Can the Euro Survive?

Can the Euro Survive?

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      What will happen to the euro in the light of the Greek crisis? Does it have a long term future or will it disintegrate?

     I have no real opinion on this. So I listened in on a debate between two of my sources: an economist and a city worker. We will call them T (Tomato Source) and B (Brown Source). The words in italics are mine – either questions, or explanations of some of the terms used.

     Do you think the euro will survive for much longer?

T: No, because Germany will soon start to want it’s own monetary policy. At the moment, the eurozone has a monetary policy but Germany will decide it needs it’s own one soon. At present, if say Greece, France, Italy have slow economies, they will want to lower interest rates across the euro zone. Germany would have to comply with this, even if their own economy is over heating. (If you cannot remember what this means, read the article on interest rates published 11-7-15)

     The bigger point though is the opposite of this. When Germany wants to lower interest rates to increase consumption but most other economies are over heating. Then they will ‘stagflate.’ (This is not a form of indigestion, it means the economy is not growing but inflation is. It’s bad.)

B: I don’t agree. The currency wont inflate because it will always be balanced by those other economies. True, if Greece now had the drachma, it could use different techniques to the rest of the eurozone to sort out its economy. However, the USA works because it is centrally run. (Central government decides on tax, government borrowing etc for the whole country. Individual states decide on only some financial points.) A new ‘United States of Europe’ would work financially but all the countries would need to agree to be centrally run.

T: At present, if France, has a fast growing economy, they cannot lower interest rates unless all the eurozone agree. All they can do is change their fiscal policy. Classical economists think this cannot work.

Fiscal policy is what the government spends and what it sets taxes at. In the eurozone, the other measures to control the economy, like interest rates and the number of euros in circulation, are all agreed centrally. So, Greece could not decide to just print more euros when it ran out of money. Germany cannot decide to lower its own interest rates.

B: California is as big as a eurozone country and central policy works for them. Detroit went bust recently, but it works because they have more central control. The eurozone would work if they decided tax and government borrowing centrally, if it became a full union, like the USA. However, the citizens of the countries, the people who get to vote for governments, have never wanted this, they want the control to remain in the individual countries. This is why they have a sort of ‘half way house’, despite the theorists wanting a full union. That halfway situation is why it went wrong. They have now centralised the regulation and insurance of banks. This was an important step. The central bank (called the ECB) now controls all the domestic banks in all the eurozone countries.

So why weren’t the Greek banks protected? Haven’t they just gone bust?

B: It doesn’t stop them going bust. The insurance just protects the deposit, the money of the general public.

T: Another big problem is, monetary policy is effectively free, but it takes a long time to take effect. We’re in a recession. If I want to encourage people to spend more (and speed up the economy) I will lower interest rates. But that takes a long time to be effective. So the public feels its not effective at all (people tend to be impatient. Especially when their money is involved.)

     A faster way to speed up the economy, is through fiscal policy. The eurozone can only work if fiscal policy works. Everyone believes this. (Classical economists believe that fiscal policy does NOT work, therefore they believe the eurozone will NEVER work!)

     Whether or not fiscal policy works depends on two different things. It depends on:
1)the size of the multiplier effect
2)the scale of the crowding out

     Hmm, complicated terms! Economists love to use fancy phrases. We need to know what each of them means.

      Let’s look first at the ‘multiplier effect’. This refers to the GDP of a country. The GDP is simply the amount of ‘stuff’ produced annually in a country. It stands for ‘Gross Domestic Product.’ We’ll use China as our example because they have a big ‘multiplier effect’.

     Pretend the government decides to build a bridge. It pays £5,000 to the builder. (Yes, I know it wouldn’t be in £, but we’re trying to make this simple!) Now, that builder spends £3,000 in China on Chinese products, spends £1,000 on imports, saves £500 and gives £500 in tax.

      This increases GDP by £8,000. (Are you keeping up? It’s the government’s first 5,000 plus the builder’s 3,000 – all spent in China on Chinese stuff.)

     Now, the £3,000 of the builder was spent on a Chinese car. The car man then spends that money. He spends £2,000 on Chinese stuff, saves £500, spends £500 on imports and tax. So now we have another £2,000 spent in China on Chinese stuff, so their GDP increases again.

      That same money keeps multiplying the increase to their GDP (I am getting a hint as to how they chose that name now.) In fact, that original injection of £5,000 (from the government to the builder) increases GDP by £20,000.

     We used China as an example because in China, no one saves much, no one buys many imports (most things are ‘made in China’) and no one pays much tax. So, the ‘multiplier’ is much higher than somewhere like Belgium. Therefore, government spending in China is very effective.

     Now let’s look at ‘crowding out’. Pretend a government wants to build that same bridge and to raise the money to do so, it sells government bonds. These are in effect a way the government can borrow with interest. It borrows from banks and individuals (perhaps through National Savings Bonds) for a set period and then pays it back with interest.

     That money, when it is lent to the government, stops circulating, which slows the economy. (If I put £100 in Savings Bonds, then I am not using it to buy a new tele.) This is called ‘crowding out’.

     So, the ‘multiplier effect’ is the inverse of ‘crowding out’. (I wanted to write that it was the “opposite” of crowding out – because to my mind it is – but both my sources inform me that strictly that is not true, so we will stick with “inverse” knowing that for normal people that means “opposite”.) Whether or not fiscal policy works depends on which one – multiplier or crowding – is the most dominant

T: Therefore, fiscal policy will be less effective in places like Germany and France than somewhere like Poland. (Remember ‘fiscal policy’ is government spending and taxes.) So, even if the whole eurozone economy is slow, countries within the zone will disagree on how to speed it up, because fiscal policy will work better for some but not others. This is due to the diversity of countries within the eurozone. If they were all like France and Germany, then a central policy would be much more likely to be possible.

B: I don’t agree. In the USA, states have huge economic differences and yet a central policy works there.

T: That is because the culture across the states is broadly the same, the amount of stuff they import, the amount of tax they pay does not vary much between states. This allows a central policy.

B: Actually, I think it is because of central policy that they are similar. If all the countries across the eurozone accepted centralised government borrowing and taxation, then the euro would work. The Greek problem would probably never have happened.

     Politically, this is very unlikely to happen.

     So, can the euro continue?

B: The trouble is, politicians need to be popular to get votes. Democracy means that they are pressurised into continually borrowing as much as possible, so that life is good for the current population. They borrow from the future to keep voters happy today.

     This causes the temptation to behave rashly, to alleviate hardships today and to not live within their means. The euro takes away some of the consequences of over spending. Bad government decisions are spread across the eurozone. In the UK (not part of the eurozone) if the government overspends, then fairly soon it will face the consequences. Like Brazil had to. The countries in the eurozone can behave how they want and know that the other countries will bail them out.

     Maybe, the lessons learned in Greece will cause a change in behaviour. Maybe they will do things like set up a system of policing each other, auditing what is happening in each of the countries. Part of the Greece problem was caused because they lied about the amount of debt they had and no one checked. Even if they reject a central policy, they could introduce greater accountability. They could agree on tough consequences for governments who break the rules.

T: Whatever happens, I don’t think Germany will bail out another country. If Portugal follows Greece, I think the German people will just say no and Portugal would be forced to leave the euro. The eurozone would crumble.

     So, can the euro survive? If some new rules and tough consequences are introduced, then maybe. But it is far from certain…….

Interesting Interest Rates

Interesting Interest Rates……

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       In the News this week, Janet Yellen (federal reserve chairwoman) has again said that the US central bank is likely to increase interest rates. Is this important? Will this affect you?

     Now, I have never met Janet Yellen. All I can tell you is that she has blonde hair and likes to wear dark lipstick. I can however, tell you a little about the Federal Reserve. This is the central bank of the US. It is the US equivalent of the Bank of England. So, what is a central bank?

     A central bank works for the country. In recent years, it has become acceptable for it to be independent of the government. It manages inflation and financial stability, in other words, it manages the economy. How? Well, that is a whole article in itself (not yet written but I’m working on it!) For now, lets just say that it sets interest rates.

      Now, people do not like to be shocked by what central banks do. Just like with the Swiss Pegg (see : https://anneethompson.com/the-mystery-of-money/the-swiss-peg-nothing-to-do-with-clothes-lines/) which changed the markets by 20% in a single day. They therefore usually very carefully give hints, in tightly scripted statements. So, if someone senior (like Janet Yellen) makes a statement – trying to avoid a sudden shock – the market listens very attentively. So should we.

     Anyone who is young, may not realise that at the moment interest rates are low. Very low. Possibly the lowest they have ever been. This is due to the financial crisis – the central banks have all lowered interest rates.

     I used to own a Mercedes C class coupe. It was beautiful. It drove like a dream. It also had a ‘super charge’ button which I loved (made me feel like James Bond.) When I was stuck behind something slow, I could press my super charge button and whiz past at super fast speed. The central bank, in effect, has a ‘super charge’ button, which is to lower interest rates. If it lowers interest rates people change their behaviour. They are less likely to save (because their savings wont go up in value) it costs less to borrow money, so the population goes shopping. This creates jobs, creates income, leads to economic recovery. For the last five years, every central bank in the world has done this.

      However, central banks hate high inflation. Everyone is worse off if there is high inflation. Your money becomes worth less (what you can afford to buy with a pound this year will be less next year) it slows the economy and they do not like it. One thing that encourages high inflation is low interest rates. So central banks want to raise interest rates before this happens.

     At the moment, the US economy is going relatively well, which is why the central bank will probably begin to nudge up interest rates, before inflation creeps in.

     The other reason is that those ‘super charge’ buttons have been pressed for about five years now. They only really work for giving an extra ‘umph’ when needed, they are a back-up plan. They need to turn them off before we go into a new recession. The central banks need to get everything back to normal (with slightly higher interest rates) so their ‘secret weapon’ can go back into reserve.

     How will this affect the UK? Mark Carney (who I have met, at a dinner. He seemed like a very nice chap) is in charge of our central bank. He is saying that “nothing will change for now.” However, he is also saying that if interest rates move it “would be an increase rather than a cut.” These are those carefully scripted hints that we mentioned earlier. People (you and me) need to plan for interest rates to start going up before too long.

     Interest rates today are very low. This means that even a small increase has a big impact, even a 1% increase means big changes. For example, if you have borrowed £200,000 for a mortgage you might be paying it back at 2% interest. If interest goes up by 1%, so you are now paying 3%, then your monthly payment would go up by £100. For a normal family, finding an extra £100 every month in order to pay the mortgage, would be hard. Interest rates on other borrowing would also go up. Do you owe money on your credit cards? Have a car loan? Be prepared for the repayments to increase.

     We need to be wise, to start planning now for what is likely to happen in the near future. Listen to the hints.

The Hiccups of the Chinese Stock Exchange

The Hiccups of the Chinese Stock Exchange

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     The Chinese economy is growing at 7% per year and has been doing so for a decade. It is a very healthy economy at the moment. Companies are doing well and China now has a good working stock exchange, so it is possible to buy shares in Chinese companies. So should we? Should we be taking advantage of the healthy Chinese economy and investing our money?

      We first need to understand about shares and the stock exchange. A stock exchange is simply the place where shares in companies are bought and sold. The average value of all the shares on the exchange tells you how companies are doing. If we look at the Chinese stock exchange, from July 2014 to May 2015, the average value of shares more than doubled in value. If you had invested £200 in July 2014, by the end of May 2015 it would have been worth over £500.

ImageSource: Bloomberg

     However, before you rush out to buy shares in a Chinese company, you need to know that today (July ’15) those same shares would be worth less than £400. The Chinese stock market is crashing. Why? What is happening? Their economy is growing steadily but their stock market seems to have hiccups – big jumps followed by big slumps.

     We first need to consider what actually decides the value of a share. Firstly, a share is part ownership of a company – a ‘share’ of the company. So if the company is doing well, the share should be worth more. So if you own 1% of the company (have a 1% share) and that company doubles its income in a year, then you will either receive your share of that profit in a dividend (a cheque in the mail) or your investment is worth more (you can sell it and make a profit.) So, if the Chinese companies are doing well (which they are) you would expect the shares to be also growing steadily in value.

      In the long term, this is likely to be true. The steady growth of the companies will be reflected in a steady overall increase in share values. However, in the short term it is more erratic. Why? What else influences share prices?

      The second influence on the value of prices is supply and demand. Confidence in the Chinese market pushes up prices of shares. (Refer back to the article on market places if you are unclear on this. Remember, it’s just like ebay. Something that is popular will go up in price.) Global confidence in the Chinese market pushes up share prices. The share prices might even be higher than the value of the company itself.

     An example of this (though not a Chinese one) is Uber. In London, only black cabs can be hailed. Regular taxis have to be prebooked. Uber has created an app whereby a customer wanting a taxi can ‘order’ one on their phone. Any taxi who is part of the Uber scheme can respond and pick up the customer. It links taxi drivers and passengers. Excellent idea. I predict the company will do well. Unfortunately for me, lots of other people also think it will do well. That has pushed up the price of its shares, because lots of people see it as a good investment and want to buy them. According to the share price, Uber is worth twice as much as Sainsburys (though Sainsburys is probably worth a lot more as a company.) If I want to make money on the stock exchange, I need to be ‘ahead of the pack’. When everyone notices the same trend, it pushes up the price of shares, which lowers the likely profit from a short term investment.

     Now, the Chinese stock market is unusual because the overwhelming majority of shares are owned by small time Chinese investors. It is a culture that likes to gamble. The share holders are not interested in long term investment, they want short term profit.

      The Chinese stock market is very new (has grown up in the last five years) so people have not really seen any big ‘crashes’. It is seen as a safe bet. This is a bit like when we bought our first house. We had only ever experienced house prices going up, we assumed that a house was a ‘safe’ investment. It was something of a shock when houses prices plummeted at the end of the 80s.

      At the moment, small time investors see the Chinese stock market as a ‘safe’ investment. A lot of people are investing in, gambling on, the stock exchange. The share prices have become driven by rumour and speculation as people try to predict the future value of companies. The stock market has become more linked to crowd behaviour and less to the real value of companies. This explains the hiccups.

Deflation

 

 

 

 

Deflation

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 This week, the Bank of England announced that inflation is now negative – this is known as deflation – for the first time since the early 1960s. This means that buying basic goods is getting cheaper rather than more expensive. This is good right? It means we all save some money? Let’s have a look.

     Firstly, what has caused this deflation? Inflation is often driven by the price of oil. So much of both manufacturing and our every day lives are dependent on fuel, that a change in oil prices affects everything. If oil goes down in price, almost everything else does too. In the last six months, crude oil has halved in price.

     So, what has caused this? Why has oil, a commodity which cannot be made but only extracted and refined, suddenly become cheaper? Oil is produced by very few countries and many of them are in the middle East, including Saudi Arabia. Now, Saudi Arabia has deliberately increased the amount of oil it is extracting and selling. The oil markets are like any other market (see the article on the Swiss peg). If there is lots of oil, then the price goes down.

     Why though, would Saudi Arabia increase their supply? They have halved their income from $100 per barrel to $50 per barrel. Why would they do that? Good question! No one actually knows (apart from the Saudis I guess.) However, there has been lots of speculation and there are two different likely reasons:

     Possible Reason 1: Due to oil prices being so high, people had become very inventive at finding ways to not buy oil from Saudi Arabia. They started trying to find their own oil. One method is through fracking, removing oil from shale (in your own country). Fracking is expensive but if it is cheaper than buying oil from Saudi Arabia, then it is worth doing (unless you live above where they decide to it of course!)

      Now, Saudi Arabia sells a lot of oil to the US, they are not happy that the US is becoming self-sufficient with its oil production. If therefore, Saudi Arabia reduces the price of oil, just for a little while, just until all the new fracking companies go out of business, then in the long term, it will be better off. They can then raise the price again, having bankrupted all their competitors. Is this why they have increased production? Not good for the US frackers (I need to be very careful how I write that word!)

      Possible Reason 2: Depending on your political/religious viewpoint, some of the dodgiest regimes in the world are completely dependent on selling oil. (Places like Russia and Iran.) The most effective way to defeat a regime is thought to be economic – people who cannot have what they want to have are generally dissatisfied, dissatisfied people try to change their government. Up until now, sanctions against these countries have been less than effective because they both have oil. That oil is now worth less (because Saudi Arabia has flooded the market, so to speak.) This will put a lot of pressure on those regimes. The US will like that, so maybe Saudi Arabia is acting in unison with the US.

     Let’s go back to the original question, is deflation good or bad? Governments, on the whole, do not like deflation, they think it is bad for the economy. If everyone is spending, moving money around, that is good for the economy. If companies are investing (buying new equipment) then that too is good for the economy. However, if people see prices coming down, if they know that if they wait for a month, that new television will probably cost less, then they delay spending money. Delayed spending means less money moving around, which is bad for the economy. Therefore governments like to have low inflation. Now, this present deflation is probably going to be fairly short in duration and will not plummet too far, so it will make very little difference. It is an interesting occurrence though and shows what a completely connected world we live in.

A financial article is posted every Saturday.

The Swiss Peg (Nothing to do with Clothes Lines)

The Swiss Peg

In January 2015, the Swiss Central Bank de-pegged the Swiss Franc. Within a few hours, the amount of euro you could buy with Swiss francs decreased by 20%. What does this mean and why was this significant?

Let’s start at the very beginning (in the words of a famous song.) In the global society that we live in, people want to buy and sell stuff between countries. That means, buying things that use different currencies. For centuries now we have had exchange rates, which decide what one currency is worth compared with another. They determine how many euro you can buy with your pound when you go on holiday.

Who decides what the exchange rate should be ? Who decides how many euro you will get for your pound (or dollar or yen) Well, in most Western countries the exchange rate is set by “the market”. Every day the banks match up buyers and sellers of currency across the world and that decides the price, ie the exchange rate. People want to change currency for a number of reasons, pushing and pulling the exchange rate up and down. For example, maybe millions of Americans want to come to the UK to watch the Olympics, that will put up the exchange rate – they will get fewer pounds for their dollars. But at the same time, Apple might bring out an exciting new iphone that everyone wants to buy, that will raise the price of the dollar, making it even again.

We can see how the foreign exchange markets work by looking at ebay. Pretend you want to sell your VW beetle lego model on ebay. If you set the price too high, no one will want to buy it but other people who own a lego VW will see it and decide that they want to sell theirs too. There would be too many sellers and no buyers and the price would start to go down. The opposite is also true. If you put your lego model on ebay at a low price, no one else in the lego community would think it was worth selling theirs. Then lots of buyers would bid for your model, which would push the price up. At a certain point, other lego bods would decide it was worth selling their models too and the price would stabilize. It finds a natural level.

Now, some countries do not want to be part of the free market, so they control their currency. The government sets a price and their currency can only be bought and sold at that price. It reduces the amount that other countries want to trade. (In recent years, this has happened in China and the old USSR.) Or, sometimes a dictator will decide to set the price of their currency too high (in recent times, this happened in Zimbabwe) then people decide to just ignore it and an illegal black market is formed.

In the open market place prices are also affected by fashions, rumours and what people think will happen in the future. So, when the Conservative government won the last election, whatever your own personal views might be on that, the international market thought that the UK was worth more and the price of the pound went up by 4%. Nothing had changed, we didn’t suddenly have great weather and become a tourist destination, it was just that people’s view of our economy changed and that altered the markets. It reflects what causes most changes in the exchange rate. It is more about optimism and fashion and less about physical things, real economy or cash flow.

In the last five years, there have been lots of worries about Europe. There have been worries that some countries (Portugal, Ireland, Greece) might collapse and the Euro might go down in value. In comparison, the Swiss franc has looked very stable, very safe and so its value has gone up. That’s good for the Swiss people right? Well, not necessarily. It means their foreign holidays will be cheaper. But if they are an exporter, wanting to sell their chocolate, watches or knives abroad, then it makes their goods more expensive, fewer people will buy them. For the Swiss, their core industries are their exporters (if you have forgotten what that means, read the article about the European Union.) Therefore, too high an exchange rate is generally bad for Switzerland.

So, the Swiss government decided to do something. In 2011 the Swiss Central Bank set a target maximum price for Swiss francs, they said they would act in the markets so it would not go above a certain rate. This is called pegging. They agreed they would always sell Swiss francs at a certain price, so no one would go elsewhere and buy them at a higher price, therefore no one bothered to try and sell them at a higher price. The bank then had to actually sell francs at the declared price (to make it real) so it was regularly buying other currency (which it stored.) Now, because they were a strong, trusted bank, saying they would buy other currency, which kept the Swiss franc below a certain price, everyone believed them. This continued for several years.

Then, in January 2015, they announced that they were removing the peg. The exchange rate changed by nearly 20% in a morning, the biggest one day change in a single major currency for decades. Wow.

The European Union: A Benefit or a Hindrance?

The European Union: A Benefit or a Hindrance?
Anne E Thompson

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      In society, people have different economic roles. Some work for the government (nurses, teachers) and provide a service. Some work in the private sector (this just means ‘not government worker’ – sounds more complicated than it needs to!) In the private sector, some people provide a service (coffee shop worker, plumber) and some increase the stock of assets of the community. In other words, some people add something (farmer grows grain, factory makes cars.)

If we look at that last group, they increase the stock of assets in various ways. Some reap from nature (miners, farmers). Some create/make things (factory workers, writers of computer software). Some bring in wealth from other countries (tourist industry). Lets call these three groups “the core industries”. Remember, they are adding to what a country has.

In the long term, the prosperity of a country depends on these core industries. The people who provide services are important ( I am particularly fond of Costa coffee) but they just move money in circles. It is the core industries who actually add to what a country owns.

We have just had a general election. The politicians spent a lot of time discussing how they planned to move money around, to spread the wealth between rich people and poorer people. There was very little said about actually helping those core industries (the industries who actually add to how much is owned.)

Now, I am really enjoying watching Bear Gryll’s series The Island. I sit and shout at my television, giving them all lots of advice. The two groups spend a lot of time discussing who spends too long sunbathing, how much water they can all drink every day. However, none of them will survive unless someone actually collects the water or finds some food. In other words, they need some core industry.

We live today in a globally connected world. Within that world, the UK needs some core industries, something that it is really good at. We do not, compared to places like Australia, have great mining resources. We do not manufacture as well as the Germans. Our computer industry is not as advanced as the US. We do not farm on the scale of Brazil.

So what does the UK have? We are the world’s trusted market place. We have a sensible legal system, a stable government, a city that is geared up to helping the world do business. And we are good at it. The Chinese, the Russians, the Indians, they all trust the UK. This is the place where they trust they will be treated fairly, they want to conduct their business here. English has become the international language of business.

Now, if you talk to a German, they know that keeping Volkswagon, Mercedes, BMW, Porsche, Audi strong is important. They know that these are their core industries. If they go down, their economy will be in trouble. In the UK, most people do not seem to realise that our lawyers, insurers, bankers, traders, accountants (the people who operate that global market place) are our best core industry. The money they take from the rest of the world ripples down to the rest of us.

If we want to remain as the world’s market place (and remember, we don’t really have anything else that’s as good at increasing our country’s wealth) then we need to stay connected to the rest of world. We need as few barriers as possible.

In the last twenty years, the European Union has been a huge part of that market place for the UK. People from around the world use the UK as a gateway to trade with Europe.

It is clear, even to me, that the European Union is far from perfect. I think they have some silly laws and we have a problem with immigration. However, we need to be wise. These may be things we have to endure in order to protect our core industry. Leaving the European Union would severely damage our status as the world’s market place. The knock on effect of that would affect all of us.

If we think again of Bear Grylls, someone has to kill the pigs.

Manipulation of the Financial Markets

Manipulation of Financial Markets

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This week, a bank was fined two and a half billion US dollars for manipulating Libor. There was also an English man who had his bail set at five million for spoofing Futures markets. What do these terms mean? What did they actually do that was so bad?

Let’s go to Rabbit Town. They have a big fruit and vegetable market. Jim has a stall where he buys and sells carrots. The market has a big carrot section, there are about fifteen other carrot stalls. Every day, the town publishes the average price for carrots. People use the Town Price when they are doing their deals. For example, the Rabbit Town school buys 20 carrots every day from the farmer and they agree they will pay the farmer whatever the published price is.

The town calculates the Town Price very carefully. They ask all fifteen stall holders what their price is for that day. They then take off the top two (most expensive) and the bottom two (cheapest) and work out the average of all the others. That then becomes the Town Price for that day. People do not have to use it, but it’s a helpful guide.

Now, Jim has two brothers. One brother is a carrot farmer and he sells carrots. The other brother owns a soup factory, so once a month, he buys carrots. Both brothers have contracts with other people and they have agreed to buy and sell carrots at the Town Price. They know that the price that Jim gives in to the town hall, very slightly affects what the Town Price is set at. When they have carrots to buy or sell, they go to see Jim and ask him to slightly move the price on his stall. Not too much, because he doesn’t want to be in the top or bottom, but just enough that it alters the average a tiny bit, moving it to be in their favour. Jim likes to help his brothers, so he agrees. Sometimes he even persuades his friends to change their prices a little too.

If carrots are interest rates, then Libor is the Town Price. It stands for London Interbank Offer Rate. It is the interest rate that banks use when they lend to each other.

Jim was meant to give in the actual price that he thought he could buy and sell carrots at, not a price that would help his brothers. Even though, due to averaging, it doesn’t change the price much, it is still corrupt. The fines given to banks who do this have been huge. Now, as Jim’s false price sometimes went up and sometimes went down, it is unclear how other people were impacted. The big fine does not seem to really correspond to the financial damage that was caused. We’ll discuss this a bit more later.

Let’s take a look at ‘spoofing’ now. What is it? Well, imagine Jim has loads of carrots and he wants to sell them to other stalls. He wants the price to be as high as possible, so he makes up a rumour. The rumour says that a big carrot buyer is about to visit the market and he needs lots of carrots. Jim then sends anonymous notes to all the other stall holders, putting in orders for lots of carrots. All the stall holders quickly put up their prices, ready for when the big buyer comes to town. Jim then quickly cancels the false orders, sells his carrots to them at the higher price and makes a nice profit. This is called spoofing. It is against the law in financial markets.

Let’s look at one other thing that might affect prices. Jim has some special carrots. They are bigger and more orange than all his other carrots. He keeps them on a special shelf and they are not the same price as all the other carrots. That is allowed – he can have a special price for special carrots. What he is NOT allowed to do, is to wait until a customer arrives and then change the price for what he thinks he can get. He cannot look at Mrs Bunny and think, “Ah, nice watch, designer handbag, new shoes, I will charge her fifty quid a carrot for my special carrots.” This might be what your plumber does (“Big house, that’s a £70 call out fee” or “Small house, old lady, that’s a £30 call out fee.”) but banks are increasingly not allowed to. It is called ‘price discrimination.’

Now, we can see that banks are expected to behave differently to other institutions. If a car company does something bad, even something which is negligent and causes people to die, they will probably be given less big fines than the banks. Why? Is this fair? Personally, I think it is right. I think that the fine is not related to the injury caused financially, but the injury that has been caused to the bank’s reputation.

Our society relies on banks. We need them to be completely trustworthy and so the standard set for banks needs to be higher than the standard set for shops or manufacturers or plumbers. The financial stability of a country depends on the banks, so we need stringent rules set in place to keep them honest. They used to have similar rules to other companies but that has changed and they are now much more tightly regulated. If the laws are clearly set in place and applied to all banks equally, I think that is fair. I want to be able to trust my bank. In the same way as I want to be able to trust my legal system.

There are some politicians who like to bash banks, who think that if they impose big fines then they will be elected to a higher office, they will personally look good. Personally, I think this is cheap and they are stupid. Don’t vote for them.