Tag: The Conversation

Australia’s AAA rating affirmed by Moody’s

From The Conversation.

Moody’s has reaffirmed Australia’s AAA credit rating, as Malcolm Turnbull seeks to put pressure on Labor and crossbenchers to pass measures to help repair the budget.

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Moody’s Investor Services said in a statement on Wednesday that reasons for maintaining the status quo were the expectation that Australia’s “demonstrated economic resilience will endure in an uncertain global environment”; its very strong institutional framework; and stronger “fiscal metrics” than many of its similarly rated peers.

The agency’s assessment notes that moderate nominal GDP growth will continue to dampen revenue and “the government faces political hurdles to the implementation of fiscal tightening measures, as it rules with a very thin majority in the House of Representatives and a splintered Senate. The effectiveness of fiscal policy may be undermined somewhat.”

Moody’s points to two factors that could push the rating down. One was if there was evidence that the economy’s resilience to negative shock was reducing, especially “if it led to severe challenges to the government’s or the banks’ financing from international investors”. The other was if there were “indications that the hurdles to fiscal consolidation are higher than we currently expect”.

In a speech to be delivered on Wednesday, Turnbull warns of the uncertain economic times and says if “we falter in our plan to transition the economy, there is a real risk of Australia falling off the back of the pack of leading economies”.

When parliament resumes the government will present an omnibus bill for multiple savings totalling about A$6.5 billion. It says these are savings Labor built into its pre-election figures.

Treasurer Scott Morrison said the Moody’s affirmation was a “welcome boost” as well as a timely reminder on the need for policies to keep the economy strong.

“Our AAA credit rating helps to keep borrowing costs low for businesses and consumers across the economy, as well as ensuring Australia is in a much stronger position in the event of any external shocks,” he said.

He said the agencies were sending a very consistent message about the government’s budget trajectory.

“The challenge is to see that budget supported by the parliament. We are having very constructive discussions with new crossbench senators,” Morrison told a news conference.

“As welcome as this result is today, and it is, we cannot take these things for granted.”

Morrison used the Moody’s point about the strength of the institutional framework to counter the Labor push for a royal commission into the bank.

“Our banking and financial system is one of the core pillars of our economy that underlie our prosperity into the future. You don’t go play politics with that. You don’t go messing around with the banking and financial system to make cheap political points,” he said.

Author: Michelle Grattan, Professorial Fellow, University of Canberra

How running companies for shareholders drives scandals like BHS

From The Conversation.

You might think the £423m Philip Green made from British Home Stores, which is now under administration, is a one off. Unfortunately, it is not. It is just one of the outcomes of our shareholder value-driven economy that is backed by business “common sense” and required by company law.

Let me explain. Company law requires directors to act in the interests of shareholders – it doesn’t require directors to preserve the company for the benefit of employees, BHS or otherwise. In other words, the law requires Green as a director to act in the interests of himself and his wife, as two of the major shareholders.

But there are legal limits to what shareholders can claim. The law is clear that while shareholders own a right to revenue they don’t own the company’s assets – so in law they are not owners. And there are rules about paying dividends – the sum of money paid regularly by a company to its shareholders – from company assets. There are also rules about what counts as a “realised profit” for the purposes of distribution. But there are ways around this.

How to make shareholder value

The first step is to avoid the scrutiny applied to public companies by becoming a private company. After Green bought the shares in BHS plc from Storehouse plc in May 2000, one of his first acts as director was to re-register it as a private limited company. A 75% shareholder vote is all that is required to do this – which was easy enough given the Greens’ shareholdings.

Then there is a finessing around what counts as a “distributable profit” – in law, this is accumulated realised profit minus accumulated realised losses. But in practice it is fuzzier.

With BHS it went something like this. BHS shares cost Green £200m in 2000, which was considerably less than the net assets of £388,086,000 shown in its accounts up to March 1999. However BHS profits had been patchy and the company had an image problem so Green acquired it at a bargain price. This bargain for the buyer is called “negative goodwill” and is shown as an asset on the company balance sheet – although it can also be shown as profit on the profit-and-loss account.

Negative goodwill enhanced BHS’s profit by more than £103m, and to further boost short-term profits, Green sold BHS property worth £106m to Carmen Properties – whose shares were owned by Tina Green. These were then leased back to BHS. These profits were cashed in as dividends: £166,535,000 in 2002 and £256,000,000 in 2004. As a result, little money was used for the business or for pensions and the company was loaded with debt.


The BHS brand will disappear from high streets on August 20 with the closure of the chain’s final stores. Martin Christopher Parker/Shutterstock

By 2004, BHS debts totalled £373,870,000 and net assets were just £5,358,000. For the remaining years of its existence, BHS languished in debt. No more dividends were declared for the Green family but they were repaid a £28,975,000 bond and their companies charged BHS an estimated £124,000,000 in rents.

Huge dividends were also declared in other parts of Green’s retail empire. Green purchased the shares in Arcadia Group, which owns Topshop, through a Jersey-based company, Taveta, for £866,395,000 – a sum which was mostly borrowed from HBOS. Green (as director) later transferred the shares to a newly formed company, Taveta Investments, for shares worth £2.3 billion, effectively revaluing the Arcadia shares – even though Taveta Investments was ultimately wholly owned by Taveta.

Taveta Investments then declared a dividend of £1.3 billion for its shareholders in 2005 – which ultimately went to the Greens as the shareholders of the parent company. By using Taveta Investments, Arcadia’s shares could then be revalued and owned by another company so that the increased value could be in some sense “realised” and qualify as dividends.

The revaluation obviously did not produce extra actual cash. But it did allow accountants PwC to approve the dividends, even though they were funded by loans. Green described it as “a technical move … approved by the courts, the Inland Revenue, our auditors Price Waterhouse Coopers, our lawyers Allen & Overy and our tax advisers, Deloitte”.

Squaring morality and the law

So was selling company assets and taking out loans to pay dividends wrong? While common sense screams yes – the law is not as clear and there is no suggestion that the Greens did anything illegal.

Private companies have much more freedom to transfer value to shareholders and need to disclose very little. Public companies that re-register as private companies are treated like small family concerns even where the business and the workforce are unchanged. In BHS’s case, the sale of assets and the taking of loans to fund dividends were a fatal drain on a business that employed more than 11,000 people.


Green speaks before parliament’s business select committee on the collapse of BHS. Reuters

On the other hand, negative goodwill does account for a bargain and a value for the company. The accounts were audited and they were signed off. Similarly, Arcadia’s shares had been revalued by a well-regarded firm – the accounts were upfront about these transactions and they were audited and signed off. And the directors successfully delivered returns for shareholders. Of course, they were the shareholders but that’s usual in private companies.

Green might have pushed the envelope a little – and how much he did will be key to establishing any possible liabilities or disqualification as a company director. However, what Green did for himself, company directors are doing for other shareholders all the time. Their remuneration and employability depends upon it. The pursuit of shareholder value destroys jobs, communities, innovation, investment and the long-term health of the economy, but as long it is a legal imperative, Green’s behaviour is just business as usual.

Author: Lorraine Talbot, Professor of Company Law in Context, University of York

The legacy of Glenn Stevens in three lessons

From The Conversation.

On September 18 2016, Glenn Stevens will end his ten-year mandate as governor of the Reserve Bank of Australia (RBA). His experience in the top job provides a wealth of lessons for the next generation of policymakers; that’s arguably his most important legacy.

RBA-Pic2A graduate from the University of Sydney and the University of Western Ontario in Canada, Stevens worked in the RBA research department between 1980 and 1992. He then held positions as department head, assistant governor (economic) and deputy governor. In 2006, he was appointed governor.

Throughout his tenure as governor, Stevens has had to deal with a highly volatile and generally fragile global economic and financial landscape. Domestically, he has been confronted with the end of the mining boom and a prolonged contraction of gross domestic product (GDP) below its potential level.

It is probably not an exaggeration to say that the ten years from 2006 to 2016 have been some of the most difficult economic times in post-war history. But it is exactly this highly complicated environment that provides a valuable learning opportunity for policymakers and for the economics profession more generally.

The monetary policy framework

The first lesson concerns the need for a “risk management” approach to monetary policy in a time of crisis.

The RBA’s monetary policy framework centres on an inflation target of 2%-3% on average over the medium term.

This means that actual inflation may deviate from the target in the short term in response to the cyclical conditions of the economy. For instance, when a negative demand shock reduces GDP below potential and causes unemployment to increase, reduced inflationary pressures allow the RBA to stimulate the economy by reducing the cash rate moderately.

In September 2008, when the global financial crisis hit the world, Australian inflation had been above target and on the rise for three consecutive quarters. This should have made the RBA prudent in cutting interest rates.

Instead, conditions worldwide were such that a change in monetary policy thinking was needed. The risks were simply too large to be treated with a normal policy approach.

Accordingly, the RBA moved to a “risk management” approach that, while broadly consistent with the flexible inflation-targeting framework, allowed for a quick (and much-needed) response.

As a result, the cash rate was reduced from 7.25% to 4.25% in the period September to December 2008 and then to 3% in the course of the first half of 2009. Comparatively, only the Bank of England cut its interest rate by as much as Australia.

The cut in the cash rate largely passed through to commercial lending rates, resulting in an increase in disposable income for many individuals. This then contributed (together with other factors, including the fiscal stimulus) to maintaining the Australian economy out of a recession.

It is highly likely that without this risk-management approach to monetary policy, Australia would have been much more severely affected by the global financial crisis.

The limits of monetary policy

The second lesson is that policymakers ought to be realistic and pragmatic about what monetary policy can and cannot deliver.

Through changes to the cash rate, monetary policy can affect the pace of real economic activity in the short term. But, in the long term, growth and unemployment are driven primarily by supply-side factors and monetary policy only affects inflation.

Moreover, the extent to which monetary policy can affect growth in the short term decreases as interest rates get lower. During the GFC, monetary policy effectively contributed to shielding the Australian economy because higher interest rates gave the RBA more room to cut.

But when interest rates are already low, the monetary policy space is reduced and further cuts are unlikely to produce significant effects.

Understanding the limits of monetary policy is particularly important in the current economic context.

The Australian economy has been operating below potential for several years now, as data from the International Monetary Fund suggests.

In response to this prolonged contraction, the RBA has reduced the interest rate to record low levels. It has reached the point where further cuts would probably be more damaging than beneficial.

Now more than ever recovery becomes a matter of fiscal policy interventions.

How to use monetary policy

The third lesson is about the use of monetary policy.

The inflation-targeting framework requires the RBA to set the cash rate having consideration for a variety of factors and data, including qualitative information received from conversations with businesses, investors and stakeholders.

In making the best possible use of these data and information, the RBA follows two guiding principles.

First, policy should not be driven by conclusions drawn from short runs of data. This then implies that the cash rate should not be fine-tuned continuously in response to marginal developments occurring month by month.

In normal circumstances, the interest rate ought to move gradually and rather infrequently to provide individuals (businesses and households) with some certainty about the course of monetary policy.

Second, monetary policy in Australia ought to be both outward- and forward-looking. An outward look is required because, as a small and open economy, Australia’s inflationary dynamics are heavily affected by developments on international markets.

This does not mean that the RBA should passively mimic the behaviour of other central banks. However, it does mean that the importance of international factors for the Australian economy should be adequately taken into account.

Forward-looking refers to the fact that forecasts ought to play a central role in the monetary policymaking process. To express this in Stevens’ own words:

After all, if monetary policy takes some time – several years – to have its full effect on the economy and inflation, forecasts have to be at the centre of things, don’t they?

Author: Fabrizio Carmignani, Professor, Griffith Business School, Griffith University

Why credit rating agencies’ economic advice shouldn’t be trusted

From The Conversation.

The Australian government is using warnings from rating agencies like Standard & Poor’s Global Ratings (S&P), which placed Australia on a negative watch during the election, to make the case for passing budget measures. In reality, S&P (and the other two agencies in the credit rating industry) has no moral or technical authority to make such a warning.

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S&P warned that Canberra needed to take “forceful” fiscal action to address “material” budget deficits, which is unlikely in the near future, or face losing its AAA rating.

However, rating agencies shouldn’t be entrusted with this sort of power. As a matter of fact, it is not clear at all why the rating agencies, S&P included, are still in business. These agencies were instrumental in bringing about the global financial crisis, but have survived because of the lack of political will and because the ratings are required by law as a regulatory requirement.

The reputation of the credit rating agencies has been tarnished not only by the global financial crisis but, before that, by the Enron scandal, the Asian financial crisis and the financial collapse of New York City in the mid-1970s. The agencies’ track record shows failure to detect frequent near-defaults, defaults and financial disasters, as well as failure to downgrade troubled firms until just before (or even after) the declaration of bankruptcy. In fact, the credit rating agencies follow the market, so the market alerts the agencies of trouble, and not vice versa.

During the global financial crisis, hundreds of billions of dollars’ worth of triple-A-rated mortgage-backed securities were abruptly downgraded from triple-A to “junk” (the lowest possible rating) within two years of the issue of the original rating. About 73% (over $800 billion worth) of all mortgage-backed securities that one credit rating agency (Moody’s) had rated triple-A in 2006 were downgraded to junk status two years later. In the US, the Financial Crisis Inquiry Commission puts a big chunk of the blame for the global financial crisis on the agencies, while European Union officials blame agencies for contributing to the advent of the European sovereign debt crisis.

The failure of the rating agencies can be attributed to negligence and incompetence. Starting with negligence, there is every indication that the credit rating agencies did not check the soundness of their ratings because customers were willing or forced to buy it. Negligence means that the rating agencies were in a position to make sound judgement but did not make the effort to do a thorough job. Given the bullishness prevailing in the run-up to the crisis, the agencies chose instead to receive big pay for a lousy job.

The agencies did not have the expertise to do the job the agencies were entrusted to do, particularly when it came to the evaluation of risk embedded in structured products. In his testimony to the Financial Crisis Inquiry Commission, Gary Witt (formerly of Moody’s CDO unit) said that Moody’s didn’t have a good model on which to estimate correlations between mortgage-backed securities, so they “made them up”.

Credit rating agencies promoted inferior products knowing the quality of these products. The credit rating agencies knew that the risk was great or that the securities were not really AAA, yet they passed them as AAA.

While the credit rating agencies may be perceived as “willing victims” of investment bankers and the issuers of securities, there is also evidence to suggest that the transparency, quality and integrity of the agencies’ other practices and processes were substantially lowered. This was in order to support the extraordinary growth of the agencies’ structured finance operations. In effect, the agencies deliberately overlooked the possibility that rating may have been unwarrantedly high.

For all of these reasons the rating agencies must not be taken seriously. The agencies are more stringent in rating countries than in rating private-sector firms, because they do not receive fees for rating countries, which is the “public relations” part of business. Credit rating agencies have every right to compete on a level playing field, but these agencies shouldn’t have oligopolistic power and should be forced to operate under the investor-pays model to avoid conflict of interest.

Author: Imad Moosa, Professor, Finance, RMIT University

Land of the ‘fair go’ no more

From The Conversation.

Australians often pride themselves on living in the land of the “fair go”. However, the available evidence shows the distribution of wealth in this country is no more egalitarian than the average for the OECD countries.

In fact, depending on how wealth is measured, Australia may have above average inequality in wealth distribution.

Most think of inequality in terms of income differences between rich and poor people. But even more fundamental are the differences in the value of the assets that people own. It is the presence (or absence) of this accumulated wealth that determines people’s social position and their opportunities in life; who gets what depends substantially on who owns what.

Until recently, we have known very little about wealth inequalities. The last official national census of wealth in Australia was 101 years ago.

In recent years, however, international data compiled by the OECD and political economist Thomas Piketty’s research have provided a better basis for seeing how Australia compares with other nations.

Wealth distribution in Australia

A new report by the Evatt Foundation marshals the existing evidence on wealth in Australia.

As you would expect, Australia as a whole has become much wealthier since 1970: the total stock of capital has grown twice as fast as national income during the decades since then.

But what is more striking is the marked increase in wealth inequality over the same time. We have become collectively richer but much more unequal.

A reasonable estimate is that, currently, the poorest 40% of Australian households effectively have no wealth at all: about half of them actually have negative net wealth because of their personal debts. At the opposite pole, the wealthiest 10% have more than half the nation’s total household wealth. The top 1% alone have at least 15% of the total wealth.

This affluent elite is getting cumulatively richer – not only when compared with poor households but also, significantly, relative to the middle 50% of households.

Two faultlines are widening. One is between the bottom 40% and the rest, and the other is between the top 10% and the 50% in the middle. The latter division is ultimately explosive, since it indicates that the broad Australian middle class is getting a shrinking share of the fruits of economic progress.

Distribution of wealth in Australia, 2013-14. Evatt Foundation

How does Australia measure up internationally?

Compared with the 16 other OECD countries for which comparable data exists, Australia looks slightly more egalitarian than average if all forms of wealth are included.

However, this is largely because of ownership of household durables, such as clothing, furniture, appliances and cars. The household durables represent 12% of our wealth compared with the OECD average of 7.7%.

There are many reasons why durables should be excluded to improve comparability. The national accounts, for example, excludes durables from the aggregate household balance sheet. Piketty’s analysis also excludes durables. Australia’s HILDA survey excludes all durables except cars.

The Evatt Foundation report shows that if we also exclude durables from the OECD wealth data, Australia’s top 10% of households own about the same wealth share as their counterparts in France, Norway and Canada. The only rich countries that are clearly less egalitarian than Australia are Austria, the Netherlands, Germany and the US.

An emphasis on narrowing wealth inequality needs to be present in all public policies. Ann-Marie Calilhanna/AAP

What does this mean for politicians?

Ultimately, the case for Australian egalitarian exceptionalism is weak. Australia is not more equal than most other comparable rich countries, and its wealth inequality is growing.

Dealing with this situation is perhaps the biggest challenge facing our political leaders today, although you might not get this sentiment from the victors’ public statements in the recent election.

Other recurrent political economic stresses need attention – most obviously, climate change, financial instability and job insecurity. But these challenges are interlinked, and they all need managing in relation to economic inequality. If the policies are not equitable, they will not be sustainable.

An emphasis on narrowing wealth inequality needs to be present in all public policies. These range from pensions and superannuation to disability services, housing provision, transport, regional policies and taxation.

Unless this integrated approach is taken, the cherished belief in a “fair go” will be a dwindling feature of life in Australia. The evidence suggests it is already disappearing.

Authors: Christopher Sheil,Visiting Fellow in History, UNSW Australia; Frank Stilwell,Emeritus Professor, Department of Political Economy, University of Sydney

 

Britain fails to understand the nature of globalisation at its peril

From The Conversation.

There remains great uncertainty in the aftermath of the UK vote to leave the European Union. Few seem to have a plan for what Brexit will look like and how the UK’s relationship with the outside world will take shape.

But while the desire for sovereignty and to “take back control” were top of many voters’ list of reasons to vote to leave, the fact that we live in a globalised world where economies and trade supersede national boundaries cannot be ignored.

Much of the confusion about how Brexit will affect the British economy has resulted from the inability of those for and against it to acknowledge the realities of the position of the UK in the contemporary global economy. This failure to understand the realities of globalisation is partly why there is such confusion about how to deliver the kind of post-Brexit UK demanded by those who voted leave. But regaining national sovereignty is extremely difficult, if not impossible, in today’s global economy.

The interconnected world

The recent global financial crisis should have sent a powerful message. The degree of interconnection between places in the global economy has reached unprecedented levels and attempts to “unpick” these interconnections are highly problematic.

Globalisation is complex. It is no longer a case of “us” and “them”. Capital, goods and services flow within, between and across national borders – and the flow is uneven. It is often directed through key cities. So when we talk about flows of foreign direct investment between the UK and Germany, we are actually discussing flows of people and money between cities such as London and Berlin.

In fact, cities are the key drivers in trade. It is no surprise therefore that there were significantly higher votes to remain in the EU in cities such as London and Manchester. This is because these cities are points in the global economy through which trade, services and people flow. It is in these locations that we can most easily see the benefits of interconnection with cities in the EU and beyond.

Cities have benefited disproportionately from globalisation. Andy Sedg, CC BY-NC-ND

Outside of the major cities, the regions of the UK have experienced a downward shift in the scale at which economic activity takes place and political power is exercised. The national shift from manufacturing to a service-based economy has had a geographically uneven impact. Many manufacturing industries in the UK’s regions have shrunk or disappeared. This has not been helped by UK national policy which focuses on the financial services sector (predominately in London).

Globalisation’s disconnect

Globalisation has brought with it disconnection between the way that economies and their management have been simultaneously downscaled and upscaled. So, as well as the concentration of decision making in Westminster, there are also a number of decisions being made abroad that affect regions across the UK – the evolution of the European Union epitomises this process.

This upscaling of power is necessary. Many of the most important issues of the last three decades are shared across national boundaries – take for example environmental concerns. The formation of supra-regions begins with an acknowledgement of the benefits of removing trade barriers and having free movement of goods and services, which should create opportunities for all regions of the UK.

Cross-border concerns are better shared. motiqua/flickr, CC BY

In fact, the best hope for deprived areas of the UK is not to place decision making squarely back in the hands of the UK government. This gives power back to the very institutions that created and exacerbated the regional inequalities seen in the UK today. Benefits such as investment in local enterprises and infrastructure, improvements in working conditions and levels of employment result from international engagement and cooperation.

Those who – justifiably – feel isolated and economically depressed should call for greater decision-making power at a more local level. Local power, combined with access to international resources and opportunities, can start rebuilding local economies. Globalisation makes this possible as cities and regions do not necessarily need to go via London for trade and investment. These connections are essential for local economies to compete in the globalised world.

But leaving the EU means leaving the hundreds of trade agreements the UK has with non-EU countries and also possibly the freedom of movement of goods and services there is within the EU. Until these are rearranged (which will take several decades), the UK’s constituent regions may struggle to access international markets. So the “take back control” rhetoric offers no solutions, only problems.

The UK government has consistently failed to articulate the rationale and benefits of upscaling in its relations globally (specifically in the form of EU membership), despite the economic benefits it has brought. It is not about the removal of national boundaries but rather an acceptance of how so much of what drives the global economy occurs outside of these strict boundaries.

Closer economic cooperation is the only logical response to globalisation and the best way to ensure stable growth. Indeed, the short, medium and long-term impacts of the Brexit vote will surely serve to provide the UK with a harsh lesson in the dangers of going it alone.

Author: Jennifer Johns, Senior Lecturer in International Business and Economic Geography, University of Liverpool

How the Bank of England rate cut will hit personal finances in the UK

From The Conversation.

The Bank of England has cut interest rates by 0.25 percentage points to a historic low of 0.25%. The move was expected and comes in response to worsening economic data following the UK referendum vote to leave the European Union.

Bank-Of-EnglandThe cut is part of a package of measures that also includes a big boost to the bank’s quantitative easing scheme, geared towards stimulating spending and growth in the real economy.

Conventionally, cuts in interest rates are used to reduce the cost of borrowing and the return on savings in order to stimulate firms to invest and households to spend. However, UK interest rates have been close to zero since March 2009 and the problem the economy faces right now is not so much the cost of borrowing but huge uncertainty about future prospects in the post-Brexit world.

Both firms and households, when faced with uncertainty, tend to pull in their horns and conserve their resources as a buffer against whatever adverse events might be around the corner. Moreover, households have been squeezed in recent years by poor wage growth and inflation, so have little capacity to spend more. But while the latest rate cut might not prompt you to rush out and spend, it is still likely to have an impact on your personal finances and so cannot be ignored.

Borrowers and savers

For borrowers, mortgage and credit card rates will not necessarily fall – though the Bank of England’s package includes some ultra-low-cost funding for banks, which if taken up, may see the rate cut passed on to some borrowers. But for existing borrowers, at least the day when their repayments eventually rise has been pushed further into the future.

Savers may not be so lucky and can expect further cuts to the paltry returns on savings accounts (less than 1.5% on easy access accounts and around 2% if you can tie your money up for five years). The only good news is that, since the introduction of the Personal Savings Allowance in April this year, most savers now get their interest tax-free.

If you want higher returns, you will need to consider riskier investments. The quantitative easing part of the package will tend to push up the price of corporate bonds, reducing their return and encouraging investors to look to shares. Although markets had already factored in the 0.25% rate cut, the extra quantitative easing could give a further boost to the stock market over the medium term, fuelling concerns about asset price bubbles.

Insurance and inflation

The interest rate cut may also push up the cost of many types of insurance. The premiums you pay for insurance are invested to provide a pool from which claims are paid. Typically, insurers use a high proportion of relatively safe investments, such as government stocks. When the returns on these fall, insurers may try to recoup the lost return by increasing premiums, though the ability to do this depends on the level of competition between insurers. This can apply to any type of insurance, such as car and home policies, but is a particular problem with annuities (insurance against living longer than your savings would last).

Bank of England governor, Mark Carney. Twocoms / Shutterstock.com

The rate cut adds further downward pressure on annuity rates, making them look even less attractive, and is likely to make more people approaching retirement opt for “drawdown”. This means leaving your pension savings invested and drawing income (and lump sums) straight from this pot. Unlike annuities, your income is not secure and may have to fall if your investments perform poorly, and there is no guarantee that your money and income will last for life.

It’s unlikely that the Bank of England’s measures, which were widely anticipated, will have much impact on the exchange rate, which has already fallen substantially in response to the referendum result. However, the bank acknowledges that the combination of the exchange rate fall and its new measures may push price inflation above the 2% target rate. Again, this is good news for borrowers, who will see the value of fixed debts fall, but is bad for savers.

Whether the Bank of England measures alone are enough to stave off the economy flat-lining or falling into recession is a moot point. Tax cuts and increases in government spending are likely to be needed too – and much sooner than the planned Autumn Statement, the regular mini-budget that typically takes place in December.

Author: Jonquil Lowe, Lecturer in Personal Finance, The Open University

Forget Super Thursday, the Bank of England can only offer Mildly Useful Thursday

From The Conversation.

The Bank of England is expected to announce on Thursday measures to stimulate the UK economy following signs that there will be a significant economic downturn following the vote for Brexit. The Bank may cut interest rates, inject another dose of quantitative easing or conjure up something new to give the economy a monetary boost.

Although some have dubbed this “Super Thursday”, it cannot hope to be anything of the sort. The Bank only has tools to help ameliorate the immediate damaging impact of the Brexit vote. It can do little to address the underlying structural problems of the UK economy; structural problems that are likely to deepen unless the government makes a U-turn and uses fiscal policy as a means to stimulate long-term economic growth.

The impact of the Brexit vote will be revealed over many years. The immediate evidence is patchy but the initial signs are that the economy is slowing down. The Purchasing Managers’ Index, which is a lead indicator of GDP, shows that the UK economy suffered a significant deterioration following the Brexit vote.

Sterling totters. J D Mack/Flickr, CC BY-ND

Sterling has weakened and this was expected to stimulate manufacturing exports. But the immediate evidence suggests that even manufacturing activity is slowing down. The Bank is also expected to revise downwards its growth forecast for the UK economy – not simply because of its macroeconomic model but also, as the Financial Times has reported, because some of its economists have been talking to businesses and finding out the story from the horse’s mouth.

Stimulating

The Bank, assuming the mantle of the “muscular” interventionist, is expected to introduce further monetary stimulus to help business confidence and encourage spending. This should help to reduce the depth of the emerging downturn and it will assuage markets that at least there has been some response to deal with the impact of the Brexit vote.

But there is little evidence that monetary stimulus alone will address the long-term weaknesses of the UK economy. There are two major limitations of excessive reliance on monetary policy to manage the economy.

First, it does little to expand the capacity of the economy by stimulating new investment. Second, it increases the inequality of wealth: the big gainers are those who own assets which are propped up by the monetary stimulus such as housing, bonds and shares. Very low interest rates have increased demand, but this demand has served to increase the prices of existing assets – such as the cost of housing. It has had little impact on the creation of new assets, such as house building and corporate investment and expansion.

… Mr Carney. EPA/ANDY RAIN

The Big Problem

One of the major long-term problems facing the UK economy is stagnant productivity, the prime determinant of future prosperity and income growth. There are a number of drivers of productivity including investment in capacity, investment in education and the creation of new ideas. Monetary stimulus can do little to stimulate these.

Low interest rates may stimulate private sector investment in normal times, but such investment is discouraged by economic and financial uncertainty. An active fiscal policy is required to address the productivity problem, including state investment in infrastructure, housing and education.

And the productivity problem is likely to get worse in the long-term as the UK wrestles with its post-Brexit legacy. First, the UK will find it more difficult to trade with both Europe and the rest of the world. This will lead to a widening of the UK’s trade deficit or a permanently lower exchange rate – or possibly a combination of both. Second, the level of foreign direct investment into the UK economy is likely to fall as foreign firms remain in, or move into countries within the EU single market.

Flagging up problems. ruskpp/Shutterstock

Third, there will be serious disruptions to the UK’s innovation system. Universities are one of the strong aspects of the UK system, but their ability to attract funding and world-class researchers will be hindered when (or if) the UK leaves the single market. Furthermore, much business research and development in the UK is carried out by overseas firms, which may fall if such firms move or expand abroad.

A New Industrial Policy?

The Brexit vote has led to a new government and a new opportunity to recast economic policy. The new Prime Minister has indicated her support for industrial policy and she has established a new Department for Business, Energy and Industrial Strategy. But we have been here before and the rhetoric and rebranding has often not been followed by action.

The decisions of the Bank of England that will be announced on Thursday may be mildly useful, but they can’t hope to be much more than that. They can do little to alter the long-term direction of the economy. The key issue is whether the new government acknowledges the important role for the state in driving long-term growth and re-orientates fiscal policy towards increasing public investment in infrastructure, education and innovation.

 

Author: Michael Kitson, University Senior Lecturer in International Macroeconomics at Cambridge Judge Business School, University of Cambridge

How contactless cards are still vulnerable to relay attack

From The Conversation.

Contactless card payments are fast and convenient, but convenience comes at a price: they are vulnerable to fraud. Some of these vulnerabilities are unique to contactless payment cards, and others are shared with the Chip and PIN cards – those that must be plugged into a card reader – upon which they’re based. Both are vulnerable to what’s called a relay attack. The risk for contactless cards, however, is far higher because no PIN number is required to complete the transaction. Consequently, the card payments industry has been working on ways to solve this problem.

The relay attack is also known as the “chess grandmaster attack”, by analogy to the ruse in which someone who doesn’t know how to play chess can beat an expert: the player simultaneously challenges two grandmasters to an online game of chess, and uses the moves chosen by the first grandmaster in the game against the second grandmaster, and vice versa. By relaying the opponents’ moves between the games, the player appears to be a formidable opponent to both grandmasters, and will win (or at least force a draw) in one match.

Similarly, in a relay attack the fraudster’s fake card doesn’t know how to respond properly to the payment terminal because, unlike a genuine card, it doesn’t contain the cryptographic key known only to the card and the bank that verifies the card is genuine. But like the fake chess grandmaster, the fraudster can relay the communication of the genuine card in place of the fake card.

For example, the victim’s card (Alice, in the diagram below) would be in a fake or hacked card payment terminal (Bob) and the criminal would use the fake card (Carol) to attempt a purchase in a genuine terminal (Dave). The bank would challenge the fake card to prove its identity, this challenge is then relayed to the genuine card in the hacked terminal, and the genuine card’s response is relayed back on behalf of the fake card to the bank for verification. The end result is that the terminal used for the real purchase sees the fake card as genuine, and the victim later finds an unexpected and expensive purchase on their statement.

The relay attack, where the cards and terminals can be at any distance from each other. Author provided

Demonstrating the grandmaster attack

I first demonstrated that this vulnerability was real with my colleague Saar Drimer at Cambridge, showing on television how the attack could work in Britain in 2007 and in the Netherlands in 2009.

In our scenario, the victim put their card in a fake terminal thinking they were buying a coffee when in fact their card details were relayed by a radio link to another shop, where the criminal used a fake card to buy something far more expensive. The fake terminal showed the victim only the price of a cup of coffee, but when the bank statement arrives later the victim has an unpleasant surprise.

At the time, the banking industry agreed that the vulnerability was real, but argued that as it was difficult to carry out in practice it was not a serious risk. It’s true that, to avoid suspicion, the fraudulent purchase must take place within a few tens of seconds of the victim putting their card into the fake terminal. But this restriction only applies to the Chip and PIN contact cards available at the time. The same vulnerability applies to today’s contactless cards, only now the fraudster need only be physically near the victim at the time – contactless cards can communicate at a distance, even while the card is in the victim’s pocket or bag.

While we had to build hardware ourselves (from off-the-shelf components) to demonstrate the relay attack, today it can be carried out with any modern smartphone equipped with near-field communication chips, which can read or imitate contactless cards. All a criminal needs is two cheap smartphones and some software – which could be sold on the black market, if it is not already available. This change is likely the reason why, years after our demonstration, the industry has developed a defence against the relay attack, but only for contactless cards.

A rigged payment terminal capable of performing the relay attack can be made from off-the-shelf components. Author provided

Closing the loophole

The industry’s defence is based on a design that Saar and I developed at the same time that we demonstrated the vulnerability, called distance bounding. When the terminal challenges the card to prove its identity, it measures how long the card takes to respond. During a genuine transaction there should be very little delay, but a fake card will take longer to respond because it is relaying the response of the genuine card, located much further away. The terminal will notice this delay, and cancel the transaction.

We set the maximum delay to 20 nanoseconds – the time it takes a radio signal to travel six metres; this would guarantee the genuine card is no further away than this from the terminal. However, the contactless card designers made some compromises in order to be compatible with the hundreds of thousands of terminals already in use, which allows far less precise timing. The new, updated card specification sets the maximum delay the terminal allows at two milliseconds: that’s two million nanoseconds, during which a radio signal could travel 600 kilometres.

Clearly this doesn’t offer the same guarantees as our design, but it would still represent a substantial obstacle to criminals. While it’s enough time for the radio signal to travel far, it’s still a very short window for the software to process the transaction. When we demonstrated the relay attack it regularly introduced delays of hundreds or even thousands of milliseconds.

It will be years before the new secure cards reach customers, and even then only some: there is only one Chip and PIN specification, but there are seven specifications for contactless cards, and only the MasterCard variant includes this defence. It’s not perfect, but it makes pragmatic compromises that should prevent smartphones being used by fraudsters as tools for the relay attack. The sort of custom-designed hardware that could still defeat this protection would require expertise and expense to build – and the banks will hope that they can stay ahead of the criminals until the arrival of whatever replaces contactless cards in the future.

Author: Steven J. Murdoch, Royal Society University Research Fellow, UCL

Rate Cut Reactions

From The Conversation.

The Reserve Bank of Australia has lowered the cash rate to 1.5% in an effort to stimulate growth, boost inflation and encourage a fall in the Australian dollar.

The cut of 25 basis points from 1.75% is the last decision from outgoing RBA Governor Glenn Stevens. In a statement on the rate decision he says:

“Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes.”

Pin-Global-CrisisProfessor Richard Holden from UNSW says the cut was needed.

“At 1.0% per annum — well below the target band of 2-3% – there is even the risk of deflation. Growth is relatively weak—indeed, net disposable national income growth has been negative for several years. The labour market is fairly weak as well. All in all, a cut was very much in order,” he says.

In his statement, Glenn Stevens also addressed the concerns around Australia’s property market. He noted Australia’s banks have been cautious in lending to certain sectors like the property market and despite the possibility of a considerable supply of apartments emerging over the next few years, lending for housing has slowed this year.

However Professor Holden says Stevens is downplaying the risks.

“I think that’s something of a blip, and that the housing price inflation risks are very real. I think he called this one incorrectly,” he says.

The Commonwealth Bank of Australia announced it would pass on 13 basis points of the cut to owner occupiers and property investors, Professor Holden says Australians can expect the rest of the big four banks to do the same, apart from ANZ.

Economist Saul Eslake from the University of Tasmania says he still doesn’t believe there is a reason for the RBA to cut rates, as moderate growth and modest expansion in employment weren’t cause for alarm at the last rate cut.

“Inflation is substantially below the RBA’s 2-3% target – but the post-meeting statement didn’t indicate that the most recent inflation data had prompted a major downward revision to the inflation outlook, such as would warrant lower interest rates, as it did when it last cut rates back in May,” he says.

The RBA statement cited international pressures such as China’s slowing economy, but Mr Eslake says this more likely to impact Australia in medium term rather than here and now.

“China has probably done enough to ensure that it meets this year’s GDP growth target of 6.5%. But they’ve done it in a way that increases the risks of a financial crisis down the track – by getting their banks to fund the latest lending splurge (which has helped to revive the Chinese property market)…by borrowing in the wholesale markets rather than through customer deposits,” he says.

Phillip Lowe takes over next month as the new governor of the RBA and he may be faced with limited reserves of monetary stimulus after this cut.

Mr Eslake says reserves might be needed if Donald Trump were to win the United States Presidential election in November.

“If that prospect were to prompt a ‘rush for the exits’ on the part of foreign investors in the US, [it could] send the US dollar substantially lower and hence, possibly, sending other currencies, including the Australian dollar, much higher against the US dollar than the RBA would feel comfortable with.”

Economist Timo Henckel from ANU says the RBA will probably wait a few more rounds before cutting further.

“By historic standard, Australian interest rates are exceptionally low, and economists will want to see how these low rates affect the wider economy, a transmission mechanism that is complex and characterised by long and variable lags,” he says.

Author: Jenni Henderson, Assistant Editor, Business and Economy, The Conversation