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In Harms Way

In the current debate about whether or not to bomb Syria, beyond the substantive issue, much has been made about the issue of leadership and particularly the way the Leader of the Opposition tried and failed to whip his party on the vote. His actions have been contrasted with the decisive leadership shown by the Prime Minister.

However on the issue of Syria I am not sure the Prime Minister has exercised the leadership one might want on an issue of this magnitude and urgency.

Everyone seems to agree that the first duty of government is to provide an effective defence of the country. The Prime Minister has made it clear that his top priority in government is the protection of UK citizens. Their physical safety trumps even the obsessive objective of dealing with the deficit.

When considering ways in which to maintain the security of the nation recourse to military action has to be a final resort. Putting our armed forces in harms way is something no Prime Minister should undertake lightly. Indeed Mr Cameron has made this point many times over the past few weeks. The Prime Minister must be convinced that there is a clear and substantial threat to the country that must be dealt with. What is more a threat which cannot be dealt with in any other way than by taking military action.

Given all this you might have thought the Prime Minister would want to act with all urgency to protect the citizens of the UK. Take the issue to Parliament as soon as possible. But no, he did not want to take the matter to Parliament until he was absolutely certain of a majority. But that begs the question what would he have done if no majority looked likely or indeed if he had lost the vote.

No one seems to have questioned why, once he was convinced of the threat, he did not go immediately to the House of Commons to press for the to extension of the war into Syria. Further, if he lost the vote why would he not go to the country. If the threat is grave enough to put soldiers in harms way then should it not be the first first duty of the Prime Minister to secure action as soon as possible.

It could well be said by supporters of the war “Well he got there in the end”. His delay was a carefully devised strategy to get the support he needed and now we have commenced the bombing he wanted. It feels however a bit like an exercise of leading from behind. Wait until the case is won and then go and make it.

I can’t help thinking the Prime Ministers’ very commendable commitment not to put troops in harms way is underpinned by an equally strong commitment not to put his job in harms way either. Even if he believes the country faces a clear and present danger.

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Should we bomb Syria?

This is the question of the moment and members of the Opposition have been asked to listen to what their constituents think. This is my view. In essence I think we should bomb Syria. However, only if we are prepared to be engaged in a long and bloody ground war to militarily defeat ISIL. And only if we are prepared to put in the social, political and economic effort that will be required to subsequently eradicate the conditions that created it.

Why should we bomb ISIL?

ISIL certainly take barbarity and cruelty to new heights and this should clearly influence our view of them. However if we adopt the principle that we go to war with those that murder and torture their own, or other states, citizens we are going to be involved in a lot of wars.

An argument put forward in favour of the invasion of Iraq was that Saddam Hussein was an evil man. Whilst I agreed with the premise I did not think it was sufficient reason for going to war then, and, despicable though they are, I don’t think it is sufficient reason for going to war with ISIL now.

There is however a fundamental difference between Iraq under Saddam Hussein and ISIL. The former was a vicious, regional bully, the latter want to establish dominion over the world and have an apocalyptic religious view that underpins this. They believe the End of Time is nigh and that they are engaged in a world historic struggle with the Antichrist (broadly the West but specifically the US).

A central strategy to achieve their goal is terrorist attacks which they believe (with good reason) will incite the West to enter a prophesised battle which will result in the destruction of the army of “Rome” (the West) in the town of Dabiq.

These are people al-Qaeda cut all ties with because of their “notorious intransigence”. They are not the type to make a reasoned judgement about whether they can win, they are going to kill people until they establish a global Caliphate or until they are dead.

Britain is in their sites, not just in the long term of the Global Caliphate, but here and now. They will continue to encourage and sustain terrorist attacks in the UK and other Western countries until we engage, which ultimately we will.

Will bombing secure victory?

No. All the military advice seems to be you cannot win a war from the air. The Prime Minister (PM) has intelligence there are 70k troops on the ground already, mainly of the Free Syrian Army but including others and there are Kurdish armed groups to support the effort.

Lets assume the intelligence that there are 70k+ troops is correct, and has not been sexed up in any way, there remains the question of how effective they are. Is there a unified command structure, do they have similar or even commensurate aims?

I suspect there may be some wishful thinking around all this but lets assume that everyone genuinely believes there are sufficient and capable resources on the ground already. That is fine as a starting point however what is “plan B” if this proves to be wrong. There are wildly differing estimates of the number of ISIL troops on the Ground in Iraq and Syria ranging from 20/35k to 100k+.

Even if it is the lowest number one has to keep in mind the single-minded purpose of ISIS underpinned by religious certainty. Certainty, which means death is glorious martyrdom and guaranteed entry to paradise. Even if all of them do not buy into the whole picture they have demonstrated a ferocious fighting capability.

The PM must answer the question what happens if the existing ground forces are not sufficient? What military advice has he had about what happens in a scenario where ISIL gain or maintain their position on the ground despite the move to bomb Syria. We have been using our super smart missiles in Iraq for some time now and it is not clear we are winning that side of the border.

I would be surprised if the Military have not thought through a scenario where the current boots on the ground do no prove up to the job and what alternative strategy they might need to adopt. If they have not I think they are at best remiss.

If we enter this conflict we must accept that there is a real risk that we will have to commit ground troops. I personally think that we have to prepare for that contingency because I think it is almost certain to happen. To be clear I don’t think that changes the decision about whether we bomb Syria however I think it is misleading to even suggest that this is going to be anything other than a very drawn out and expensive war.

What is the plan for after the war.

Let us assume we get to the point where we have militarily defeated ISIL where will we be? Answer, in a mess. When the fighting stops the job of peace making begins. The coalition is a pretty explosive cocktail but when you add in Russia and Iran then even the most optimistic diplomat may throw in the towel. How do you start to build a peace when Russia the US and Turkey have all got different ideas about who the enemy are now.

The question of Syria’s future, more specifically that of Assad remains a fiercely contested issue. Getting agreement about Assad will be a miracle. Agreement on what replaces him will be even harder amongst a range of groupings including forces within Syria, regional and global powers.

The PM’s statement about the post war reconstruction of the area seemed to amount to £1bn commitment of funding and a lot of optimism about talks with regional players, groups within Syria and some parties that we would prefer not to deal with in an ideal world.

What we cannot do is what we seem to have done in previous engagements. Establish some kind of a standoff/ceasefire with a limited amount of shooting, provide for free ish / fair ish elections and then get the hell out as fast as we can. However sick we are after a long and bloody ground campaign we need to remain in the region and we need to participate in the physical, social and most of all economic reconstruction of the area.

This will be immensely difficult as we will have to do it in partnership with local people, and it is very unlikely that those “local people’ will be a homogenous group with a unified picture of what needs to be done and what the priorities are. Some may argue this is impossible and they may be right. However, if we do what we have done in previous wars in the middle east we will only be going home for R&R whilst the regions decends into another crisis.

There seems to be a view that holding elections creates a democracy. Nothing could be further from the truth. Elections are the result of democracies not the cause. Independent judiciaries, a free press, an independent civil society, trade unions, distributed power, a sense of community are key building block that must be firmly established if the out come of an arithmetic process is to have credibility and acceptance.

There needs to be a Marshall Plan for the region which supports economic growth and this needs to be established early and rapidly. Military defeat of ISIL will only be a temporary success if the causes of radicalisation are not addressed. This means working with people in the region to secure a reasonable standard of living and the prospect for that to be improved through sustainable economic growth. This will cost the West a lot of money. However, wars in the region have cost Trillions of dollars in recent years.

We may have to invest as much into the peace as we did into the war. If that helps to stabilise the region it would be a price worth paying.

The picture I have painted may be grim and depressing. It will certainly contrast with the “grave but optimistic” picture painted by the PM. Time will tell which one is right.

It may be asked, given how tough it will be and how uncertain the outcome is it not better to stay away. The region is spiralling out of control and will continue to do so whether we withdraw or not. Its conflicts will spill over into neighbouring regions, Turkey is on the front line at the moment as is Greece. The refugee crisis will get worse and worse.

Bombing Syria is bad. Not bombing is bad. The balance of the decision is fine. Those that are against war however need to be certain that there is a diplomatic route forward. ISIL’s actions, their ideology and their belief in religious certainty make me think they are proof against rational debate. It is only a matter of time before we are forced to engage with them.

 

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Other People’s Money

“Don’t tell him your name Pike” Capt. Mainwaring.

Capt. Mainwaring is one of the hero’s of this book. John Kay remembers back to a time when bank managers were boring but trustworthy. When they took seriously the duty of care they acquired with other people’s money and spent tiScreen Shot 2015-10-16 at 17.14.40me understanding the needs of their clients and customers. This model of bankers as pillars of the local community, a touch fuddy duddy but completely reliable lasted well beyond the time of Mr Mainwaring.

When I left University and was seeking a mortgage I met a clone of Mr Mainwaring at my bank, the Midland. He asked me all kinds of difficult questions about what I spent my money on, why I had a history of overdrafts, whether he could see the budget he assumed I had produced to demonstrate to myself that I could afford owner occupation, what my prospects were. God he was a pain, and God did he irritate me, and God was he right! This was the early 1980’s.

That bank manager was probably one of the last of the breed, in 1986 we had the big bang which aimed to release all the pent-up creativity of the financial industry. Old-fashioned bankers who wanted to understand exactly how clients were going to repay them were to become a thing of the past.

For those that have not kept up with the changes John Kay’s book is an excellent guide. If, like me, you still thought the role of banks was to take in deposits from lots of people and then lend that money out to businesses that needed help starting up or expanding, think again. If you thought that the bank of England created money by printing notes and pressing coins, think again.

Mr Kay examines how financial services have exploded over the past 30 years and whilst some of that has been positive we are now in the position of having “too much of a good thing”. In fact we have a critical area of the economic system which is generating instability and risk. More than this we have a process where a service, finance, has begun to transform the operation of the wider economy and society. A process of “financialisation” which undermines much which is valuable and creates enormous benefit for the few and enormous risk for the many.

Let us go back to the role of the bank to illustrate the scale of the issue. According to Mr Kay “Lending to firms and individuals engaged in the production of goods and services – which most people would imagine was the principal business of a bank – amounts to 3 percent of the total.” The vast bulk of banks balance sheets nowadays are the claims financial institutions have against each other. But what are these claims?

They are trading positions (or what you and I might call bets) on fixed income securities, currencies and commodities. JP Morgan’s exposure to derivatives of this kind is around $70 trillion. Have in mind that the annual Gross Domestic Product of the world is about $70 trillion. Deutsche Bank has $55 trillion worth of derivatives exposure. Against this it has deposits, the savings of people like you and me, of $577 billion and it lends money to customers of $397 billion. These are big numbers but they mean that what you and I think banks do amounts to 1% of their activities.

Mr Kay identifies 4 key functions of the finance industry: i) a payments system, cheques, ATM’s, bank transfers etc.; ii) “intermediation”, matching borrowers to lenders; iii) enable individuals to manage personal finance across lifetime and generations; iv) help individuals and businesses to manage risk. He then goes on to explore how modern finance does in relation to each of these. In each case we end we conclude that the financialised world is not serving us well.

If we take matching lenders to borrowers banks do provide an important “intermediation” service. Historically they did this by taking in lots of small deposits which people wanted instant access to and converting these into long-term loans. They could manage this trick because a) they had money invested by the owners and b) in practice not all those that deposited money with the bank would want it back at the same time. This meant they only needed to keep a fraction of the money deposited and invested on hand to pay out to those who happened to want it back.

In the mid 19th century it was typical that banks owners would have invested equity equal to 40%/50% of the banks total investments. This meant of course that 40%/50% of the loans that they made could go wrong and the depositors money would still be safe. However, banks decided they could be more efficient and create more profit if they pushed the logic of this along a bit.

By the start of the 20th Century the typical level of equity had dropped to around 25%. (See Admati and Hellwig) Post big bang however they went for it and did two things. First of all took the view that if a banks purpose is to lend money and it wants to expand then it needs more money. If depositors like you and I were not providing enough then they needed to go to the wholesale money markets and borrow big chunks from institutional and large-scale investors. They therefore borrowed a lot more, although still on short terms, but they did not increase the equity reserves.

In the run up to the financial crisis according to Admati and Hellwig the debts (deposits and wholesale borrowing) of many large banks financed 97% of their assets. What this means is, if more than 2% of its loans go bad the bank is insolvent. You might try going to a bank with a start up business and ask to borrow 97% of the costs, putting 2% in yourself. The banks would consider such a prospect as unfundable. So why are they fundable? Because you and I, as taxpayers, have been providing an implicit, and since 2007/08 explicit, guarantee to those that invest in banks.

One key outcome of the explosion in financial services has been the incredible growth in credit. As Mr Kay makes clear some credit is a good thing. When an economy is growing new businesses require credit to get up and running and to expand their activity. At these times and expansion of credit is a good thing. Indeed in times like this credit may well grow faster than the economy as a whole. It is important to appreciate the causal relationship however. Banks argue that the supply of credit will push growth. It may be of course that in reality growth pulls the supply of credit.

Everything is fine if credit is going into new productive investments creating new products and services that the public want. In the current economy however the demand for investment in new businesses is changing. New high-tech businesses do not have huge capital requirements. Google needs no factories or heavy equipment. Indeed many of the existing large businesses in the world fund their growth needs from internally generated cash.

Investors want good returns and security, a combination that seems contrary to economic theory. One way to square this circle is to invest in existing assets like houses and leverage your investment with borrowed money. So now around 70% of traditional bank lending is to purchase homes. Credit expansion fueling demand can be created by the stroke of a pen or more like the tap of a keyboard. Building houses to create supply is a much more complex and time-consuming business. The result asset price bubbles.

The investor appetite for this kind of business was insatiable in the early part of this century and led to the creation of asset-backed securities. This involves banks bundling mortgages together and “securitising” them. In other words selling the income stream that all the mortgages generated to a third-party, possibly another bank.

This basic asset backed security can then be “structured” and transformed into a collaterals debt obligation (CDO) which pays different rates of return to different investors from different slices of the asset. The purported purpose of all this financial jiggery-pokery was to diversify risk and to place it with those best able to manage it. And then to spread the problem a little further those with CDO’s would take out a Credit Default Swap (CDS) which insured them against defaults on the asset.

Now go back to what all this financial pile of crockery is standing on. A mortgage. Had it been just on my mortgage, taken out after I have been through a third degree interview with Mr Safe who pretty much knew every creaky corner of my finance and prospects then probably 2007/08 may not have happened. However, because there was such demand and so much innovation Mr Safe was long gone. Mortgages were no longer treasured and provided, they were marketed and sold. The third degree was replaced with the mirror test. You placed a mirror in front of the mouth and nose of the applicant and if it went misty they passed.

However high you build the pile and however sophisticated it is, if the underlying asset is worthless everything above it is.

The financialisation of the world since the mid 1980’s has transformed it in many ways, some subtle, some the opposite. Mr Kay’s book guides you through the changes with the insight of someone who really understands what has happened and applies very bright common sense to an area of very murky cleverness. The critique is withering and the implications revolutionary. His prescription for this illness is not ever more detailed regulation. As he puts it “too big to fail is too big.” What is needed is structural change to transform the drivers and incentives of individuals’ actions. The Wolves of Wall Street need to be repelled by the Home Guard of Warmington on Sea. Capt. Mainwaring might not be cool but he is trustworthy.

John Kay. Other People’s Money: Masters of the Universe or Servants of the People? Profile Books 2015

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Climate of Change

In December this year, in Paris there will be the meeting of the 21st annual Conference of the Parties (COP21). The parties concerned are those that are signed up to the United Nations Framework Convention on Climate Change (UNFCCC). This is the convention agreed at the Earth Summit in Rio de Janeiro in 1992 aimed at stabilising greenhouse gases in the atmosphere to prevent dangerous interference with the climate system. It was the 16th session of the COP at Cancun that went further and agreed that future global warming should be limited to 2 degrees centigrade above pre industrial levels.

Given this is the 21st Conference you may think it is just another of those climate change conventions that seem to confirm things are getting worse, talk about what progress is being made with renewable energy and what urgent action needs to be taken and end in a diplomatic fudge. Given the track record it is probably right to be sceptical.

There is just a chance however that it might start to gain some traction in the mind of the public as the deadlines for action start to close in. In 1992 when the issue of climate change was still relatively new and the science hotly contested, talking about issues which may have an impact in the middle of the next century was unlikely to generate much public concern.

The situation is different now. The International Energy Authority (IEA), an autonomous agency established in 1974 to promote energy security among its 29 member countries, has written a report in advance of the COP21. It is an interesting read.

In terms of the tone of the document think of Blackadder, yes the Rowan Atkinson one. Imagine the kind of report that Captain Darling might have written to Lord Melchitt about the success to date and prospects of the strategy adopted by the British Generals in World War One. Explaining to an irascible and unwilling superior who might have you shot for dissension why the strategy adopted to date is probably not going to cut it.

As you might expect the report starts with an emphasis on the positive. It talks about the sustained level of investment in renewables at $270bn per annum. It also talks about the fact that 2014 seemed to indicate a decoupling of growth from increases in carbon emissions i.e. whilst the global economy grew by 3% CO2 emissions stayed flat.

It then goes on to say what sterling work nations around the world are doing with things called Intended Nationally Determined Contributions (INDCs). It is worth just pausing to analyse the terms in this concept. “Intended” – we will do our best but we cannot guarantee. “Nationally Determined” – we will decide if we want to participate in saving the world, not some international busy body. “Contributions” – we are not doing this on our own, if you don’t we wont.

Perhaps a bit harsh as there has been genuine progress with e.g. the European Union pledging to cut green house gas (GHG) emissions by 40% by 2030 relative to 1990 levels.

However, we now turn to the bit about walking towards machine guns. The report points out that “With INDCs submitted so far, and the planned energy policies in countries that have yet to submit, the worlds estimated carbon budget consistent with a 50% chance of keeping the rise in temperature below 2 degrees C is consumed by around 2040 – eight months later than is projected in the absence of INDCs.”

In essence if we continue as we are, even with the mitigation strategies in place that we have, in 25 years time we either stop burning fossil fuels all together (one can see the whiskers of the Oil Industry Melchitts starting to twitch at this point) or drop the 2 degrees C target and accept the risks that flow from that.

The IEA propose building on the INDC’s position to create “a “virtuous circle” of rising ambition”. This is Captain Darling speak for “What you are doing is nowhere near working and you have to get real.”

In a rather convoluted fashion they call on “political leaders of the highest level” to make clear their commitment to low carbon development. They identify four pillars to support that achievement. Captain Darling like, they set these proposals out at a level of abstraction which they hope will hide their radical implications.

1) Peak in Emissions – set the conditions that will achieve an early peak in global energy-related emissions.
2) Five Year Revision – review contributions regularly, to test the scope to lift the level of ambition.
3) Lock in the Vision – translate the established climate goal into a collective long-term emissions goal, with shorter-term commitments that are consistent with the long-term vision.
4) Track the transition – establish an effective process of tracking achievements in the energy sector.

Having got this far without being shot Captain Darling gets on a bit of a roll and proposes a “bridging strategy” to deliver a peak in energy related emissions by 2020, 5 years from now. The Bridge Scenario relies upon 5 measures:

1) Increasing energy efficiency in the industry building and transport sectors;
2) Progressive reduction of the least efficient coal-fired power plants and banning construction;
3) Increase investment in renewables from $270bn to $400bn in 2030
4)Phasing out of fossil fuel subsidies by 2030
5) reducing methane emissions in oil and gas production
These measures involve “putting a brake on growth in oil and coal use within the next 5 years…” Oops I think I hear the sound of a firing squad being drawn up.

Whilst the report is written as diplomatically as possible the underlying reality shines through. Burning fossil fuels as we are and expecting to prevent global warming is as rational as marching soldiers towards machine guns to win a war. The reality is we have to stop using fossil fuels, and quickly. Whilst the worst of the consequences are some time off the time we have to take effective action is now.

There are signs that the issue is starting to move up the agenda of politicians and policy makers. In 2014, as recorded in the FT, the then energy secretary Ed Davey “called for tougher rules to be applied to companies holding “risky” fossil fuels assets that could plunge in value because of global action to tackle climate change.” Mr Davey went on to talk about some analysts who were estimating such actions could cost the fossil fuel industry over $28trn in lost revenue over the next two decades.

Earlier this week Mark Carney warned investors that they may face “huge” climate change losses. With almost a 5th of the FTSE 100 industries being natural resources and extraction companies this is a matter of come concern. The carbon budget the world can use if it is to secure its 2 degrees C temperature increase target amounts to between one fifth and one-third of proven reserves of gas and oil.

To be clear, this suggests that somewhere between four fifths and two-thirds of the current reserves, which are giving value to extraction company balance sheets, may be “stranded” in the ground.

Some investors are already alert to this issue. The heirs to the Rockefeller fortune and Stanford University have started to sell out of oil and coal shares. It may of course be there is some ideological driver to those that divest early. However if politicians “at the highest level” start to take actions along the lines set out in the IEA report mentioned above, then serious investors, concerned only with financial returns, may start to move. If this happens it will have implications for everyone. Who’s pension does not have shares in BP? There is no easy option here and the longer the issue is left the worse the options become.

At the moment there are plenty of urgent issues to deal with: ISIS; the Russian intervention in Syria; Austerity; the slowdown of the Chinese economy; and potential crisis in developing economies. Whilst these issues demand attention our leaders cannot ignore the growing crisis that global warming might represent. The science seems to be overwhelming and certainly sufficiently clear to require the adoption of the precautionary principle given the stakes.

Mr Cameron is always telling us about the difficult choices he is willing to make. Is he going to tell the fossil fuel industry that its business model is broken, or gamble with the future of the planet. That may be a particularly difficult choice…for him

Sources:

Energy and Climate Change World Energy Outlook Special Report; FT 11 December 2014; FT 29 September 2015