Making Rules

Its often observed, as technical advancement is constantly making easier to spread knowledge , low quality knowledge has grown exponentially.

Good knowledge is as if drowning in the pool of low quality knowledge. Something similar to a economist’s phrase – bad money drives out the good.

Recently, I came across a gem by Lon Fuller legal philosopher 1902-1978.

Moral tale of King Rex and eight ways in which he fails to make laws:

1)      Fails to make rules, so everything is decided on a adhoc basis.

2)      Does not publicize the rules

3)      Enacts retrospective laws

4)      Incomprehensible laws

5)      Contradictory laws

6)      Rules that require conduct beyond power of affected parties

7)      Introduces frequent changes

8)      Fails to achieve congruence between rules announced and official action

In our daily lives sometimes we make rules which we ask others to follow and sometimes follow rules made by others.

May we make better rules !

 

 

 

What is good for an economy – inflation or deflation?

We often hear about inflation. Recently, more about dangers of deflation.

So I thought I will write about this phenomenon as I have noticed from the point of view of employer -`capitalist` and employee- `labour`.

 

Men have short memories, a few years of inflation or deflation taken to continue forever and economic decisions are based on them.

 

 

Moral of the above story!

In a capitalist system, where capitalist is free to employ his capital to whichever source is most profitable, labour also has this choice and should make this choice of providing his services to the capitalist who pays him the highest wages.

 

The question arises why does capitalist makes this choice and labour does not?

Answer: Habit.

Man is a slave to his habits.

A capitalist is thinking about his investment decision practically every day.

And an employee makes it very occasionally. Usually when he is forced by circumstances.

Labour has nothing to offer but himself; thus one should always gain knowledge, experience + new skills to make oneself more valuable and constantly change employers.

Farmageddon

Farmageddon

I had been reading this book recently and few interesting facts that I came to know, are listed below:

1 – Common Agricultural Policy (CAP) of EU ; setup in 1962 consumes nearly half of EU budget – c€50bn. Similarly, US has a Farm Bill policy setup in 1933 , total bill $30 bn ; 3/4th of which goes to top ten farms in US.

2. Farm animals consume :
1/3rd of all world cereals; and
30% of global fish catch ; and
1/2 of all antibiotics consumed in the world.

3. Mad cow disease ( happened in Britain) due to cows being feed meat and bone meal.

4. Lastly more than 200,000 Indian farmers have killed themselves since 1997 because they could not repay debt taken to buy fertilizers and GM seeds.

Amazing world we live in !

 

 

Banking and its regulation

Bank of England  (BOE)                                                                       Reserve Bank of India(RBI)

BOE                                                                                    RBI

Banking in recent past has also changed because of :

A. Technology – I remember when I first started at a bank,  our major job was to calculate  interest, balance books, all sorts of tasks were being performed manually, technology has brought a quantum leap in banking mostly for the better, but as one of my old bosses used to say our stock in trade is money by increasing the velocity of money, we can gain a lot of money but other other hand loose even more, before we even know about the loss !

One side effect, in the UK I observe that banks have basically de-skilled in their frontline staff.

B. Deregulation – I came to the UK from India. In India most of the banking sector is dominated by the government owned banks. It has its advantages like mis-selling does not occur but a bigger negative side is the banks are not customer focused or competitive.

But the Central Bank (RBI) is very active and helps a lot in providing guidance and support. Reserve bank is  truly  a lender of last resort and thus have an omnipotent presence in the market, it does not hide behind rules and procedures as I have noticed in BOE’s case.

One of the most surprising thing I came to know after the crash was that BOE did not see the housing asset bubble as its problem. Now we have PRA in the UK with a mandate to oversee the market risk, before this as per BOE’s interpretation of its own job profile, it was not their job to see what was happening in the market.

All these scams like LIBOR manipulation, miss selling of PPI, miss selling interest hedging products, selling of card lost protection (when one did  not even need it as per law), FX rate rigging were happening in the market. Even de-skilled frontline staff were aware of them, it’s hard to believe BOE was not aware of them. The problem was, BOE thought it was not their problem.

This is a simple error which happens when there are more than one regulator, one regulator thinks its the other’s job and vice versa and nobody does the job!

Housing Bubble in UK

earnings-to-hosue-prices

Borrowing costs have reduced resulting in high assets prices including housing. Investment banks and hedge funds have borrowed money and invested in stocks. Individuals in the UK have borrowed and invested in properties. Both have taken advantage of low borrowing costs.

Asset bubble has also taken place as FIs are lending ever greater amounts. Example income to loan ratio have soared in past 30 years from 2.5 to 4.5 times eg. Banks in the 1980s in the UK were lending maximum of 2.5 times of income as loans.

Lets say if Mr and Mrs A have a combined income of £30k in 1980s, they would get a maximum loan of 30 x 2.5 = £75k.  In 2014 (after the crash) they can get 4.5 ie. 4.5x 30 = £135k.

As we all are aware most of the houses are bought with bank’s money (mortgages), people are inclined to pay more as a purchase price, if the banks are willing to lend more. If banks curtailed their income to loan ratio house price increase can easily be arrested, even reversed but I am not sure if a reversal will be a good idea !

FATCA and bank accounts

FATCA

 

 

What is FATCA ?

Foreign Account Tax Compliance Act (FATCA), effective as of 1 July 2014 is a law of United States.

 What is the use of FATCA ?

This law is primarily designed to tackle tax evasion by US Citizens and US Companies who keep their savings and investments overseas and do not inform Internal Revenue
Service (Tax department of US Government)

 Am I affected?

Yes.

Many countries (like UK) in the world have signed `Inter-governmental agreements` with US Government.

This means all banks operating in the UK have to comply with FATCA provisions.

If you open personal or business bank accounts your bank will ask you to fill in a form. You may wonder why you need to complete this form as you have no connection with the US.

The issue here is, you know that that you have no connection with US but your bank does not know that. You are being asked to complete this form as a confirmation that you have no connection with the US.

Form filling

Most of the forms are straight forward but form W-8BEN-E is a bit complex thus I thought I will write about it.

Most of the legal entities (Companies, partnership, trust etc) in the UK with no connection with US, will be classified as Active Non-Financial Foreign Entity (NFFE).

 

Note – This article is written as a very simplified guidance to FATCA, your circumstances may be different. Please go to IRS website (click here) to get more information.

Double Taxation Avoidance Agreements (DTAA)

DTAA1

 

 

Agreement between countries not to tax the same income twice.

To illustrate, a UK company does some business in India. Indian tax authorities will rightly ask the company to pay tax on that Income in India. UK tax authorities may also ask the company to pay tax on its Indian Income to them. To avoid this double taxation which is unfair for the tax payer, countries usually enter into these agreements to make rules among themselves as to which countries will collect tax on certain income and the other country will not ask the tax payer to pay tax on that income if her had already paid tax to the other country.

Let’s examine this by a numerical example :

UK Company earns £100 by a business in India. Both UK and Indian Tax rate is at 30%

Tax Calculation (without DTAA)

Income                                                 £100
Indian Tax @ 30%                               £30
UK Tax@30%                                        £30
Net Income                                          £40

Total Tax Liability                            £60

Tax Calculation (with DTAA)

Income                                                 £100
Indian Tax @ 30%                               £30
UK Tax@30%                                        £30
Indian tax already paid                     £30
UK Tax Liability                                     NIL

 Total Tax Liability                             £30

Thus it is clear from the above example that UK tax authorities give rebate for the tax already paid to Indian tax.

Next, as this is an agreement between two countries, in case there is a conflict between the local laws (tax laws or any other law) and the DTAA provisions. Provisions of DTAA prevail.

So why to countries sign these agreements at all, will they not be better off charging tax payers as much as possible?

Governments enter into these treaties to minimize the vagueness of taxation rules in regards to international trade this improves certainty for businessmen which in turn encourage them to expand the trade ,increasing employment and in turn living standard of the general population.

Misuse of DTAAs – Indian example
Mauritius is a small island nation in the India Ocean with a population of 1.2m people but as per Government of India’s own records it has invested circa 40% of all the foreign direct investment during the period of 2000 to 2011.Click here

Even a UK banker was punished by UK regulators who was involved in arranging an investment for Reliance ADA Group via Mauritius . For more details see the UK tribunals order , read page 21
Click here

To be continued…

Age of turbulence by Alan Greenspan

“Some books are to be tasted, others to be swallowed, and some few to be chewed and digested”

Francis Bacon

 

While turning over my old papers today, I found a note I made on this book.

Mr Greenspan has written if I remember correctly on the 1st page of this book something which amazed me as if I found the key to economic progress.

Main requirement for an economy to grow is ‘Property rights’.

This is in direct opposition to Marx’s idea.

“As living requires physical property food, clothing, homes – people need the legal protection to own and dispose of such property without the threat of arbitrary confiscation by the State or mobs in the street”

Being an Indian I thought, how does this translate to the Indian context, what things we need to do in India:

Police and Judicial reforms – by more investment and better training in these sectors.

 

A trip to Romania – May 2013

A trip to Romania – May 2013

Every time you visit a place again, you see new features, facets which as if were invisible on lasts visits. One understand s it more and realises more in hidden than revealed.

This journey has also being full of adventures, or let’s says experiences I had. I think understood more of this country and have had time to reflect on past few years of my life.

I see more and more progress being made in terms of infrastructure of the country a new extended airport, bridges being refurbished, roads almost being built overnight.

But I see conditions of less important highways are far from satisfactory. Government still needs to do a lot to improve the standard of living of its people.

And this I realise is in contrasts to my thoughts when I first came here, Then I was comparing Romania with India (where I use to live then) and found it to be a much more developed country.

This time I compared it with United Kingdom, where I live now.

Political
People and political parties seem aligned to the European Union’s idea of democratic state with its central idea of free movement of goods and people.

There are a number of TV news channels, reporting even live news. Competition seems fierce e and I have seen major political figures like the President Traian Basescu on them.

After seeing their television and talking to different people it appears that the country is firmly on the path of democracy for the time being.

People

It is often said money cannot buy happiness. I know this statement is both true and false.

Money can buy happiness if one is hungry and have no means to buy food. Maybe a poor example but I know from personal experience how important money is for survival ie. fulfilment of basic needs like food, clothing and shelter, after that its utility starts decreasing.

I see here that people are having better housing; they are buying nicer cars and clothes. Huge super stores are sprouting out everywhere.

Younger people aspire to a better life and now whole of Europe is open to them.

Conclusion

Overall a progressing country a good place to be for a businessman.

1 Country needs a lot of infrastructure, especially in housing and road construction.

2 Maybe in the medium term rail transport is a great opportunity, as most Romanians use their own cars (rich ones which are still few) or minibuses.

3 Thousands of old elevators need replacement. As the communist era ones are rapidly aging.

4 Urban upkeep: Municipal services like waste collection and gardening are almost non-existent.

5 Sport goods – very low competition, with usually low quality wares

6 Garage Business: Like AA of UK not sure but have not seen any advertisement. But cars it seems are selling like hot cakes.

7 Solar Farms: Spotted 2 huge ones but lot of scope still exists. Sun is in abundance supply.

Hyper inflation – International Accounting Standard 29

Basic idea –  In a hyperinflationary economy, financial statement should be adjusted in a way that the figures in them are shown in terms of the currency value as at the balance sheet date.

BACKGROUND

As distance is measured in meters, kilo meters, light years etc. money is measured in US dollars, GBP, Euro and other currencies.

We know a meter (unit of measurement) remains the same ie. a road measured in 1920 to be 100 kilo meters, if measured today will be again 100 kilo meters long
but this is not the case with money. £100 of 1920 is not equal to £100 of 2014, the value goes down due to a phenomenon with which we are all familiar named inflation.

Thus in accounting our scale of measurement itself is fluctuating.

Inflation is so much engrained in our lives that Accounting Standards do not even think about it.

This standard deals with a special situation called hyperinflation.

STANDARD

Hyperinflation is simply as the name suggests a situation where the value of currency is going down rapidly. This standard guides us in process to adjust figures in the
financial statements to remove the effects of hyperinflation.

Accounting standard does NOT give an exact percentage rate at which we can treat an economy to be hyper inflationary, this is in line

with the principles of accounting standards as being guiding principles rather than hard and fast rules.

But the standards have given us pointers to think when considering the question of hyperinflation:

(a) The general population prefers to keep wealth in assets like gold, silver , cig grates etc. or in a more stable currency like US Dollar , GBP , Euros etc. Also local currency earned by the entity is immediately converted in these assets / currencies to avoid loss of purchasing power.

Please note you will find many situations in developing economies, say India, in current time that companies especially those trading overseas may prefer to keep their overseas earnings in foreign currencies. For example, many outsourcing companies selling services to US clients get paid in USD. They may prefer to keep their earnings in USD maybe in a bank account in US with two motives. Firstly to escape the onerous foreign exchange regulations in the developing world and secondly to save the purchasing power of their earnings.

But we see that not many of them convert their local currency holdings to USD or in a similar stable currency.

Please also remember the words “general population” mentioned. So we are not limited to the accounting entity’s behaviour only.

(b) The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that currency.

We can see such examples in the countries that have newly joined the EU and are on the path to convert their currencies to Euros in the near future eg. on the streets of Bucharest, Romania you will see many things priced in Euros  along with  the local currency, not only things like Houses , Cars , televisions, but things like monthly telephone contracts, home loans instalment . Here mostly vendor is a multinational company head quartered overseas and its main items of expenditure are in Euros (except in case of a house). They want to eliminate the currency risk by passing it to its consumers. Therefore a Romanian earns in RON (local currency) and pays his bills in Euros! The individual takes the currency risk rather than the multinational.
Why does such a thing happen? This comes down to bargaining power and we move in the field of economics like demand and supply. Where accounting ends, economics begins but there is a large overlap among them.

But even in the above Romanian example this standard will not trigger as the price quotations are not due to inflation but for reasons quoted above.

(c) Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short.

(d) Interest rates, wages and prices are linked to a price index.

(e) The cumulative inflation rate over three years is approaching, or exceeds, 100 per cent i.e circa 26 percent annum.

Calculation:

Year1                    Year 2                    Year 3                    Year 4

£1                         £1.26                     £1.58                     £2

When we think of hyper inflation we think of extreme examples like Zimbabwe, Hungarian crisis and the Deutschmark after WW1 but there are a number of countries experiencing hyper inflation today.

CIA fact book is a good source of information and they have compiled a useful list of countries with their inflation rate , link :

https://www.cia.gov/library/publications/the-world-factbook/rankorder/2092rank.html

 

Measuring Unit –

We cannot just convert the currency values in financial statements to a more stable currency like if we are preparing financial statements in Venezuela for the year ended March 2014, simplest solution would have been to convert the trial balance figures of  Venezuelan currency to say USD at the reporting date and prepare the annual accounts but the Standard wants us to adjust the figures as per the General Price Index.

The standard (IFRS for SMEs not main IFRS ) states that ‘normally’ a recognised standard Index calculated and published by the Local government in our case the Venezuelan Government, but we all know Government’s usually try to push inflation figures down if they are not successful in reality.

As we are aware financials statements should show true and fair view , where using the Index produced by the local government may not be a satisfactory solution and an entity will need to look further afield for a satisfactory
Index like a stable foreign currency.

Please note prior year comparative figures will also need adjustment.

Process of conversion
Balance Sheet 

Monetary items like Cash in hand and at Bank, short term Debtors and Credtiors are NOT converted.

Assets and liabilities like loans etc which are Index linked (our Index or any other ) are converted as per the Index in the agreement.

All other items –

Items that are carried in the balance sheet at Net Realisable Value or Fair Value are NOT reinstated.

Fixed assets carried under historic cost will need adjusted from the date they were acquired both cost of acquisition and accumulated depreciation will need conversion.

All other asset/liabilities will be converted.

Equity – At the beginning of the first period of application of this Standard, the components of equity, except retained earnings, are restated by applying a general price index from the dates the components were contributed or otherwise arose.

This means suppose this Standard was adopted for the financial year 1st April 2013 to 31st March 2014. We will need to restate the balance sheet as at 31st March 2013 and any difference in the balance sheet due these conversions will be adjusted with Equity.

Restated retained earnings are derived from all the other amounts in the restated statement of financial position.

Profit and loss account

All Income and expenses will need to be converted from the date they were first entered in the books. Say we are making books for a company which has a year end at 31st December.

I have tried to convert the monthly wage bill of £100 as per the standard.

Monthly wage bill £100
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Price Index 100 120 140 140 150 155 160 160 160 160 180 180
Adjusted wages £180 £150 £129 £129 £120 £116 £113 £113 £113 £113 £100 £100
Total wages for P&L £1,473
Actual monies paid £1,200
£100 x 12 months

Example of May Conversion:

Expense               (Monthly wage bill ÷ the May index ) x  the December Index

100 x 180  =  £120
150

If general inflation is approximately even throughout the period, and the items of income and expense arose approximately evenly throughout the period, an average rate of inflation may be appropriate.

Any profit and loss occurring due to these adjustments will need to be shown separately.

 Points to ponder:

Please remember in an inflationary economy there is a gain of purchasing power by borrowers/debtors and loss of purchasing power by savers/creditors.

Example:

Suppose Mr A took a bank loan of £10000 , when his salary was £5000. There was a war or some other calamity in his country and rate of inflation shot up from say 1 % to 1000% per annum. Mr A is lucky he is part of a Workers Union and they collectively negotiate a salary increase in line with inflation of £100000 for him. Now you may notice that his salary is much larger in money terms but in reality he can only afford the same amount of goods and services that he use to last year with his £5000 salary. But he has gained in one respect. He notices that he can very easily pay off his bank loan of £10000 which has remained the same.

If we think in a different way the loan amount of£10k was almost worth 2 years of Mr A’s    wages but due to inflation , now his yearly salary is £100k ie. £8.33 k per month thus loan represent less than 2 months of wages of Mr A. I think Mr A will be very happy with his condition but the bank and ultimately the savers of the bank suffer.

Using this trick many governments in the developing world wipe off their huge debts on expense of their hard earned savings of their citizens but that is another topic.
Soon I will write to you why a country like India will not face a sovereign debt crisis like Greece.

When the economy ceases to be hyperinflationary – these adjustments stop as we take last year figures as our base to move forward.

Disclosures

(a) that financial statements have been adjusted;
(b) the identity and level of the price index
(c) amount of gain or loss