Bureaucrats create more champagne

On 13 March, the Institut National des Appellations d'Origine (the French agency charged with controlling the labelling of wine, cheese and a whole host of other food products) announced an expansion of the French region of Champagne. Now, 357 villages (up from 317) will have the right to make sparkling wine and label it champagne, from 87,000 acres of vines (up from 84,000 plus). This was done in order to meet growing demand for champagne.

More here and here.

Now for some Fermi estimation:

• Maximum champagne yield from the old territorial delineation was about 300m bottles a year, about 3,500 bottles an acre, as it says here.
• The new acreage will add some 10m bottles to current production at current yields.
• But annual sales were already exceeding that by some 40m bottles - 338m bottles in 2007!
• By 2020, assuming champagne demand grows at a rate of 5% per annum - not outlandish if you believe China and India are nascent luxury demanding economies - then annual demand will be more like 600m bottles.
• That's about 81,500 extra acres - a doubling in size of the champagne region...

Clearly, the price of champagne is going to go up by a lot in the future. Best drink more (good champagne) now. The Pretty Lady is nodding as I write this. Better go and get a few bottles.

How expensive was alcohol in the old days?

There's a great deal in the tabloid press about Binge Britain - the propensity of young Britons to get stinking drunk and come to grief in the streets, in front of the horrified eyes of the media, and of course, their parents and elders. This is blamed on many factors - the new 24 hour licensing laws, the moral failure of society, and the easy availability and cheapness of alcohol, among others.

The last one got me thinking - is alcohol so cheap these days? These concerns have been around for a long time. The adjacent image, from historic-uk.com, depicts London in the 18th century, when people drank pints of gin. In addition to the 18th century, concerns also flared up in Victorian times, when in the 1870s the upper and middle classes worried about the poor and middle classes. It's a question Fermi estimation can probably help answer.

So, let's start:

• Alcohol in the 1870s cost about 2 shillings for a pint and a half of gin. That's 2 shillings for about 862ml.
• Strength of the gin was probably 50-60%. Let's take 55% as the mid-point.
• Consumer price inflation was about 80x from 1870 - 2008 according to the UK Office of National Statistics. If you add rents in to get to an RPI measure it should be less, since rents in Victorian times were quite high, but that shouldn't matter too much.
• A shilling is 5p under decimalisation.

Then a Victorian would get 59.2ml of alcohol per pound sterling (of today's money). You can get 700ml of vodka for about 6 pounds sterling, which at today's strength of 40% would be equivalent to 46.7ml of alcohol per pound sterling. Of course cheaper deals may be available, but that's probably true of my Victorian data too.

So alcohol was probably cheaper in Victorian times. I suspect the same is true of the 18th century too. Which only goes to prove that at least part of the current debate is due to the usual inability of the older generation to accept the younger generation's mores and behaviour. But how much though? Fermi estimation probably couldn't answer that.

Statistics, or an efficient way to lie

Mum and Dad sent me this link. It's pre-election season in Malaysia (elections to be held some time in March 2008), and the Second Finance Minister - the First Finance Minister is the Prime Minister - claims that "the country’s per capita income had risen by 40% between 2004 and 2007, from RM15,819 (US$4,163) to RM22,345 (US$6,452)". He also said that the "the average economic growth from 2004 to 2007 was 5.9%, compared to 5.1% from 2000 to 2003".

This claim is clearly ridiculous. And here's why.

• First and foremost, the 40% increase is correct if you take his numbers at face value. At least they haven't lied that blatantly.
• If he means GDP per capita, then by his own growth numbers he's talking rubbish. He would need GDP to grow at least 12% per annum and the population to remain static to actually hit his 2007 income number. Maybe the population has fallen - anyone who can leave is leaving...
• If he means actual wage income per capita, then to achieve that level of wage income growth, on his inflation numbers (supposedly 2.5% a year), wages grew by close to 10% in real terms. Some googling around and messing about on some investment bank research websites turned up a more likely range of between 3-5% real wage growth.
• Add that range to the real inflation number (I believe it's somewhere between 3-6%, personally), and you get a nominal wage income growth rate of between 6-11% - surprise surprise, his number isn't completely outside the realms of possibility. But only if you have far higher inflation than the Malaysian government will admit.
  

Of course, the proper way to check would be to tally up the wage component of GDP and divide it by the number of workers. But Malaysia's official statistics are probably fairly unreliable anyway. Plus, you have to pay for them. It's only RM25, but there's no point throwing money away.

More at Tony Pua's blog. He calculates how much the Malaysian population must have shrunk to get to the GDP per capita growth rate of 12% - about 16%. That's a big brain drain.

Update 13 February 2008: He did mean GDP per capita! US$6,452*25m people = US$161bn. This is on the same order as Malaysia's GDP in USD at current exchange rates - around US$170bn. This could mean 2 things - (a) he's too stupid to lie convincingly, or (b) he's got such contempt for the electorate that he can't be bothered to lie convincingly. Or possibly, both.

Much ado about not very much

Someone very indignant brought this story to my attention today, together with a lot of complaints about how this country is going to the dogs, and that the UK is wasting a lot of money on "multiculturalism" and "immigrants". That, of course, isn't true, but it gives a certain type of Briton some satisfaction to think so. The problem with this particular instance is that the amount of money is peanuts.

First, a quick summary of what the story is about - basically under the current Labour government, it has just been decided that men in polygamous relationships will be allowed to claim benefit for all their wives, not just a single one, despite bigamy being illegal in the UK. Now, this is wrong - why should immigrants get paid to break the law? But the Telegraph story implies that this is a big waste of money. It's not - as a bit of thought and Fermi estimation will show.

• Benefit that a polygamous couple gets per extra wife = GBP33.65. A quick search on Google doesn't enlighten as to whether it's weekly or monthly, so let's just assume it's weekly (52 weeks in the year) for the worst case scenario.
• Number of polygamous families in the UK = 1,000. Let's assume that they are all 4 wife families, giving 3,000 extra wives in total.
• Then extra amount spent on benefit to polygamous families is 3,000*33.65*52 = GBP5.2 million.
• If the benefit were paid daily, the amount spent is GBP37m.

Now, even GBP37m is pretty small compared to some of the cock-ups announced recently. For example, see this story on defence overruns on both the Astute submarine and Type 45 destroyers - approximately GBP2bn. Better focus management energy and talent on sorting out the big wastes first.

Malaysian share capital ownership

Something interesting in the Economist this week - in an article about Malaysian Indians and the political unrest caused by Hindraf, there was a chart that showed share capital ownership per head, split by race (see image from Economist.com).

As you can see, Chinese people own RM34,000 of share capital per head - I'm guessing this to be market value - while Malays (Bumiputra in the article, but that's not really a distinction) own RM7,000 and Indians RM3,000 respectively. These are rough numbers. Assuming the numbers represent market value, I can draw the following conclusions:

• According to Wikipedia, the stock market capitalisation of Malaysia was US$350bn in October 2007, or RM1,330bn using the same exchange rate as in the graphic.
• Assume that the Chinese make up 30% of Malaysia's population (27.5m), Malays 62% and Indians 8%.
  
• If one assumes that all shares owned by Malaysians are Malaysian, this means that Malaysians own RM407bn, or 31% of Malaysia's stock market.

So who owns the rest? Aren't Bumiputras supposed to own a substantial stake in public listed companies?

OK, so maybe it's par value of stock - in which case, the Bursa Malaysia market cap is only 3 times the nominal value of stock in issue! This seems unlikely.

I have problems believing that Malaysians own substantial amounts of share capital outside Malaysia, as the government prefers to keep local capital local... after all, it's better to finance one's own growth from one's own capital. However, I'm forced to come to the conclusion that Malaysians do own substantial amounts of share capital outside Malaysia. This in turn implies that the risk-return tradeoff is much better elsewhere.

Which of course, is exactly the case. I've believed this for years - and it looks like my fellow Malaysians agree.

How busy is my gym?

I use a gym in the City of London, near where I work. The locker rooms have floor to ceiling lockers, in 2 banks, one above the other. I tend to use the lower bank. When I'm changing after my workout and shower (and hence need to have the locker open for the longest time), very often the chap who has the locker directly above mine, on the upper bank, turns up as well, usually after having showered too. As there's only just enough space for one person, one of us has to wait. This tends to annoy me a lot. This leads me to ask - just how busy is my gym anyway? The odds that the bloke with the locker above mine turns up to use his at the exact time I want to use mine must be quite small, unless there's a huge number of people using the gym...

Anyway, here's the first question - how many people are at my gym?

• Assume that of the 250 or so lockers in the men's locker room, anyone who turns up is equally likely to use any one of the lockers.
  
• Someone turns up at my locker, competing for space, about 70% of the time.
• Then the number of lockers in use at the men's locker room at any one time (when I tend to go) is 0.7*250 = 175.
• Add in another 175 women, then at any one time there are 350 people at my gym.

That's not all - how many people come in and out of the locker room?

• Say that the peak period is 2 hours at lunch time.
• Then say the average workout takes 45 minutes.
• Then over 2 hours there are 175*3 = 525 men coming in and out of the men's locker room
  
• Then at any one time there are 4.375 people coming into the men's locker room.

The problem is, only about 2 people come in per minute at the busiest times, and there are perhaps 150 people at most (including ladies) in the gym at any one time!

I guess I'm just unlucky, or maybe I use really popular lockers.

Is it possible to create a whisky futures market?

Whisky is currently much in demand. The integration of India and China into the world economy brings more than 2 billion new consumers to global product markets. Of course, whisky producers, like producers of any other product, hope that at least some of these 2 billion consumers will choose to consume whisky - and to that end, they are reopening old mothballed distilleries and building new ones. And not only in Scotland - they are being built in Japan, Ireland, England and very likely in India and China too, perhaps in the not too distant future.

Unfortunately, whisky distilling is a long term game. Whisky can't be called whisky under the rules of the Scotch Whisky Association until it has been aged for 3 years in a barrel, and obviously more if one wants a decent product. The time taken from distillation to sales is therefore fraught with financial risk. One needs to cover the operating costs of the distillery for 3 to 15 years before one has sales to generate cash flow. Whisky distilleries therefore offset their costs in the following ways:

1. Cask sales to independent bottlers.

The distillery can sell off casks of their distillate before they mature fully to independent bottlers (IBs). The IBs then take some of the risk on each cask (even single malt whiskies are vatted from several casks in order to maintain consistent quality), and therefore would only be prepared to pay a low price.

2. Diversify their product range.

Other spirits, like vodka and brandy, have shorter maturation times. A whisky distiller could divert capital into setting up a vodka sales operation, say, or make liqueurs using ready distilled spirits, building up a brand in the process, and cross-subsidising the distillery and its costs. This runs the risk of diverting consumer attention away from the whisky product however.

3. Sell futures.

Some distilleries already offer this. One buys futures on a cask of whisky, essentially buying the cask forward, to be bottled either at a date of one's choice or at the discretion of the distillery manager. All very well and good for the whisky connoisseur, but what would he do if he changed his mind. Nope he can't sell it - this sort of product is non-tradeable.


Would it therefore be possible to set up a tradeable market in whisky futures? Futures markets depend on several factors: standardised contracts, liquidity and few restrictions on price discovery (usually no restrictions on short sales) are the more important ones. Taking these 3 pre-requisites as necessary and sufficient conditions it's easy to see that the third helps create the second, and the first is a tough one to meet.

Because each distillery's output is different, there is no easy way of categorising whiskies neatly enough such that standardised contracts can be created with sufficient liquidity. There would certainly be insufficient liquidity to trade outputs of individual distilleries. Larger groupings along geographical lines might work, but would be difficult to categorise because the concept of terroir doesn't apply to whisky. A contract for a case of Islay whisky to be delivered in 10 years time would be confusing - which Islay did you want? Ardbeg, Laphroaig or Bunnahabhain? Peated or unpeated? Still, this might work - after all, government bond futures settle using the "cheapest to deliver" bond, and perhaps something similar could be created.

Now for some Fermi estimation. What's the size of a whisky futures market?

• The size of a whisky futures market could be supported by potentially up to 200m litres of production a year. Most annual whisky production would go into blends, but 200m litres of single malt distilled and sold is a reachable target within the next decade, if one believes the China and India story.
• If one assumes average open interest of 10 times contracts held to delivery, then there could be contracts with value of up to 2 billion litres traded a year (not including possible futures for blends and grain whisky...).
• Say average price is 100 sterling a cask (a guesstimated figure), then the market is worth 200 billion pounds sterling, or $400bn. Definitely a market that could achieve reasonably good liquidity!

So a whisky futures market is possible and feasible, if producers decided to band together and spread their financial risk around.

US sub-prime mortgage losses

The current turmoil in the US and global economy due to losses in US sub-prime mortgage debt (and sub-prime mortgage debt in other countries too) is fed partly by the fact that no one is able to quantify the losses exactly, and partly by the fact that no one is quite sure who has those losses, including the banks who hold some of the debt. This uncertainty prevents banks from lending aggressively, as they need to conserve their capital in case their exposure to sub-prime mortgages, whether directly, through structured credit, or through SIVs, turns sour.

I'm going to try to answer the first question using Fermi estimation. This approach is unlikely to work for the second question however, so we'll resort to plain old guessing.

What are the losses on US sub-prime mortgages?

• The total stock of US sub-prime mortgages is certainly more than $1.3 trillion. Say $1.8 trillion to be conservative, although in reality we are interested in the 2003-2007 vintages.
• The major losses will be on the 2006 and 2007 vintages. According to Moodys, approximately 7% of October 2006 loans were delinquent in March 2007. Eyeballing the figure in the document, it's quite possible that 15% of loans written in October 2006 are delinquent now. Loans written in 2007 would probably have higher delinquency rates, say 18-20% by mid-2008. This would be a reasonable upper bound, given that loans of 2003, 2004 and 2005 (probably about 30-40% of the total stock) would have a lower delinquency rate.
• Total eventual losses on US sub-prime mortgages are likely to be around $1.8 trillion * 18-20% = $320-360bn. Remember, this is an upper bound estimate.

Who's got them?

Well, the following major writedowns have already taken place, or been part announced - Citigroup = approximately $17bn, Barclays Capital = $3bn, Merrill Lynch = $4.5bn, UBS = about $10bn, HSBC = $3.4bn, Bear Stearns = $2bn, Morgan Stanley = $3.7bn, Deutsche Bank = $3.1bn, Credit Suisse = $2bn, AIG = $2.7bn. That's more than $50bn so far, but not all of it will have been in US sub-prime mortgages. Some of it will also have represented mark-to-market losses, not defaults which are unlikely to be recovered. So there could be more than $300bn of writedowns still to come.

The cost of carbon trading schemes

Plenty of numbers being bandied around, but one which many conservative Americans are quoting is this number from the Free Enterprise Education Institute (FEEI) - 5.2% of US GDP by 2020, equivalent to a reduction in income of $10,800 for a family of four (here), if the US used a cap-and-trade scheme to move to a putative Kyoto protocol target (carbon dioxide emissions of 7% under 1990 levels). The FEEI is a think tank which has managed to secure the services of Arthur Laffer, known to econ undergraduates as the chap who came up with the Laffer curve (something also very popular with the Bush administration, who used it as one justification for cutting US taxes).

5.2% smaller isn't that bad, especially when it's an opportunity cost number. It represents a difference of a few tenths of a percentage point a year in GDP growth rate, if we're talking about a horizon of 13 years. This is well within the bounds of error, and would probably be drowned out by other factors (say the current sub-prime mortgage crisis). But there's a different way to see this, using Fermi estimation and the equivalence example (family income) quoted for easy understanding.

What's the total reduction in GDP?

1. 5.2% reduction in US GDP being the same as a reduction in income of $10,800 for a family of four.
2. Say there are approximately 100m families in America (a population of 400m people - I'm deliberately overestimating here, to allow for growth).
3. Then the total reduction over 13 years is $10,800 * 100m = about 1 trillion dollars. That's today's dollars.

How much GDP will the US economy generate over that time?

1. On the same basis, the US economy this year is worth about $13 trillion and a bit (real), let's say 13 trillion.
2. Then over the next 13 years (2008-2020), it should generate $169 trillion of GDP (again, let's be conservative and not put any growth rate in).

What's the opportunity cost each year?

1. The cumulative opportunity cost of a cap-and-trade scheme and the Kyoto protocol is approximately $1 trillion out of $169 trillion, or about 0.6% of GDP.
2. Let's say that's a per annum figure (it's not, most the costs will be front-loaded, but this is Fermi estimation, so we're allowed to make it easy). Then that's about $77 billion a year in opportunity cost. This compares favourably to the cost of financing the war in Iraq, which is about $100bn a year according to the last Congressional report on the matter.

What's a similar number for the world?

1. World GDP is about $48 trillion at PPP and today's dollars.
   
2. Using the heroic assumptions that the global economy has similar energy intensity and energy sensitivity to the US economy, then the global economy would suffer approximately $284 billion a year in opportunity cost. Call that $350 billion a year to account for more energy intensive countries.

The sense to attach to those numbers, even the ones being pushed hard by the US government in response to pressure for it to control emissions, is that they are actually rather small. Although they are significant, they aren't a major obstacle to growth. Remember, these numbers are before the impact of any alternative energy sources (say from more nuclear power plants) are taken into account. They merely describe the impact on economic growth of reducing carbon-based energy consumption and allocating the remaining consumption more efficiently.