Saturday 11 April 2020

"The Only Free Lunch ..."

A couple of weeks ago I did a piece on Black Swans involving some technical stuff on risk management, and someone asked if there was more.  Well indeed there is ... and this morning I'll pick up on some of the issues raised by our discussion on attempting to envisage some rational basis for determining a logical quantum of self-sufficiency or, as Mark Wadsworth put it, the "efficiency vs reliability" debate.

We can readily agree that full self-sufficiency is an implausible national goal.  It lay at the heart of North Korea's Juche *philosophy*, and look where that got them, even as they remain dependent on China for all manner of important things.  As one of our esteemed Anon's said BTL, "... trade vs self sufficiency, surely it's not an either/or proposition? The sin would appear to have become so reliant on single sources, which has many sources of blame, including the 'lowest price' mentality".

In normal times, it's positively beneficial to procure almost anything from multiple sources.  When one lets you down, the likelihood is another will come good.  Plus, you tend to get better prices because (a) you shop around and obtain good price discovery; and (b) suppliers quickly find you're not a mug.  (Obviously, if we thought to add Australia to our list of toilet-roll suppliers, the transportation costs would overwhelm the benefits of competition in that particular case.)

The price benefit can be real enough, but just as important is the risk-management principle involved - diversification, sometimes known as the only free lunch.  Describing it technically, we are relying on the variables of failure of each source of supply as being less than 100% positively correlated.   The maths involved here is Portfolio Theory, and it's an exceptionally important principle - at its simplest, well known thoughout the ages.  You can find it in the Bible (Ecclesiastes 11:2, v6), Shakespeare (Merchant of Venice); and Churchill famously stated "Safety and certainty in oil lie in variety and variety alone". (He was referring to his policy of sourcing oil for the Admiralty from more sources than just Persia, which had been the case in the early years of RN steamships.)  Not my job to advise anyone on personal investment, but everyone needs to bear it in mind: it has a role to play in every portfolio, large and small.

The second part of Anon's comment was also on the money.  "Perhaps it's time to start have rules on what %age of a good can be sourced from a single, foreign, nation or economic bloc? Security, after all, comes from plurality. Self sufficiency just changes *who* can take you hostage, rather than remove the threat. Add to that a minimum amount sourced internally, even it means having a nationalised source, with the capability of scaling up where possible, allows for flexibility and security of materials?"  This is exactly what happens in a good commercial risk-management regime - rules such as "no more than 20% of our business with a single counterparty" are instituted.  Quite a lot of valid maths can be put into this, to come up with something "optimal" - under a given set of assumptions.  The key, of course, is to price in the risk, to counter Anon's issue of going for the lowest (nameplate) price. We may return to risk-pricing on another occasion, if we've the appetite for even more technicalities (when we've nothing better to do in lockdown ...)

A free lunch ... but when the custard really hits the fan, variables that were heretofore less than perfectly correlated suddenly become highly correlated, all in the same direction - downwards.  If Tesco has run out of toilet paper, so too has Sainsbury - and it ain't a coincidence.  At this point the maths no longer helps us, and we're down to inventory, improvisation, *requisitioning*, sauve qui peut ... and ultimately, privation.

Thus far, Covid-19 has mostly exposed lack of diversification in medical supplies of various sorts.  There's every reason to believe that, as the months wear on and the tide recedes still further, we'll find who's been swimming without trunks on a lot more beaches.  Starting with food ..?



Thud said...

Food, the unspoken bull in the 'China' shop, our exposure is frightening but not much can be done sadly.

Nick Drew said...

will be interesting to see if a Land Army materialises for the harvest

david morris said...

Do you think anyone in guvmint has had it explained to them just how badly the economy is going to be affected by the current lockdown.......let alone an extention..

John in Cheshire said...

I remember when George Osborne was chancellor, he introduced legislation to make bank bail-ins legal; ie. for banks to be allowed to steal money from our bank accounts.

I wonder how long it will be before this legislation is used?

Bill Quango MP said...


I’m not so sure it’s such a worry. Assuming we can get food from the EU.

Britain imported 70% of its food in pre-wartime, 1939.
The highest level ever level.
It is about 50% now. And at least 20% of that is food that is not native to the uk, and won’t grow here anyway.

Raedwald said...

Yep .... food

It makes regaining complete control of the UK's Exclusive Economic Zone at the end of the year even more important. We may be eating a lot more fish.

This time, at least, our trawlers won't have E-boats with which to contend

E-K said...

I thought this was interesting. Also the Chinese found the genetic code to COVID-19 but their government tried to hide it. Scientists in Shanghai released details at risk to themselves.

E-K said...

Yes. I'm worried about food. I've written to someone near government hoping to God that they're not going to get caught short on this like they have COVID-19

I've asked for stockpiling and preparations for rationing. Not that what I say counts for much.

We have plenty of land to cultivate but a lack of knowledge and work ethic at the moment.

The West needs to get up and running economically and I'm afraid this has to be before the vaccine is available. This has to be before we're ready.

"18 months for a vaccine is unprecedented."

(Same link as my previous)

Starvation or plague.

That is the choice I believe we face and hindsight will show us that we had NO choice when this first hit us.

We weasled out of the decision we should have made.

Nessimmersion said...

Has anyone thought of running your theories on self sufficiency past Tom Worstall, who has previously explained how the best method of avoiding famine is a diversity of food supply and could no doubt explain trade a lot better than I can.

Anonymous said...

As the anon in question, I'm gratified my comment was worth a follow-up!

In terms of food, I'm genuinely unconcerned.

We generate around half of our own food, and a daresay the population could survive a reduction in daily calorie count. Prosper even. We eat far more meat, and much less of the animals edible parts, than we used to.

Tripe has made a recent resurgence as a superfood, presumably by people who've never had the chance to small bleach and innards mixed. Northern markets used to provide bulls cocks on a stick less than four decades ago. And then we have sweetmeats.

If things go truly south, we won't starve. Diet maybe, starve, no.

Worst case scenario, I'll just dangle some iPhones off branches, and wait for a millennial - desperate to snapchat their peril - to fade into a narcissistic stupor and club them. They'll have to go with peas and stout rather than fava beans and chianti, but needs must.

So a few hipsters may have to forego avocado as a spread for toast, and acquaint themselves with butter instead, and vegans can pick between ethics and mortality. Boo hoo.

Even much of the crops waiting for pickers aren't necessities, not unless you plan to set up some origami tennis players to emulate Wimbledon and are dire need of strawberries to go with that last bottle of pre-apocalyptical Pimms.

BlokeInBrum said...

I wonder if a diet of soy-boys is ultimately unhealthy, probably to much estrogen for my tastes.
Anyway, the issue with diversity of supply is that there is always one chancer who thinks that these kind of rules don't apply to them. How do you account for the Bank, or any large company who wings it by not diversifying, and gets lucky for long enough to undercut it's competitors and therebye drive them out of business?
Diversifying has its costs, and if the state keeps on bailing out companies who emphasise profits in the short term, long term stability be damned, then how do we create a level playing field?

Nick Drew said...

BiB - there is a "formal" answer to your qn ...

In both banking etc and energy, firms are obliged by law & regulation to observe certain standards of financial security / security of supply respectively (we are clearly building up to another post on this)

The rules, and the metrics used to implement them, are pretty good in "normal times" (and the calculations sweep up the aspects you mention, along with everything else). It's lax enforcement that brings the game into disrepute; and when that becomes the norm (e.g. during Gordon Brown's "light touch" regime), undercutting etc becomes rife, as it was in the run-up to 2007-08

And of course laxity brings forth some of the Black Swans which upset the applecart, whilst rigorous enforcement helps to keep things "normal"! Even if the rules don't specifically and fully cater for Covid-19 style Black Swans, they make for better all-round resilience, which is a great place to start

As often stated around here, the fact that no senior bankers were gaoled in '08-09 is a disgrace. In the UK we don't have a tradition of banging up the top men, but in the USA they most definitely do, and Obama should have followed precedent. His failure to do this was culpable - a capital error (pun intended)

To take an example close to home for me; in the Enron case (energy, of course), Jeff Skilling was sentended to 24 years + a $45 million fine. (What the top man, Ken Lay, would have received will never be known, because "he died" while his case was still under appeal)

That's they way to do it. You'll still get the Bernie Madoffs - but ordinary middle-class bankers truly don't want gaol

Nick Drew said...

PS, the Enron prosecutions took place under GW Bush - an arch Texas insider, as were Skilling & Lay. It didn't save them: much to Bush's credit

E-K said...

Anon 9.16

I'm loving the vegan predicament (a couple in my circles and boy, do they lecture.)

I wouldn't eat a whole one though. They're gristly and I don't just mean in attitude.

Raedwald said...

The Austro-Hungarian army worked on the basis of 1 bullock feeding 400 men; the bones were inedible, but parts of the intestines could be used for sausage casings, and the gristle, anus, eyelids and so forth could be ground finely for frankfurther sausages or made into a vile meat paste - which can still be bought today, and is popular amongst the very old who have lost most of their sense of taste.

BlokeInBrum said...

E-K, I have a slow-cooker. Ten hours in that and everything comes out tender. Just add BBQ or chili sauce to taste!

ND, then you have the issue of regulatory capture to deal with. All the people with talent end up in the private sector and the people without end up regulating them. Or it becomes a very cosy revolving door arrangement without true accountability.

Anyway, Happy Easter all, hope the Easter Bunny has been good to you.
May the good weather keep your spirits up!

Nick Drew said...

BiB - well yes, but tell me any institutionalised scheme that doesn't run that risk? Can't ever accept that as an excuse - just apply more determined effort

Anonymous said...

Talking about Free lunches, if you read the legislation, people with a BMI of 40 or more can get priority food deliveries as they are "at risk"

Boris must be very close to that.

BlokeInBrum said...

Well yes, who watches the watchmen? A problem as old as the hills.
But I can't help but feel that we should be doing much better on this.

A free society will have high levels of inequality - if we are to avoid unpleasantness, the majority need to believe that the elites abide by the same rules as the rest of us and haven't got where they are at our expense.

E-K said...

"Confee-dance dat laasts a' laaaf-taaam ?"

Latest British Army recruiting advert.

Hope the Chinese aren't planning a land invasion. Though I expect we'll be Bangkok to their 200,000,000 loose males before long.

Who does what for whom is simply a matter of exchange rates.