.
4. Argentinian Feelings about the War
After the war the military government of Argentina did indeed collapse and in its place came a liberal democratic government. The new government put the full blame of the defeat on the dictatorship, absolving the Argentinian people. This is an understandable reaction to defeat that has happened many times in history. It does not mean that the Argentinian people had no interest in claiming the Falklands.
The new liberal government made friends with the British, even absolving them from any legal responsibility for the sinking of the General Belgrano. That government and everything that it represented in Argentina collapsed in the economic crisis of 2001. Everything changed after the government default, the devaluation of the peso, the five presidents in two weeks, nothing was the same afterwards, including the Falkland issue. Clearly the Argentinian people have not ‘accepted’ defeat or resigned themselves to the status quo.
Argentinian protesters have marched on the British embassy in Buenos Aires, burning the Union flag, in protest at the Duke of Cambridge’s six-week deployment to the Falklands Islands.
A branch of the British owned HSBC bank was also attacked late on Thursday by a mob of 100 men armed with clubs, spray-painting it with “English out of Malvinas” – the Argentinian name for the disputed islands.
Quebracho, a hardline left wing group behind the HSBC protest, vowed to target a different British business every week as the relationship between the two countries plummeted to its lowest ebb since the conflict 30 years ago.
—Protests in Argentina as Prince William begins Falklands deployment
The great change that happened in South America means that any conflict (diplomatic, economic, etc.) between the UK and Argentina would probably escalate to become a conflict on the South American level. Not all countries would automatically support Argentina, but once they are involved it would mean that any future military conflict would involve them too. Argentina is claiming that British military presence in the area is a threat to the whole of South America.
Venezuela’s left-wing president has raised the stakes over the Falkland Islands by pledging his armed forces would fight alongside Argentina in any conflict with Britain.
The inflammatory promise from Hugo Chavez came in the run-up to the 30th anniversary of the April 1982 invasion of the islands by Argentina.
—Venezuela threatens Britain over Falklands as its president vows to side with Argentina
5. The Royal Navy
I do agree that the Royal Navy is old and by all accounts pass its prime. The sharp decline in the number of ships since the Falklands War and the loss of its aircraft carrier leaves it a less capable navy, but capable to do what? Ash says that Britain has no want or need to invade South America and I should quickly add nor do they have the capability to do so, today and thirty years ago.
The Falklands War was not about invading South America, it was about reclaiming islands 300 miles from the southern tip of Argentina after a half-backed Argentinian invasion. The whole operation was considered very difficult thirty years ago and there was a considerable risk, but the UK knew that the Argentinian did not have enough power to hold the Falkland against the whole might of the UK armed forces. A half-hearted try at reclaiming the Falkland would have ended in disaster.
The UK certainly wants and needs to maintain the Falkland Islands and the questions is: is the oldest navy still capable of defending the Falklands? Two years ago in a short post I considered that another war with Argentina would be naval suicide for Britain. This time around the chances of defeat are higher, those of victory are lower. The Argentinians are not going to repeat the same mistakes of the past. South America has changed considerably.
A defeat in the South Atlantic would not be an isolated event, but would have disastrous consequences, I once explained how a single day in war could change a country’s destiny:
British Overseas Territories
In a single day, the tenth of December 1941, attacks from Japanese aircrafts sank Prince of Wales & Repulse and broke the British power in Asia. The Japanese swept the British aside and advanced as far as Burma and would have gone further if it weren’t for the US victory at Midway.
The Falklands Islands are one of fourteen British Overseas Territories, all but four of them are in the Caribbean and South Atlantic including the British Antarctic Territory, which overlaps the Antarctic claims of Argentina and Chile.
In an interview with The Sunday Telegraph, the former head of the army, General Sir Michael Jackson, says defence cuts have made it “impossible” to win the islands back after a successful invasion, in the way the British task force did in 1982.
“What if an Argentinian force was able to secure the Mount Pleasant airfield? Then our ability to recover the islands now would be just about impossible,” says General Jackson, who was Chief of the General Staff until five years ago and led the army into Iraq.
“We are not in a position to take air power by sea since the demise of the Harrier force.”
Britain no longer has an aircraft carrier and the Harrier fleet which performed with such distinction during the Falklands War has been sold to the US Marine Corps.
—Britain could not reclaim the Falklands if Argentina invades, warns General Sir Michael Jackson
A military defeat or even a failure to reclaim the Falklands would open the door to further claims by Argentina and other South American countries. Argentina continues to claim sovereignty over South Georgia and the South Sandwich Islands. The reaction at home would also be extreme, the navy currently claims that a single ship could “take out all of South America’s fighter aircraft let alone Argentina’s,” failure would not result in rearmament, but rather extreme cuts in the navy. The less money spent on it the weaker it would get, the less it is capable of defending oversea territories on the other side of the world.
6. The American Position
South America is the backyard of the United States. As “leader of the free world” nothing happens without their involvement, overtly or covertly. Its support to the UK during the Falklands War is known:
The United States initially tried to mediate an end to the conflict. However, when Argentina refused the U.S. peace overtures, U.S. Secretary of State Alexander Haig announced that the United States would prohibit arms sales to Argentina and provide material support for British operations. Both Houses of the U.S. Congress passed resolutions supporting the U.S. action siding with the United Kingdom.
An important factor was military support. The USA provided the United Kingdom with military equipment ranging from submarine detectors to the latest missiles.
I am sure new books will be written as more information from the time is declassified. When the UK government took the gamble and sent a huge naval force to reclaim the Falklands, it forced the hands of the US and other European countries into supporting it. The current, and future, UK government will not take such a huge gamble again; the British military strategy for the Falkland is to keep a sizeable force stationed there at all times—air cover is provided by land-based air force aircraft’s—to prevent Argentina from taking it, eliminating the need for a force capable of retaking the Falkland.
Argentina is currently building domestic and South American support for its claim, while at the same time changing the status quo from normal relations to treating the Falkland as occupied territory. Currently they lack the military ability to retake the Falkland by force, but once taken they will not give it up easily and if Britain should try to retake it then it would be committing naval suicide.
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The Day after Tomorrow in Greece
A Big Mess
Now it seems that the end for Greece is near and that a default is due any day, well let us assume that such a thing will happen tomorrow, what should Greece do the day after tomorrow to rebuild its economy? Clearly Greece can not just wipe the slate clean and start with the same defunct economic structure all over again, what is needed is a radical rebuilding of the economic structures so that Greece will have a dynamic growing economy. We can change every aspect of society, but to be realistic massive social change needs a revolution and I don’t think that the Greek society is capable of one just now. This post will be confined to changes in government revenues and spending.
Effective Tax Rate in Greece
In 2010 the Greek government revenues were 39% of GDP and spending was 50% of GDP. In 2006 average net salary was $23,704 yearly. Effective tax on such income would be 8.8% to 15%. There is also a huge tax on labour, the “social security” tax:
Social Security Tax
An employer is obligated to deduct tax at source from an employee and to make additional contributions to social security as in many other EU member states. The employer’s contribution amounts to 28.06% of the salary. The employee’s contribution is 16%.
Value added tax—a tax on consumption that further inflate the cost of living and the cost of labour—is 23% and 13% for basic necessities.
An average working person in Greece will pay 16% so-called “social security” tax then 12% income tax, then 18% (average of 13 and 23) VAT tax. Combining all that tax it adds up to 39% tax on the working man’s labour, as I noted above the government’s revenue is 39% of GDP. The tax burden on labour is too high, for Greece to prosper this has to decline.
Corporate tax is 20% flat tax. Employers also pay 28% “social security” tax, this tax alone was 34.7% of the government’s revenue in 2009 (Eurostat). Of course this high level of taxation does not translate to high revenues, because of the high level of tax evasion:
Greece suffers from very high levels of tax evasion. In the last quarter of 2005, tax evasion reached 49%, while in January 2006 it fell to 41.6%. The Tax Justice Network has said that there are over €20 billion in Swiss bank accounts held by Greeks. The current Finance Minister of Greece, Evangelos Venizelos, was quoted as saying “Around 15,000 individuals and companies owe the taxman 37 billion euros”. Additionally, the TJN puts the number of Greek-owned off-shore companies to over 10,000.
—Economy of Greece [my emphasis]
In the tax game it is well known that the more one have the easier it is to avoid tax and even evade tax payment. Clearly the mess in Greece is killing the economy and the people, who have literally gave up on having babies and who would balm them if unemployment among 15 to 24 years old is 43.1% in 2011 (Greek unemployment: how bad is it for youths?)
The Way Forward
Greece has big problems and thus it needs big solutions to solve them. Technocrats and half-witted Harvard-educated politicians who wasted billions on the Olympics are the not the way forward. The government, a democratically elected one, has to package all needed reforms and hold a referendum on it and require two-thirds turnout and two-thirds majority to pass. It also has to ditch the cursed Euro and liberate itself from that straitjacket.
This is how you change from Euro to Drachma: declare all debts public and private internal and external are denominated in Drachma’s at the rate of 1 to 1, convert all bank accounts in Greece to Drachma’s at the rate of 1 to 1. Leave all Euro banknotes in the public hands. Apply severe capital controls to prevent capital flight. After the technical transition is done devalue the Drachma by 80% against the Euro, thus five Drachma’s equals 1 Euro. Let Euro banknotes be accepted as legal tender for a transitional period. Gradually lift the capital controls and float the Drachma.
Of course there is no point in going back to an inflationary Drachma, what is needed is a stable currency. Greece is fortunate in that it has a relatively large gold reserve. It would benefit greatly if its currency is linked to gold (Nathan Lewis discuss this in a series of articles).
What about taxes? One flat tax on all income, no deductions, no exemptions, no tricks: 15% flat tax on all individual and corporate income. Abolish fake “social security” taxes, abolish genocidal tax on consumption (VAT). Assets’ gain should either be treated as income and taxed accordingly or total assets should be taxed at a rate of 2.5%. That’s it, tax code in a paragraph.
The huge decline in cost of labour will make Greece competitive, the decline in cost of living will make it possible for Greek citizens to start a family. A concise and unchanging tax law (the super-majority referendum will ensure the flat tax is not changed by the parliament) will make it easier to invest and plan for the future.
What about spending? After a default and stable currency deficits will be a thing of the past. Spending will be in-line with revenues out of necessity. State owned enterprises should be run profitably whether they remain in state hands or sold (only if the economy is growing and the enterprise is profitable) becomes irrelevant when they are profitable.
Welfare payments have to be linked to revenues. The best solution would be to dedicate certain taxes to welfare, for example the 2.5% asset tax. All revenue should be distributed within the year to those who need it. No payment will be set in advance, payment amounts will depend on revenues.
All pensions and pension-related legislation should be abolished. If someone wants to save his money and invest it in whichever way he wants he may do just that, but if someone wants to spend all his money on his children and be dependent on them later in life he may do that instead. The government is clearly not able to guarantee future payments or enforce such payments.
[after writing this post I read an article by Nathan Lewis who advocate the same solution for Greece, of course my solution is his Magic Formula of Low Taxes and Stable Money. The only difference is that I think Greece should first devalue its old debt and then implement a stable currency.]
Sources:
- The Greek Tax Guide, source for the data I used to make the effective tax rate table and other information.
- Taxation in Greece, some information are outdated.
- Economy of Greece
- Taxation trends in the European Union 2011 Edition. PDF file.
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