The Economist - Science and technology

Donald Trump is sending shockwaves through global commodities markets [YHIBLOG]

Thu, 26 Apr 2018 16:03:54 -0700

THE notion that the gentle flap of a butterfly’s wings can cause chaos on the other side of the world is well known. But commodity markets have been tested in recent weeks by what could be called the 800-pound-gorilla effect: the idea that chest-beating in the White House can unleash turmoil in global metals, agricultural and energy markets.

President Donald Trump has slapped sanctions on Russia’s biggest aluminium producer, Rusal, intensified a trade tiff with China and tweeted a gibe against OPEC, the oil-producing cartel. His actions have shaken commodity markets at a time when speculation in futures is near the record heights of 2012, making markets even more volatile (see chart). Aluminium, nickel and palladium prices have soared and then plummeted. Soyabean markets are under threat. Oil prices are at their highest levels for more than three years.

Physical trade has been affected too, with some shipments to Rusal of bauxite and alumina, the raw materials of aluminium, suspended for fear of sanctions-busting, and cargoes of American sorghum to China diverted in mid-ocean because of Chinese trade restrictions. Pushing oil prices yet higher is the possibility that Mr Trump could impose sanctions on oil shipped from Iran and Venezuela next month, tightening the global supply of crude just as America’s summer driving season starts. Geopolitics has often upset global trade in commodities. But rarely has America’s government been such a source of upheaval across so many markets.

Metals have suffered most directly. From April 6th, when America’s Treasury prohibited Americans from dealing with Rusal and its boss, Oleg Deripaska, and threatened sanctions against non-citizens who traded with them, aluminium prices rose by more than 30% as buyers scrambled for non-Russian metals. Then on April 23rd, when the Treasury temporarily softened the proposed sanctions to spare “the hardworking people” of Rusal and its subsidiaries, and said it might lift them on Rusal if Mr Deripaska ceded control, they gave up around half of those gains.

Nickel prices also soared until April 19th on expectations the sanctions could extend to Norilsk Nickel, a Russian producer. José Cogolludo, global head of commodities at Citi, notes bashfully that shortly before the sanctions-related rally, the bank had been telling investors that nickel prices would hit $16,000 a tonne by 2020. They reached $17,000 in days—before falling back when the sanctions were eased.

Mr Cogolludo says that hedging of metals reached unprecedented levels as corporate clients sought to protect themselves during the price moves and speculators tried to cover short positions. He adds that computer-driven models, which account for most speculative activity in metals markets, respond quickly to market signals but are rarely good at deciphering geopolitical risk. This may have led to overshooting.

Agricultural commodities have suffered collateral damage from trade tensions between America and China. After the Trump administration imposed tariffs on steel and aluminium imports in March, in mid-April China announced a 179% preliminary anti-dumping duty on imports of American sorghum, a niche animal feed. This stopped American exports, which account for almost all sorghum entering China, in their tracks.

More significantly, China responded to an American proposal in April to slap 25% tariffs on 1,300 goods from China by threatening similar levies on 106 American imports, including soyabeans and cotton. According to Stefan Vogel of Rabobank, 35% of China’s 97m tonnes of soyabean imports come from America, which are not easily replaceable. So the market is betting that China will not carry out its threats. But if traders are wrong, and a tariff war breaks out in earnest this summer, the disruption could be severe. He says prices of soyabeans in America would plummet. Those of soyabeans in South America, spared the Chinese tariffs, could soar.

Some say that Mr Trump is showing a pattern of making threats and then backtracking, which creates noise but does little lasting damage. That view may be tested in the oil markets on May 12th. The president has threatened to reintroduce sanctions on Iran unless Britain, France and Germany agree to renegotiate the Iranian nuclear deal by then.

Some oil bulls say Mr Trump’s nomination of Mike Pompeo as secretary of state and his appointment of John Bolton as national security adviser—both Iran hawks—have made sanctions likelier. These could remove at least 500,000 barrels a day of Iranian oil from a market that is already looking tighter because OPEC and non-OPEC producers have restrained output. Abhishek Deshpande, head of oil research at J.P. Morgan, says such sanctions could raise average annual oil prices by about $10 a barrel (Brent crude has been trading near $75). Additional measures threatened against Venezuela if elections on May 20th are not free and fair could squeeze the market yet more.

But Bob McNally of Rapidan Energy Group, a consultancy, argues that the impact of higher petrol prices on American drivers may persuade Mr Trump to accept compromises on Iran and Venezuela. Nerves ahead of mid-term elections, he reckons, explain the president’s first tweet aimed at OPEC. On April 20th Mr Trump blamed the cartel for “artificially very high” prices—although high prices are also a windfall for American shale producers.

OPEC ministers, disturbed by the tweet while at a birthday party in Jeddah for the organisation’s secretary-general, Muhammad Barkindo, were not conciliatory. They claimed, however implausibly, that they were not trying to rig oil prices. But they should beware taking Mr Trump’s ability to mess with the markets too lightly. With bullish bets on oil prices near record highs, it would not take much to trigger a sharp reversal. Just ask metals traders: the 800-pound gorilla can trash prices as well as push them up.

Finance and economics

Apr 28th 2018

YHIBLOG

Technology can tackle investors’ flaws [YHIBLOG]

Thu, 26 Apr 2018 16:03:53 -0700

TECHNOLOGY has transformed finance. Consumers bank and buy their insurance policies online. They use technology to manage their pensions and other investment portfolios. But can tech improve returns? Only if it is used wisely.

If it is cheaper to trade, then costs will take a smaller chunk out of long-term returns. Technology also allows fund managers to replicate stockmarket indices, giving investors access to broadly diversified equity portfolios for a fraction of a percentage point in annual fees.

But the ease and cheapness of trading, along with the vast range of options available, create a terrible temptation. Worldwide there are nearly 7,400 exchange-traded funds (ETFs) and related products. These funds are not used only by “buy and hold” investors. Nearly half of the top 20 traded securities on American markets, by value, are ETFs.

Just because you can trade does not mean you should. And just because there is a fund specialising in smaller Vietnamese companies, or one that bets on trends in volatility, does not mean you have to buy it. Men aged over 50 can go shirtless on sunny days or wear flip-flops. But that does not mean it is wise for them to do so.

Some professional investors make a virtue of incessant trading, with a holding period for shares of milliseconds rather than years. They can use computers to crunch data faster than anyone else and to exploit small differences in securities prices. This is a Darwinian business, in which everyone is incessantly improving their infrastructure and their algorithms to get an edge on the competition.

But by definition a majority of investors cannot beat the market, whether with frequent trading or any other strategy. Instead of chasing this chimera, ordinary investors should use technology to correct for their innate flaws.

First of all, many people underestimate how much they need to save to meet their long-term needs. Some of this is down to the difficulties involved in the calculations, which require people to make assumptions about longevity, inflation and future investment returns. Another problem is the natural human inclination to spend money today rather than to save for a distant, and uncertain, future.

Either way, such short-sightedness creates a problem. Take Americans aged between 40 and 55. The median balance in their private pension plans is just $14,500. Low interest rates were adopted by central banks in the aftermath of the financial crisis in order to discourage people from saving, and to help revive the global economy. The paradox is that low interest rates mean that savers need a bigger pension pot on retirement. They must save more, not less.

Technology can help deal with this issue. A good statistical model can tell individuals what pension pot they will need at retirement; what investment return they can reasonably expect; and whether they are on track for the target. If they find they are falling short of their goal, investors can save more or adjust their planned retirement date. Just being aware of the scale of the task can make investors change their behaviour.

Secondly, technology can help investors choose a strategy that avoids incessant trading. It is easy for investors to fall into one of two traps: making an arbitrary selection of assets in their 20s and never changing it, or relentlessly fiddling with their portfolio. Too many people fall into the trap of enthusing over fashionable sectors or hot mutual funds. If a sector is in vogue, it has already risen in price, so it is quite likely to be expensive relative to its history. By the same token mutual funds become hot because of their past performance, but there is very little evidence of persistence in returns.

An automated system can impose discipline. One possible approach would involve setting up a strategic asset allocation: say 20% to domestic equities, 40% to international shares, 20% to inflation-linked bonds and 20% to corporate debt. The portfolio could be automatically rebalanced once a year, or if the asset allocation strayed a long way from the target in the meantime. Such an approach would have the merit of buying assets when they have fallen in price (and are cheap) and selling them when they are dear.

In short, investors should not treat technology as the equivalent of a “diet pill” that will help them to lose weight effortlessly and instantly. Instead, they should view it as a tool to encourage the behaviour (the investment equivalent of exercising more and eating less) that will lead to long-term success. Think of fintech as one of those step-counting apps, nagging you to financial fitness.

Finance and economics

Apr 28th 2018

YHIBLOG

A new NAFTA may be agreed on soon [YHIBLOG]

Thu, 26 Apr 2018 16:03:53 -0700

ONE year ago, a member of President Donald Trump’s administration drafted a short executive order to withdraw America from the North American Free-Trade Agreement (NAFTA), a trade deal with Canada and Mexico. The obvious interpretation was that Mr Trump was irresponsibly bullying the Mexicans and Canadians into giving America better terms. A kinder view held that he was aiming at a domestic audience. Congress was dragging its feet at the time over the confirmation of Robert Lighthizer, the president’s chosen trade negotiator. Mr Trump’s threats were a way to kick it into action.

One year on, with Mr Lighthizer long since in place, America’s attitude to NAFTA seems no less hostile. Its threat of withdrawal still hangs over the talks, and in March Mr Trump waved the stick of tariffs on steel and aluminium in case a deal to revise NAFTA could not be reached by May 1st. This tough talk may yield an agreement within the next few weeks. Negotiators are working intensively in Washington, DC, with instructions to be available until May 4th. (Even after an agreement in principle is reached, it could take a little while longer to finalise all the details.)

The details of any deal would bear the scars of hard negotiations. Mr Lighthizer has demanded that a new NAFTA expire automatically after five years and wants to weaken a clause that allows members to dispute emergency tariffs imposed by their partners. If his team prevails, the revised pact would be a step away from the integrated North American economy that the original deal was supposed to foster.

Mr Lighthizer’s team has also demanded that NAFTA be stripped of provisions that allow investors to sue governments if they are denied “fair and equitable treatment”. He reckons that claims against the American government should be tried in American courts, and that offering legal protection for American firms abroad underwrites the outsourcing of jobs. The Canadians and Mexicans, not to mention some senior Republicans, all disagree.

These proposals could yet be dropped. It seems more certain that a new deal will contain tighter “rules of origin” for cars, which specify how much North American content a car must have for it to qualify for zero tariffs. The Americans’ latest proposal is to raise the requirement from 62.5% to 75%. Although this is lower than their original demand of 85%, it could still cause disruption as car companies either reconfigure their supply chains or suck up non-NAFTA tariffs.

A related idea, to give carmakers credit towards the content requirement if they use parts made by workers earning more than a specified wage, would find support among those who worry that free-trade deals typically encourage a race to the bottom. But it would find opponents too, mostly from Mexicans who might see it as a way of favouring American and Canadian workers at their expense, and from the car companies forced to comply.

Yet the true costs of the Trump administration’s aggressive approach may show up as the three members try to move from a deal in principle to a deal in practice. Each member must have the agreement approved by its legislature. That will be more difficult if Mr Trump continues to treat NAFTA as a zero-sum pact (even if Mr Lighthizer recognises publicly that all three sides must gain).

That said, in Canada winning a vote should be fairly straightforward, given the governing party’s parliamentary majority. And although some have worried that Andrés Manuel López Obrador, the left-leaning front-runner in Mexico’s presidential race, will try to renegotiate if he wins, his pick for economy minister said on April 18th that Mr López Obrador would respect a deal struck before the election.

Oddly, America’s Congress may prove trickier. There is precious little chance of putting a deal before legislators before the mid-term elections on November 6th, and none of forcing them to vote on a deal in their final session if they are reluctant to do so. Securing votes in a lame-duck session after the election might require enticing members of Congress with special provisions to their liking, perhaps on intellectual property or agricultural markets. But those are precisely the sorts of provisions that could be ditched by negotiators in the interest of concluding a quick deal. Republicans will not like a deal that strips out the investor-state dispute-settlement rules, or has an expiry date.

Rather than courting centrist Democrats or Republicans of the sort who might have voted for the Trans-Pacific Partnership, a trade agreement from which Mr Trump withdrew as soon as he took office, Mr Lighthizer has been engaging more with left-wing Democrats and trade unions. This is a risky strategy, as these groups may still be unsatisfied by whatever labour standards Mr Lighthizer can negotiate and be wary of the political costs of associating with Mr Trump.

Mr Trump could revisit his threat of a year ago to withdraw from NAFTA, a step Mr Lighthizer reportedly favours. Presented with an alternative of no deal, that could force Congress to approve the new version. But Congress could also fight back, either by reversing any American tariff increases or by inserting “riders” in other bits of legislation to strip Mr Lighthizer’s department of funding to implement the NAFTA withdrawal. Whatever happens, agreement in principle is only the first part of the fight.

Finance and economics

Apr 28th 2018

YHIBLOG

The lapsing of Finland’s universal basic income trial [YHIBLOG]

Thu, 26 Apr 2018 16:03:53 -0700

THE concept of a universal basic income (UBI), an unconditional cash payment to all citizens, has in recent years captured the imagination of a wide spectrum of people, from leftist activists to libertarian Silicon Valley techies. Proponents see a neat solution to poverty and the challenges of automation; detractors argue it would remove the incentive to work. Trials of UBI have been launched, or are about to be, in several countries. Most are publicly funded, although Y Combinator, a Silicon Valley startup accelerator, is starting a privately funded experiment in America.

Finland was one of the first movers. In January 2017 it began a trial for 2,000 people, each receiving €560 ($680) a month. That drew legions of foreign journalists and camera crews. This week, however, international media attention abruptly centred on the ending of the experiment in December 2018. Headlines suggested that it had been “scrapped” or had “failed”. The truth is more nuanced.

The trial was always due to finish after two years, although Kela, Finland’s national welfare body, which was responsible for the experiment, had hoped to expand it (it was denied funding in January). The scheme was also more limited than the hype suggested; it was not a truly universal benefit, because all the recipients were chosen from among the unemployed. And the trial is not ending because of failure. Indeed, Kela has refused to publish any results until it is finished, for privacy reasons and to avoid biasing outcomes. The government simply has other priorities. In particular, it has decided to adopt Danish-style active labour-market policies.

More important, the UBI trial was always as much about the principle of policy experimentation as it was about the outcome. As Heikki Hiilamo of Helsinki University points out, Finland has tested policies before, such as a “full employment” trial which sought to provide a salaried job for every unemployed person in the small town of Paltamo. And the country is still keen on novelty. After the UBI trial, the government is planning to test a universal credit system.

In its desire to try new policies on a small scale, Finland is no different from many other countries. A study in five Dutch municipalities, billed by some as a basic-income trial, is in fact mainly focused on testing various options for unemployment benefits, dividing participants into three groups. (To be fair, one of these was supposed to receive something much more like a UBI before changes imposed by the national government.)

For all the hype around UBI, surprisingly few are using the most rigorous research approach—a randomised control trial. Y Combinator’s plan in America, as well as an experiment in Kenya run by GiveDirectly, a non-profit organisation, are exceptions. In the Kenyan project, 300 villages were assigned to four groups. In one, villagers get a UBI for 12 years; in the second, for two; in the third, they get a lump sum; the fourth is a control group. But all these trials are just getting started, and none has released results yet.

Meanwhile, other basic-income trials are going ahead. On April 24th the provincial government of Ontario said that it had successfully finished the enrolment phase of its UBI study, which has more than 4,000 participants in four towns. And in Scotland, four local authorities, including Glasgow and Edinburgh, are busy hashing out pilot projects to implement a basic income. Whatever the results of Finland’s trial, a definitive answer on how UBI actually affects citizens’ long-term behaviour is still many years away.

Finance and economics

Apr 28th 2018

YHIBLOG

A market-design economist wins the John Bates Clark medal [YHIBLOG]

Thu, 26 Apr 2018 16:03:52 -0700

BOSTON parents were fed up. To get their children into public schools they had to submit a list of their preferences. Spots were allocated first to those who put a school top. Only then would schools consider pupils who put them second or third. Sounds fair? Hold on. The best schools are popular. Picking them risks rejection. Good schools are sought after, too. If put second they may also fill up, leaving only places at worse schools. Should parents aim for the best and risk mediocrity, or settle for the good?

On April 20th the American Economic Association (AEA) awarded the John Bates Clark medal, given annually to a leading economist under 40, to Parag Pathak of the Massachusetts Institute of Technology. He researches market design—eg, creating mechanisms to allocate resources without money, such as school places in Boston. Solutions he devised there have been applied widely, from New York to New Orleans. The AEA says that by improving pupil allocation Mr Pathak had “influenced the lives of over 1m public school students”.

In Boston, as a graduate student at Harvard, Mr Pathak worked with his mentor Alvin Roth (since awarded a Nobel prize) on a new system. It asks pupils and schools to list each other from first to last. A computer program offers places to pupils that schools put top. Pupils take the best offer and reject the rest. Schools work down the list making fresh offers as rejections occur, with each pupil keeping a single, most preferred, offer. Parents no longer need strategies.

Mr Pathak has since pondered related questions, such as whether parents can truly judge schools’ quality. In Boston, he found that charter schools (public schools exempt from some regulation) improved the performance of disadvantaged pupils. Children randomly allocated places there tended to flourish; those elsewhere languished. Parents spotted high achievement, and applications rolled in. But in New York, where parents pay handsomely to live near elite schools, he showed that whether pupils just squeak in or just miss out, they do equally well and attend similar colleges. The best schools get the best pupils, but may not make them better.

When he was growing up in New York state, Mr Pathak “used to dream about attending a selective public school in New York City”. It seems that he needn’t have worried.

Finance and economics

Apr 28th 2018

YHIBLOG

The euro area’s economy loses momentum [YHIBLOG]

Thu, 26 Apr 2018 16:03:52 -0700

ECONOMISTS have spent the past decade wringing their hands over the health of the euro area’s economy. Last year, in a welcome respite, it expanded by a robust 2.3%, outstripping forecasts and matching America’s growth rate. But it has appeared less rosy-cheeked since.

Symptoms include moderation in a number of monthly indicators. Industrial production fell in January and February, as did business confidence; retail-sales growth was disappointing. The purchasing managers’ index (PMI), an output survey regarded as a good early indicator of GDP growth, has fallen from exuberant—and perhaps unsustainable—levels at the turn of the year, though it still points to decent growth (see chart).

Germany, the bloc’s largest economy, has not been immune. A summary indicator compiled by the Macroeconomic Policy Institute, a German think-tank, which includes production, sentiment and interest-rate data, suggests that the probability of a recession has risen, from 7% in March to 32% in April. A measure of economic sentiment based on a survey of participants in financial markets by the Centre for European Economic Research (ZEW), another German institute, has fallen sharply.

Many analysts think that at least part of the explanation could be a range of temporary factors, the equivalent of a sniffle rather than a severe infection. A cold, elongated winter across the continent, and a nasty outbreak of flu in Germany, may have depressed production and kept shoppers at home. Some German output was probably lost in February, when members of IG Metall, a large trade union for industrial workers, went on strike. But if this told the whole story, the euro area’s economy should be bouncing back by now. Although the whole zone’s PMI stabilised in April, some surveys in Germany and France dipped a little further.

Demand may have been weighed down by other factors. The waning impact of the European Central Bank’s (ECB) quantitative-easing programme could be a candidate. But the central bank’s regular survey of banks suggests that its accommodative monetary-policy stance continued to translate into looser credit conditions over the past six months.

Another candidate is the stronger euro, which may have held back exports. Although much of its rise took place last year, economists at HSBC, a bank, point out that currency changes typically feed through to the trade figures with a lag. Consistent with that, the zone’s exports fell in February; sharp falls in the PMI measure of manufacturing-export orders also point to a loss in momentum.

Barring further strength in the currency, this too should eventually pass. A complication, though, is the risk of a trade war, given the importance of exports for the euro area, and particularly Germany. The fear of protectionism could explain why some forward-looking indicators of sentiment have turned down, says Achim Wambach of the ZEW, though it is unlikely to have affected the hard data yet.

The ECB, which was meeting to discuss monetary policy as The Economist went to press on April 26th, will be watching closely for signs of more persistent weakness. One risk is that the slowdown indicates less spare capacity in the economy than expected, with less room for above-trend growth. But with inflationary pressure still subdued across the euro zone, policymakers may not be too exercised. That said, the cyclical peak in growth may be past. As spare capacity is used up, most forecasters expect growth in the zone to slow gradually over the coming years, towards its long-run potential rate.

And here a more chronic problem surfaces. In its World Economic Outlook, released last week, the IMF opined that medium-term growth in the single-currency bloc was likely to be only 1.4%, “held back by low productivity amid weak reform efforts and unfavourable demographics”. The hand-wringing continues.

Finance and economics

Apr 28th 2018

YHIBLOG

Regulating virtual currencies and ICOs [YHIBLOG]

Thu, 26 Apr 2018 16:03:52 -0700

THE pattern is familiar. Computer geeks develop technology that threatens to overturn established markets and habits. Regulators then scramble to understand and tame the beast. This is what is happening in the financial world in the wake of an explosion of crypto-currencies. Over the past year the pool of virtual currencies has both deepened, from $30bn to $400bn, and widened, with the spread of “initial coin offerings” (ICOs, a form of fundraising in which investors in young companies are issued with virtual tokens). Hedge funds, students and pensioners have all been caught up in the crypto craze.

This worries authorities, because the crypto-sphere is far from risk-free. Valuations can leap and plunge: after a giddy rise, between December and February the price of bitcoin dropped from nearly $20,000 to less than $7,000. (It is now around $9,000.) Several ICOs have turned out to be scams. Legitimate tokens are in danger of being stolen. Some crypto-currency exchanges have been hacked.

In response, national authorities are starting to think seriously about a legal framework for finance’s unruly frontier. Regulators fret about how to classify ICOs and tokens (are they securities, or not?) and how to tax them. They want to stop their use for such evils as money-laundering and financing terrorism. And they worry about how to protect retail investors from the risk of losing their shirts.

Indeed, scarcely a day passes without a supervisor somewhere calling for tighter regulation, or taking action. On April 6th the Financial Conduct Authority in Britain warned firms offering services linked to crypto-derivatives that they were subject to its rules. On April 10th Taiwan’s finance ministry said it was planning crypto regulation aimed at money-launderers. On April 17th New York state’s attorney-general asked 13 crypto-exchanges for information about their operations, conflicts of interest and safeguards for customers.

Regulators are plotting together as well as separately. When the governors of the G20 countries’ central banks met in Buenos Aires in March, crypto was high on their agenda. They agreed that at present these assets are too small to be of systemic importance, but they committed themselves to extending standards to which financial institutions already adhere—such as know-your-customer (KYC) rules and procedures for monitoring unusual transactions—to the crypto-world, in order to thwart the illicit use of virtual currencies.

When bitcoin entered public awareness it was chiefly as a facilitator of anonymous, illegal sales on the “dark web” and as the currency of choice for online ransoms. Many in law enforcement thought its anonymity would make it ideal for criminals of all stripes. But until recently evidence of this was scarce. “The overwhelming view was that crypto-currencies had great utility to cyber-criminals but limited use to other criminals,” says David Carlisle of the Royal United Services Institute, a think-tank. Volatility and illiquidity limited their use for money-laundering. But evidence that crooks are making more use of them is mounting (see article).

The most logical parts of the crypto-infrastructure to regulate are the platforms on which virtual currencies are exchanged for ordinary money. Several countries, such as Australia and South Korea, already do this. The EU’s fifth anti-money-laundering directive, which was passed by the European Parliament on April 19th, also includes measures to regulate exchanges. But many places have no rules at all.

That may suit many crypto-entrepreneurs, but not all. Several exchanges are, for example, voluntarily implementing KYC standards (eg, by asking new customers to prove their identities), banning coins promising extra privacy or using software to monitor unusual transactions.

Agreed rules would help to tie exchanges into the mainstream banking system. Many of them currently choose unfussy jurisdictions or institutions, because conventional banks will not serve them. Lenders are wary both of credit risk and of abetting crime if exchanges don’t police users. Proponents of regulation say that once exchanges operate in a clear legal framework, those risks should be reduced and banks will take them on. That in turn will make it easier to keep an eye on exchanges.

Regulators disagree about consumer protection. Some see shielding investors from harm as their job; others think people should be free to gamble if this poses no wider risk. Many have warned investors to be wary of ICOs. Some authorities want both to protect consumers and to allow legitimate crypto-businesses to flourish in their jurisdictions. Gibraltar already licenses some crypto-companies. France is working on a system of voluntary licensing. Iqbal Gandham of CryptoUK, which represents some of Britain’s largest crypto-companies, believes such initiatives could help legitimate businesses gain access to banks and perhaps even advertising. “We also don’t want to have criminals on our platforms,” he says.

Authorities also worry about taxation. They spy a new source of revenue: because trading crypto can be lucrative, they are keen to levy capital-gains tax on any profits. And they fear losing existing income: virtual currencies might be used to hide money. Because most exchanges have operated in the dark, reliable data on crypto-evasion do not exist. Most countries are still working out how to define tokens, let alone tax them. Some are stepping up, however. In February Coinbase, an exchange, said it had unsuccessfully fought an American court order and would have to hand the identities of 13,000 customers to the Internal Revenue Service. Other exchanges have fled to offshore jurisdictions with more favourable tax regimes.

With so many poorly understood risks, some regulators think the only safe answer is to shut the whole crypto-sphere down. China, for example, has banned ICOs and exchanges. But elsewhere this is neither desirable nor practical (it requires tight censorship of the internet). Crypto-enthusiasts see parallels with the early days of the internet, when authorities also strove to control a new arena—and declared it a nest of criminality. Most countries have since decided that the web’s benefits outweigh its costs. It is too early to say whether this will be true of crypto-assets or the blockchain technology that underpins them. But it would be wrong to outlaw them before knowing the answer.

Finance and economics

Apr 28th 2018

YHIBLOG

Crypto money-laundering [YHIBLOG]

Thu, 26 Apr 2018 16:03:51 -0700

AS LONG as dirty money has been around, so has money-laundering. Between $800bn and $2trn, or 2-5% of global GDP, is washed annually, estimates the United Nations Office on Drugs and Crime. Criminals have swapped money for precious metals, mis-stated invoices, rinsed cash through casinos or simply strapped it to their bodies and flown to places where banks don’t ask questions. Now they have a new detergent: crypto-currencies.

Such data as there are suggest that crypto-laundering is still a small share of the whole. But crypto-currencies’ attractions—global availability, the speed and irreversibility of transactions and the ability to hide identities—are plain. Rob Wainwright, head of Europol, Europe’s police agency, has estimated that 3-4% of the continent’s annual criminal takings, or £3bn-4bn ($4.2bn-5.6bn), are crypto-laundered. He thinks the problem will get worse. America’s Drug Enforcement Administration believes international gangs are using crypto-currencies more.

Dirty cash—from drug-dealing, say—can be washed by converting it into crypto, splitting it into smaller amounts and moving it through the crypto-sphere, perhaps via several virtual currencies. Dirty crypto, for example from a ransomware attack, can be similarly swapped around—often at high speed (“atomic swaps”) and in little chunks (“micro-laundering”)—until it is clean enough to be switched into ordinary money.

Authorities are slowly catching up. Last month a Briton was jailed in the Netherlands for taking €11m ($13.2m) in dirty bitcoin from criminals, converting these into ordinary money through his bank account, withdrawing the cash and returning it to the crooks, minus a cut. But professional launderers are using more sophisticated methods, often mixing old and new ways to evade detection, says Michael McGuire of Sussex University.

Europol recently uncovered how European crime bosses used crypto to pay a Colombian drug cartel for cocaine. European henchmen visited crypto-exchanges to convert euros into anonymous virtual currencies. These were sent to a digital wallet registered in Colombia and swapped into pesos on an online exchange. The pesos were withdrawn in cash, which local “money mules” spread over dozens of bank accounts, in sums small enough to avoid suspicion. The cartel bosses got the money by withdrawing the cash or by e-transfer.

“Sticking £10,000 down your underpants and flying to Zurich is still quite a common and easy way to launder money,” says Mr McGuire. But he warns that as governments work to get cash off the street and crack down on other ways of washing money, cyber-laundering may well be the future.

Finance and economics

Apr 28th 2018

YHIBLOG

Many results in microeconomics are shaky [YHIBLOG]

Thu, 26 Apr 2018 16:03:51 -0700

MICROECONOMISTS are wrong about specific things, Yoram Bauman, an economist and comedian, likes to say, whereas macroeconomists are wrong in general. Macroeconomists have borne the brunt of public criticism over the past decade, a period marked by financial crisis, soaring unemployment and bitter arguments between the profession’s brightest stars. Yet the vast majority of practising dismal scientists are microeconomists, studying the behaviour of people and firms in individual markets. Their work is influential and touches on all aspects of social policy. But it is no less fraught than the study of the world economy, and should be treated with corresponding caution.

For decades non-economists have attacked the assumptions underlying economic theory: that people are perfectly informed maximisers of their own self-interest, for instance. Although economists are aware that markets fail and humans are not always rational, many of their investigations still rely on neoclassical assumptions as “good enough” descriptions of the world. But this “101ism”, as Noah Smith, an economist and journalist, calls it, is less prevalent than it was in the 1950s and 1960s, when researchers like Gary Becker reckoned everything from crime to marriage could be described in terms of rational self-interest. Since the 1970s, as Roger Backhouse and Béatrice Cherrier describe in “The Age of the Applied Economist”*, a new collection of essays, the field has taken a decidedly empirical turn.

Most influential economic work today involves at least some data from the real world. Many economists made their names by finding unique datasets containing “natural experiments”, in which a change in policy or conditions affects only parts of a population. This allows researchers to tease out the effect of the change. In a famous example, published in 2001, John Donohue and Steven Levitt used variations in abortion laws across states to conclude that legalising abortion had been responsible for as much as half of the decline in crime in America in the 1990s. Other economists used randomised controlled trials (RCTs) to generate experimental data on the effects of social and development policies. In RCTs randomly chosen subjects are given a “treatment”, such as a microloan or a school voucher, while those in a control group are not. The behaviour of the two groups is then compared.

These developments have led to better, more substantial research. Yet they have also exposed economics to the problems bedevilling most social sciences, and some hard sciences, too. Researchers can tweak their statistical tests or mine available data until they stumble on an interesting result. Or they read significance into a random alignment. Economics, like other social sciences, is suffering a replication crisis. A recent examination in the Economic Journal, of almost 7,000 empirical economics studies, found that in half of the areas of research, nearly 90% of those studies were underpowered, ie, that they used samples too small to judge whether a particular effect was really there. Of the studies that avoided this pitfall, 80% were found to have exaggerated the reported results. Another study, published in Science, which attempted to replicate 18 economics experiments, failed for seven of them.

Even when a study is perfectly designed and executed, the result is open to interpretation. Environmental factors such as changing institutions or social norms inevitably play some role, but researchers cannot fully account for them. The results of an experiment conducted in one country might not be relevant in another, or in the same country at a later date. Research may suffer from more than one of these problems. Critics of the paper by Messrs Donohue and Levitt reckon, for instance, that the authors’ computer code contained an error, that they used a measure of crime that flattered their results, and that they neglected the possibility that differences in the change in crime across states were caused by differences in factors other than abortion laws. (The pair conceded an error, but responded that taking better account of confounding factors did not weaken their conclusion.)

Small wonder that economists struggle to answer seemingly straightforward questions, such as how minimum-wage laws affect employment. In 2017 two teams of researchers released assessments of a change in Seattle’s minimum-wage laws within days of each other. Each came to wildly different conclusions (continuing an established pattern of such research).

New techniques could help. Machine learning, in which computer programs comb through vast datasets in search of patterns, is becoming more popular in all areas of economics. A future beckons in which retailers know virtually everything about every transaction, from the competing products buyers considered before their purchases to their heart rates at the moment of payment. That could mean better predictions and policy recommendations without a smidgen of economic analysis. But pitfalls are already apparent. The algorithms used are opaque. And getting access to the richest data will require researchers to work with, or for, giant tech firms which have their own interests.

Read the small print

Economics enjoys greater influence over policy than other social sciences. Striking new findings are publicised by researchers and their institutions, promoted by like-minded interest groups and politicians, and amplified by social media. Conflicting results and corrections are often ignored. Being alert to the shortcomings of published research need not lead to nihilism. But it is wise to be sceptical about any single result, a principle this columnist resolves to follow more closely from now on.

Sources:

"The age of the applied economist: the transformation of economics since the 1970s", Roger Backhouse and Beatrice Cherrier, November 2016.
"The impact of legalised abortion on crime", John Donohue and Steven Levitt, Quarterly Journal of Economics, May 2001.
"The impact of legalised abortion on crime: comment", Christopher Foote and Christopher Goetz, Quarterly Journal of Economics, February 2008.
"Measurement error, legalized abortion and the decline in crime: a response to Foote and Goetz", John Donohue and Steven Levitt, Quarterly Journal of Economics, February 2008.
"The power of bias in economics research", John Ioannidis, T.D. Stanley and Hristos Doucouliagos, Economic Journal, October 2017.
"Evaluating replicability of laboratory experiments in economics", Colin Camerer et al, Science, March 2016.
"Seattle's minimum wage experience 2015-2016", Michael Reich, Sylvia Allegretto and Anna Godoey, June 2017.
"Minimum wage increases, wages, and low-wage employment: evidence from Seattle", Ekaterina Jardim et al, NBER working paper 23532, June 2017.

Finance and economics

Apr 28th 2018

YHIBLOG