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What a time-travelling Austrian might think of today’s economy

16 Nov

The Austrian School’s theory of credit and capital has a reputation for being complicated, and some posit that the reason Keynes’ ‘General Theory of Employment, Interest and Money’ holds such weight with policymakers is that it draws on the psychology of lending. Keynes saw the amount of capital channelled into investment as being inherently uncertain, a product of employer confidence in demand for goods, which depended on wider factors like the level of employment, income distribution and wage levels.

Austrians have been caricatured as prophets of the ‘efficient markets’ hypothesis, which essentially holds that artificial credit injections mess with the natural pattern of investment. They believe investment should stem naturally out of normal saving behaviour, as this creates sustainable demand for the goods and services produced through borrowing; loans or debt instruments initiated by banks which are backed on margin and not fully offset by the bank’s stock of available capital represent ‘artificial’ credit whose long-term effect is to cause price increases.

Austrian School economists are sceptical about policymakers’ belief that they can engineer optimal market conditions, believing that artificial intervention causes market inefficiencies. Broadly speaking, the argument runs that inefficient loan allocation to companies which are not sufficiently equipped to use them, or for whose products there is not enough demand, may in the short-term stimulate ‘growth’ – employment and consumption.

But the consequence of this ‘growth’ – the increase in wages and concordantly prices – will be priced into existing and future loans. The unregulated growth of credit will eventually cause a systemic shock, as confidence fails and many of the riskier debt instruments shed as investors try to exit their positions en masse. The value of higher-risk instruments plummets further, as some of the underlying assets – e.g. homes in the case of sub-prime mortgages – undergo foreclosure and are sold at a discount at auctions. Sound familiar?…

Disciples of Haberler, who was more concerned with the structural allocation of credit across the ‘vertical’ chain of production – from commodity mining and production to equipment manufacture to the factories where this equipment is used – would focus more on the credit tied up in cap ex by companies investing in new technology or expansion.

The central bank is supposed to moderate growth, preventing unsustainable expansion and stimulating consumption and/ or investment. Setting a minimum interest rate is just one of many ways in which it does this. Asset purchase schemes, and quantitative easing, are two others. Note in support that the ‘inflation premium’ detailed by economist Irving Fisher is priced by default into interest rates by commercial issuers; the government traditionally just provided a benchmark.

These asset purchase and what we’re going to nickname ‘capital injection’ schemes (when the government creates bonds it then buys back from banks, creating liquidity but also increasing the public deficit) have the net result of more reserves ending up deposited with the central bank. As more capital is circulating, some of it inevitably ends up in current accounts with the banks and they are required to hold a certain ratio of this capital as reserves with the central bank for security.

If and when the central bank decides to raise interest rates, in fairness it must apply the policy rate to its own reserves, effectively paying interest on its own debt at the taxpayer’s expense. If it does not, this will act as an ‘opportunity cost’ – effectively a tax – to banks who could have invested the money elsewhere at a profit. This trend has been analysed in more depth by those such as Claudio Borio, Head of the Monetary and Economic Department of the BIS. For a brief introduction to the argument, see the speech given by him and the Bank of Thailand’s Mr Piti Disyatat on ‘Helicopter Money’.

One of those historical Austrian economists, transported to the present day, might find that their essential doctrine that when tampered with interest rates can have a distorting effect on growth, still has relevance. Unquestionably, QE has boosted spending, and new, sometimes innovative investment. But the cost has fallen on those financial institutions that must take the new risks, as they are forced to chase ever higher yields; pension funds which are struggling to climb out of their own deficits, as former ‘safe-haven’ assets provide insufficient income to meet their liabilities.

The rise of alternative finance seemed for some time to provide another option to the legislation-hampered banks, whose rigorous screening tests and core capital obligations prevented them from extending loans to all comers. But the marketplace lenders’ models which were heavily reliant on ‘diversifying’ the risks they did not properly analyse, by aggressively seeking new loan applicants to replace the loans that had gone bad, are now looking likely themselves to face the price of over-expansion.

The USA’s Lending Club is a prime example, and has suffered losses of $36.5m in the third quarter of this year – though up from $81.4m in the second quarter – as it confronts the need to tighten up its due diligence operations and tackle non-performing loans.

Reversing the secular and government-sponsored decline in interest rates may not be a painless process, but the alternative is to enshrine a borrowing climate which is not profitable for the majority of lenders, or investor in the resulting securities. Can the market rely forever on the government to prop it up, even as the government’s own debt must increase to fund its stimulus measures? Does this rhetorical question even need a response?…


Ludwig von Mises

The ‘Austrian’ Theory of the Trade Cycle

Borrowed the capital theory developed by Carl Menger and elaborated by Eugen von Bohm-Bawerk. Mises attempted to prove that when, in an unsustainable credit expansion, interest rates are forced down, capital is allocated inefficiently. Because loans are granted in an indiscriminatory fashion, the production process ties down capital for too long a period in relation to ‘the temporal pattern of consumer demand’. In the end, the discrepancy means the market for both consumer and capital goods (loans) readjusts to counteract the misallocation.


Friedrich A. Hayek

Can We Still Avoid Inflation?

Plotted series of right-angled triangles to show the two factors of time and money, as capital flows through the production process. It is agreed to have been overly simplistic in imagining capital as ‘tied down’ in development loans when in reality it still circulates fairly freely. But Hayek pioneered the use of time as a vital factor in analysing the boom-and-bust sequence.




The Future of Food: Home-Grown Meat. Stem Cell Burger’s Next Stage of Development

31 Mar

Professor Mark Post claims his stem cell burger could hold the solution to growing global meat demand. He explained how his scientists are trying to achieve that final elusive lab result – making it something people want to eat.

The nineteenth-century doom-laden Malthusian prophecy of global starvation due to population growth has still not come to pass. But today there is a major factor impacting world food supplies, and that is our nigh universal love for meat. Around 70% of arable farmland is dedicated to crops, not for human consumption, but to feed the cattle we serve up as steaks, sausages, mincemeat, burgers, kebabs…. To produce 15g of meat, an animal must be fed 100g of vegetables. That is not an efficient productivity ratio.

And because of the growing demand for meat in emerging market diets, the proportion of arable land used to feed these animals is on course to increase. The diet in developing economies is approaching the west’s trophic level of 2.3 (where a completely carnivorous individual would have a trophic level of 3, and a vegetarian one of 2). Some experts claim that at current rates of expansion, by 2050 all the world’s crops will be needed just to sustain production of the world’s meat products.

The solution coined by Mark Post, of the Department of Physiology at Maastricht University in the Netherlands, was to grow animal tissue using muscle stem cells. Stem cells are the components of body tissues that can differentiate to grow and replace damaged cells very fast. Every vertebrate has these stem cells in their muscle tissue.

Stem cells grow very, very fast. Given the right nourishment and environmental conditions, they double 35 times. One muscle extract obtained through a biopsy from a live animal can yield 10,000kg of meat. After differentiation, they merge to form a smooth wall of muscle. Still, the scale at which this growth occurs is small. The resulting rings of muscle cells are just 2.5cm long and 1mm in diameter. Further expansion is difficult, because they have no blood vessels to transport nutrients to cells in the centre.


This is an area Post is keen to explore, and sees two possible solutions: either an “artificial channel system to mimic the blood vessel system”, or to grow a biological blood transport system, complete with tiny capillaries. It seems this could necessitate an artificial pump, but he suggested that “stimuli coming from the interior cells that drive growth and repair” could be sufficient to direct the flow of nutrients. His ultimate goal, he said, was to create an authentic T-bone steak, – without harming any animals in the process.

Post claimed his original idea was to make a sausage and “present it to the audience while the pig was running around honking.” But after he presented the proposal to Google founder Larry Page, his new patron insisted as a condition of his support that it was a burger, rather than a sausage, as Post had first envisioned.

“I wanted to produce a sausage, and present it to the audience while the pig was running around honking.” (Mark Post, Maastricht University)

Another way the professor proposes to enhance the technology is through tailoring the proteins and amino acids the meat contains. He states that in future, they might remove harmful proteins such as those which cause colon cancer. And that they would incorporate fat cells, which would serve the dual purpose of making the burger juicier, and of improving its nutritional content: the fatty acids, when separated from their respective glycerol molecule, are essential for bodily functions including steroid synthesis, and in the phospolipid bilayer which forms a part of the plasma membrane in all body cells.

Fun Fact:

A number of other important biological molecules are also lipids. Vitamins A, E and K are terpenes, compounds similar to steroids but somewhat smaller. Steroids, of which Vitamin D and cholesterol are two examples, are lipids consisting of four interlinked rings of carbon atoms. Other important steroids are derived from cholesterol, among them the sex hormones progesterone and testosterone, and the hormone aldosterone secreted by the adrenal cortex. Bile salts, such as glycocholate and taurocholate, are polar metabolic products of cholesterol necessary for functioning digestion of lipids.


Here comes the science…

Tests have been conducted as to the ideal solution to promote adipogenesis, adipose or fat stem cell replication. Post cites Lin et al, ‘Tissue Engineering A,’ 2011, as having demonstrated the effectiveness of ADSC in collagen gel for this purpose. The expression of fatty acids Rosi, Phytanic and Linoleic acids were especially boosted, and to a lesser extent myristoleic and elaidic acids.

The optimum condition to enlarge and increase muscle cells is achieved through subjecting them to tension (“Muscle cells are exercise junkies,” says Post), so stretching them between two points gives them an effective workout that could also increase the muscle mass. It has been found that electrical currents stimulate muscle activity, but over time this wears them out rather than building them up.

In addition, the team is experimenting with the solutions it will use on the muscle tissue as it is being incubated. By coating the cells with a substance such as Matrigel, at a concentration of 1:200, you create an immersive 3D culture environment. In contrast, a petri dish donates nutrition via a flat, 2D surface. Matrigel was the most effective coatings tested, causing the highest relative expression of stem cells. Other coatings trialled in the experiment were laminine (concentration 1:10) and biolaminine (concentration 1:25).

A potential obstacle to sustainability is that, in addition to the original biopsy, calve serum is used to deliver vital nutrients. Eventually if cultivation of muscle cells can be scaled up, it would be possible to grow new cell populations out of cells already synthesised in the laboratory. But to maintain a supply of calve serum would necessitate diverse herds of livestock; something Post wants to phase out, as an inefficient use of land and corn. They have had promising results with a few non-serum media.*[1]

The first three stem cell burgers were served up live on TV last August to notable food critics, author Josh Schonwald and Hanni Ruetzler of Future Food Studio, who gave the home-grown dish what Post calls a polite but honest reception. The cost of this particular menu item was in total €250,000 in equipment, materials and labour. In order to make the process efficient and cost-effective, the team would have to expand production to a commercial scale. The task of modelling how to achieve this was contracted to J.Rowley, allegedly the world’s largest supplier of stem cells for laboratory purposes.

J. Rowley’s model did not account for all the further enhancements envisioned for the process. It made a number of technical assumptions: that 52 population doublings were possible; that the achievable cell concentration in the microcarrier culture would be 7.0e6 cells/ml; and the microcarrier concentration 10g/L. Consultants at J.Rowley mapped out a method by which cells were conveyed from plates to flasks, to a cell factory to a cell culture, via a mixing facility to a filling facility, and culminating in a discrete freeze drier. The final cost per kg of beef production? An average of $65.57, which at current exchange rates is £39.33. At the current retail price of meat, this seems on a par with livestock farmed the traditional way.

The headline figure is that a single bioreactor, incorporating 13 cycles per year, could feed a population of 10595. Each batch of cells yielded by the chain of production would yield 35000kg of meat, without endangering the life of a single cow.

That’s 175,000,000,000,000 individual, artificially synthesised cells, for those of you who are impressed by big numbers.

And why stop there? Post jokingly hypothesised about the creation of ‘animal hybrids’, meat containing components for two or more different species. Pick and Mix…He theorised that technically, it would be possible for people to grow meat at home in domestic incubators, provided they tended their incubator with the same care and patience as a garden or allotment.

Hey, it sounds fantastical. But five years ago, what would you have said in response to someone who claimed they could ‘grow meat’?

[1] If you are interested, results for the solution 6% Xerum free + Mix +1% P/S/A ingevoren aliquots suggested it could be a viable alternative.

New Research from Cass Business School on Investor Sentiment Index

23 May

The franchise for reproducing this article is pending

The latest landmark report to emerge from Cass Business School’s consultancy division has proved it really does pay to ignore crowd mentality in investment decisions. Professors Nikos  and Dr Nomikos Papapostolou presented their report on dry-bulk shipping. They took historical data of boom-and-bust cycles, and found that investor sentiment acts as a contrarian indicator to returns.

Cass academics used regression analysis to determine the correlation between their investor sentiment index, and benchmark vessel prices dating back to 1996. The data set was from several different sources; they used a combination of different variables, and therefore more than one input. They used the supply-demand balance to determine asset valuation. From the same data they extracted proxy values and parameters. To set a value for market expectations, they quantified investment activity. And to measure liquidity they took the volume of trading, From the S&P they took key market parameters, including IPO returns and volatility, based on information regarding the frequency and size of trades, and the positions of speculators and hedgers.  Their deduction? That overwhelmingly, “sentiment is a contrarian predictor of asset prices.”

If the market seems to be moving up, it could be time to start preparing for a fall. Boom-and-bust cycles in the shipping industry shared a number of characteristics. The initial peak, (or trough), is located at the highest (or lowest) point within a five-month window either side of that point. A fall in investor sentiment either coincided with a decline in asset value, or predated it – as was the case in September 2000, April 2005 and July 2008. Each phase has a minimum duration of five months. Once you have exceeded this time period, it could be time to start betting against the market. Perhaps to buy or sell a ship.

Professor Nomikos drew the team’s findings to their logical conclusion, asserting a ‘buy signal’ was when the sentiment index crosses the zero line from above, and the ‘sell signal’ when the index crosses the zero line from below. This being said, they were careful to issue a disclaimer, insisting they were not offering trading advice, but a new, solid, economic indicator. They believe it superior to the pre-existing Moore-Stevens index, because it can be calculated in a monthly basis and does not rely on surveys, which are rarely accurate predictors of real decisions.

Their overall market sentiment indicator was set against to various sector-specific ones: for capesize, paramax, supramax and handy vessels. Regression analysis showed there was no strong correlation between the market and individual sector sentiment. Moreover, between the two points April 2008 and December 2009, “the capsize sentiment index moves in a more erratic way, reflecting the idiosyncratic features of each sector.” In contrast, “market sentiment is smooth, reflecting market side movements.” Generally, sector sentiment was only significant with the larger factors capesize and panamax.

This reflects the variable demand between capesize vessels, carriers typically above 150,000 dead weight tonnage, which are too large to pass through the Panama Canal, and the smaller more manoeuvrable handy vessels the Handysize and Handyman. Specific categories of ship have different qualities. The supramax is a bulk carrier designed for large quantities of materials which are dense, corrosive or abrasive: when demand or prices of cereals, coal, ore and cement rise, so do requirements for the supramax. Forming around a third of the world’s merchant vessels, it and the capesize are the only two sectors the researchers consider to have significant impact on overall sentiment.

Overall, their model had an 80-85% accuracy of capturing changes in the shipping sector. Partly this was attributed to sentiment contagion between sectors, to the extent that a separate synchronisation index was chalked at 80%, “consistent with strong market integration and herd-like behaviour.” Asked whether shipping was known for the high level of imitative behaviour within the industry, in terms of managerial decisions, Professor Nomikos replied: “There is a high degree of substitute ability – crossover between cargos they can carry and operational ability,” which necessitated inter-firm communication. Larger firms, he noted, were the first to notice a change in market trends as the most affected.

For comparison, they matched their Sentiment Index to two other predictive factors, the ‘Buy and Hold’ model which holds that all short-term market fluctuations of owned assets should be ignored as irrelevent, and the ‘Probability of Expansion’. The latter was estimated using “a specialist econometric model that calculates probabilities (rather than prices).” They calculated changing prices on a forward-looking basis, where the indices are calculated using the available information at each time interval. The Sentiment Index was found to be vastly superior, with a Sharpe ratio higher than the other two for every step.

Lest we put too much weight on this ephemeral concept, sentiment, it is worth clearly defining the term. Cass academics state that investor sentiment is “the propensity to trade on noise rather than info; it may also refer to investor optimism or pessimism.” So presumably if everyone was making properly informed, considered investment decisions, today’s findings would be null and void? Let’s hope for the sake of the few observant individuals that the rest of the sheep in the herd keep following their gut feeling.