Buttonwood

Sauce for a Brussels goose

Billions depend on the choice of a discount rate



DIVORCES are rarely easy. In the 16 months since Britain voted to leave the EU in a referendum, the negotiations have made little progress. One of the trickiest aspects is the amount that Britain should pay to meet its existing spending commitments for EU programmes.

This is not analogous to dividing up the bill in a restaurant, and deciding who had the lobster and who stuck to the mixed green salad. Take the cost of EU officials’ pensions. The tricky bit in calculating it is that pensions are long-term commitments; a bureaucrat who starts work in Brussels today might still be collecting a pension 70 years from now. Working out the cost is fiendishly complicated, requiring estimates of how much wages will rise (if the pension is linked to salary) and how long employees will live. Then the sum of future benefits has to be discounted at some rate to work out the current cost; the higher the discount rate, the lower the presumed expense.

The EU doesn’t pre-fund pensions for its officials; it pays them as they fall due. So the calculations don’t need to involve any assumptions about investment returns. But the cost estimate needed for Britain to pay its “fair share” will depend on what discount rate gets used.

And that could be the subject of a big dispute.

In its annual accounts, the EU calculates a pension liability of €67.2bn ($79.3bn). This is based on a discount rate of 1.7% in nominal terms and 0.3% in real terms (after inflation). This cost has jumped from around €35bn in 2011 because the discount rate has fallen sharply. This rate has not been plucked out of thin air; it is based on the interest rates paid on EU government debt. An agreement to pay a pension is, after all, a debt like any other. So it may seem that there is little to argue about; Britain should simply cough up its share of €67.2bn.

However, when it comes to calculating the contributions of employees, the EU uses a completely different approach. As a Eurostat document shows*, the discount rate in these numbers is a 22-year average of real government-bond yields. This includes the period from 1995 to 2000, when real rates were often 4% or higher. The result is a nominal discount rate of 4.8% and a real rate of 3.1%.

Up until 2012, the EU used a 12-year average of bond yields. But it is steadily moving to a 30-year average by 2021, which means that those high real yields from the late 1990s will stay in the numbers for longer. The remarkable result is that while the discount rate in the balance-sheet calculations has been falling, the discount rate used for the contribution of officials rose in 2016. The good news for employees is that they were required to contribute 0.5% less of their salaries than would otherwise have been the case.

Had the EU used the discount rate it applied to its balance-sheet to calculate the size of contributions, its officials would have had to stump up a lot more—resulting in significant cuts in take-home pay. So it is understandable that it has softened the blow. But Britain is surely at liberty to argue that what is sauce for EU bureaucrats ought to be sauce for British taxpayers as well. Bruegel, a think-tank in Brussels, concluded that, if this more generous discount rate were used, the British pensions bill would fall by between a third and more than half. In cash, that could be €2.5bn-4bn.

All Britain has to do, then, is argue this case. But EU negotiators might ask how Britain calculates the pension liability for its own public servants. Unfortunately, the accounts of the England and Wales teachers’ pension scheme show a real discount rate of just 0.24%. That would undermine the logic of the British argument.

Another approach might be for Britain simply to pay its share of the pensions bill every year; after all, that is what the EU does at the moment. Then Britain would not be “punished” by the use of a historically low discount rate. But the snag would be that Britain could still be paying out for some bureaucrats in the 2070s, creating the kind of festering sore that the country’s tabloids will complain about for decades (and demand that some future government repudiates).

Perhaps some cunning British civil servant has found a way of escaping this dilemma. When Buttonwood contacted the Department for Exiting the EU (DEXEU), he was told it was a matter for the Treasury; the Treasury said it was a matter for DEXEU. There was no news on whether either department planned to hold its Christmas party in a brewery.


* “Pension Scheme of EU Officials (PSEO): Actuarial assumptions used in the 2017 assessment”. June 2017.


There are alternatives: late Brexit or no Brexit

Two years was never going to be long enough to repatriate responsibilities

by Philip Stephens





Amid the noise everyone can cling to one certainty. Whatever the terms — cliff-edge exit or amicable separation — Britain will leave the EU at the end of March 2019. It says so in Article 50, and the treaty cannot be gainsaid. Wrong. It is time to add third and fourth options to the miserable confusion that is Britain’s effort to leave its own continent. Brexit could be delayed beyond 2019. And it is not impossible that it will be abandoned.

Pace the conspiracy theorists among Brexiters, there is no secret plan to thwart them. Rather, politics and bureaucratic circumstance are driving events in their direction. Donald Tusk, the president of the EU council, gave voice to the thought when he spoke in the European Parliament. It is “up to London how this will end,” he said. “With a good deal, no deal or no Brexit.” Mr Tusk, an intelligent and generous man who represents Europeanism at its best, weighs his words carefully.

“No Brexit”? To suggest that the 52:48 per cent vote in 2016 does anything but bind the nation in perpetuity has become a heresy. Burning at the stake is too light a punishment for those who dare suggest that unfolding realities might give cause for sober second thoughts. These are “enemies of the people”. The Brexiters are blind to irony: self-styled champions of parliamentary sovereignty they decree that parliament be denied the final say in the outcome. Democracy must make way for majoritarianism.

For all that, the Conservative party’s ideologues have a problem. They can hound Theresa May. True to character, Boris Johnson can whisper and plot against the prime minister. The foreign secretary might succeed in toppling her. But on one thing he is bluffing. Mr Johnson does not have troops at Westminster to implement his infantile vision for something called “global Britain”.

The EU27 have been accused of dragging their feet. Time is on their side so they have indeed been using the leverage. This is what happens in negotiations. The real obstacles to progress, though, have always resided in London.

What is missing is a cabinet consensus as to the shape of a final settlement. The faultline lies between sensible folk like Philip Hammond, the chancellor, who want to preserve significant post-Brexit access to the single market, and those who want to dispense with all ties to Brussels in the blind hope that business would thrive within a World Trade Organization framework for EU trade.

I am told that Mr Johnson’s response when presented with inconvenient truths is to cover his ears and hum the national anthem until the bearers of the bad news go away. One of the things that gets him humming most loudly is the hard evidence that falling back on WTO rules would decimate Britain’s professional services businesses.

Until the impasse is broken — and it is hard to see how it will be — neither negotiations in Brussels nor preparations in London for Brexit can proceed at a pace. Whitehall public servants say two years was never going to be long enough to repatriate responsibilities devolved to Brussels during more than four decades. More than a year has already been wasted. And in the absence of political direction, a post-Brexit transition period would simply shift the cliff edge into the future.

This is not just about setting up new customs arrangements, as complicated as that will be. Brexit demands an entirely new national infrastructure of regulation, standards-setting and oversight. Oh, and environment, fisheries and farm policies. Big government, you might call it. And nothing can be done until the cabinet agrees on the extent of future divergence from Brussels.

Even then the prime minister has still to reach a deal with EU27. She can take nothing for granted — even her proposed two-year transition. “Why should a non-member state have access to the single market?”, an ally of German chancellor Angela Merkel asks curtly. As for the final destination, Berlin is clear. Britain can have a Norway-like arrangement or it can spend five years or more seeking a trade deal that significantly limits access to the single market.

Put all this together and it is obvious the Article 50 clock is ticking too fast. Mrs May privately has already accepted the need for a three-year transition. That may not be enough. Though an outline divorce agreement could be completed during 2018, parliament will then demand its say. Those at the sharp end of Brexit are beginning to think the actual date of departure may have to be put back a year or two. There is nothing to stop Mrs May asking for such a delay.

The still more intriguing possibility, though, is that the prime minister fails to secure cabinet support for any arrangement acceptable to the EU27 and yet cannot get through parliament any deal (or no deal) that would win the backing of Mr Johnson and co. Deadlock.

The assumption has been in that in those circumstances Britain would simply crash out of the union. But would that be possible if parliament had not put in place anything to replace EU laws? Watching the country fall to political crisis, would a responsible prime minister really chose economic anarchy over the dispatch of a short letter to Mr Tusk, asking, with all due humility, if Britain might change its mind? The writer at present is a Richard von Weizsäcker Fellow of the Robert Bosch Academy in Berlin


Why Luck Is the Silent Partner of Success

scale of luck and skill


Why do the rich underestimate the role of luck in their success? Why does that mindset hurt society? What can be done about it? These are some of the questions that Robert H. Frank, author of Success and Luck: Good Fortune and the Myth of Meritocracy, addresses in this opinion piece. Frank is an economist at Cornell University and an economics columnist for The New York Times. His books, which include Success and Luck and The Winner-Take-All Society, have been translated into 24 languages.

As the essayist E.B. White once wrote, “Luck is not something you can mention in the presence of self-made men.” Some people are of course quick to acknowledge the good fortune they’ve enjoyed along their paths to the top. But White was surely correct that such people are in the minority. More commonly, successful people overestimate their responsibility for whatever successes they achieve.

Even lottery winners are sometimes blind to luck’s role. In his 2012 book, The Success Equation, Michael Mauboussin describes a man inspired by a succession of dreams to believe he’d win the Spanish National Lottery if he could purchase a ticket number whose last two digits were 48. After an extensive search, he located and bought such a ticket, which indeed turned out to be a winner. When an interviewer later asked why he’d sought out that particular number, he said, “I dreamed of the number 7 for seven straight nights. And 7 times 7 is 48.”

The tendency to overestimate the predictability of events extends well beyond lottery winners.

The sociologist Paul Lazarsfeld illustrated this tendency, known as “hindsight bias,” with people’s reactions to a study that investigated how different groups of men adjusted to the rigors of military life. As he described the study to his subjects, its principal finding was that men who had grown up in rural areas adjusted far more successfully than their urban counterparts. Many of Lazarsfeld’s subjects reacted exactly as he had expected. Why, they wondered, was a costly study needed to confirm something so obvious?

The twist was that Lazarsfeld’s description of the study was a fabrication. The study had actually discovered that men who had grown up in urban settings adjusted to military life more successfully. If Lazarsfeld had reported the actual finding to his subjects, of course, they would have found it just as easy to construct a compelling narrative to explain its truth.

In similar fashion, when successful people reflect on their paths to the top, they tend to view their success as having been all but inevitable. In their attempts to construct narratives to explain it, they search their memory banks for details that are consistent with successful outcomes. And because the overwhelming majority of successful people are in fact extremely talented and hardworking, they’ll find many ready examples of the long hours they logged, the many difficult problems they solved, and the many formidable opponents they vanquished.

But as the psychologist Tom Gilovich has shown, they’re much less likely to remember external events that may have helped them along the way — the teacher who once steered them out of trouble, perhaps, or the early promotion received only because a slightly more qualified colleague had to care for an ailing parent. This asymmetry, Gilovich points out, resembles the one with which people react to headwinds and tailwinds.

When you’re running or bicycling into a strong headwind, for example, you’re keenly aware of the handicap you face. And when your course shifts, putting the wind at your back, you feel a momentary sense of relief. But that feeling fades almost immediately, leaving you completely unmindful of the tailwind’s assistance. Gilovich’s collaborations with the psychologist Shai Davidai demonstrate the pervasiveness of analogous asymmetries in memory. People are far more cognizant of the forces that impede their progress than of those that boost them along.

An unfortunate consequence of seeing ourselves as entirely self-made — rather than as talented, hardworking, and lucky—is that this perception makes us much less likely to support the public investments that made our own successes possible in the first place.

Being born in a good environment is an enormously lucky thing and one of the only lucky things we can actually control. Basically, we get to decide how lucky our children will be. But that requires extensive investment in the future, something we’ve been reluctant to undertake of late. Even as a shrinking group among us has been growing steadily luckier, a growing number of the unluckiest have been falling still further behind.

The good news is that we can easily do better. It turns out that when successful people are prompted to reflect on how chance events affected their paths to the top, they become much more inclined to pay forward for the next generation.

It would be a mistake, however, to think that simply telling successful people that they’ve been lucky will elicit this reaction. On the contrary, it seems to have precisely the opposite effect, making them angry and defensive. It’s as if you’ve told them that they don’t really deserve to be on top, that they aren’t who they think they are.

Consider Elizabeth Warren’s 2012 you-didn’t-build-that speech, in which she reminded successful business owners that they had shipped their goods to market on roads the rest of us paid for, they had hired workers educated at taxpayer expense, and they had been safe in their factories because of police and firefighters the community hired. In return, she then reminded them, the social contract asks them to pay forward for the next group that comes along.

It is difficult to spot anything controversial in these words. Yet shortly after she spoke them, the video of her speech went viral, provoking outraged comments by the millions.

No, simply telling rich people that they’ve been lucky won’t make them more willing to invest in the next generation. Mysteriously, however, an ostensibly equivalent rhetorical move seems to have precisely that effect: If you ask your successful friends whether they can think of any lucky breaks they might have enjoyed, you’ll almost invariably discover that they seem to enjoy trying to recall examples. You’ll see, too, that their eyes light up as they describe each one they remember.

Research has demonstrated that priming people to experience the emotion of gratitude significantly increases their willingness to incur costs to promote the common good. And people who recall instances in which they’ve been lucky reliably experience gratitude, even when there is no specific person to whom they feel grateful.

The economist Yuezhou Huo, for example, asked one group of people to list three external causes for something good that had recently happened to them, a second group to list three personal traits or actions that had contributed to the good thing, and a third group merely to report a good thing that had recently happened. Subjects received a bonus payment for their participation in this study, and Huo offered them a chance to donate some or all of that payment to a charity when the study ended. Those who had been asked to list external causes — many of whom mentioned luck explicitly — donated 25% more than those who were asked to name personal traits or behaviors. The control group’s donations fell squarely in the middle.

As psychologists have long understood, logically equivalent statements often elicit very different emotional responses. Calling a glass half empty, for example, conveys something quite different from calling it half full. So, too, with our statements about luck. Don’t remind your successful friends that they’ve enjoyed a bit of luck. Instead, ask them to recall examples of lucky breaks they might have enjoyed along the way. Even if their recollections don’t prompt them to adopt a more generous posture toward future generations, you’re bound to hear some interesting stories.


Doug Casey: How I Learned to Love Bitcoin, Part II

By Doug Casey, founder, Casey Research


In all of Africa, most of South America, and a great part of Asia, fiat currencies issued by governments are a joke. They’re extremely unreliable within those countries. And they’re totally worthless outside the physical borders of the country. That’s why those people now want dollars. But those are physical paper dollars. And governments everywhere are trying to eliminate physical currency.

I think, therefore, that the Third World will adopt Bitcoin in a huge way.

That’s not just because people who own cryptocurrencies are currently making money. They’re saving an appreciating asset rather than a depreciating asset. You’re on a Sisyphean treadmill if you try to save a Third World currency—but three-fourths of humanity has no alternative.

Nobody in these backward places wants to save the worthless local currency—but, by law, that’s typically their only option. Billions will try to get into Bitcoin.

These coins are also private. They can transfer wealth outside of the country, which is very helpful. Kwachas, pulas, pesos, and such are worthless outside of the countries that issue them.

Of course, governments hate that, and this will present a big problem down the road.

Governments hate Bitcoin. It gives their subjects a huge measure of extra freedom.

The whole Third World is going to go to these cryptocurrencies. They all have smartphones in these countries. A phone is the first thing they buy after food, shelter, and clothing. Bitcoin will become their savings vehicle.

Sure, it’s a bubbly market. But soon billions more people will be participating in it. So, it’s going to get more bubbly. That’s my argument for the bubble getting bigger, and the prices of quality cryptos going higher.

But like I said, cryptocurrencies are just the first application of blockchain technology. I think they have staying power simply because government fiat currencies are bad, and will be getting worse. They’re not going away. But I view them mainly as a speculative opportunity right now.

How high is Bitcoin going to go? Bitcoin is kind of the numeraire. It’s the gold standard, as it were, of cryptocurrencies. John McAfee, who founded the cyber security giant McAfee, Inc., thinks it’s headed much higher. He thinks Bitcoin’s going to $50,000.

That sounds outrageous, but it’s entirely possible. Another 10-1 in a manic market is possible—although it brings up thoughts of tulip bulbs, of course.

Remember, Central Banks all over the world are printing up fiat currencies by the trillions, desperately trying to put off a collapse of the world economy. Many will issue their own cryptos—they’re trying to totally abolish paper cash as we speak. And they won’t want competition from private currencies like Bitcoin. Governments may well try to outlaw peer-to-peer cryptos.

That’s a topic worth exploring. Governments are going to get into these currencies in a big way.

But only their own versions, probably making private cryptos like Bitcoin illegal. With paper cash no longer available, they’ll then be able to track absolutely everything that’s bought and sold.

At that stage—which is in the near future—the blockchain tech will have gone from one of the biggest pro-freedom innovations to one of the most repressive. Like gunpowder—first a liberator for the average man, then a means to suppress him. That said, technology, in the long run, is eventually always a liberating force.

And there’s one more factor that few are considering in the crypto revolution. They’re very good for gold. That’s because they’re drawing attention to the nature of the monetary system.

Something few people think about. At all.

When people buy these cryptocurrencies, even if they know nothing about hard money, economics, or monetary theory, they implicitly ask themselves, “Hmm, Bitcoin or the dollar?”

They’re both currencies. Then they naturally start asking questions about the nature of the dollar… the nature of inflation… and whether the dollar has any real value, and what’s going to happen to it, and why. Figuring out the differences between currencies—as opposed to just accepting the dollar and central banking as if they were constants in the firmament, which almost everyone does now—is part of a monetary revolution.

People are going to start asking themselves these questions—which wouldn’t have otherwise occurred to them. They’re going to see that only a certain number of Bitcoin will ever be issued, while dollars can be created by the trillions, by the hundreds of trillions.

That’s going to make them very suspicious of the dollar. It’s going to get a lot of people thinking about money and economics in a way that they never thought about it before. And this is inevitably going to lead them to gold.

So, the Bitcoin and cryptocurrency revolution will prove extremely positive for gold. It’s going to draw the attention of millions, or hundreds of millions of people, to gold as the real alternative to the dollar and other currencies, after Bitcoin.

Plus, I suspect future versions of Bitcoin, or Bitcoin 2.0, will be easily redeemable in gold grams. This is actually a big deal that most people aren’t looking at.