Buying Greenland - a valuation perspective

A history of US territorial purchases

Recent indications that Donald Trump is mulling the prospect of the US buying Greenland are not quite as ridiculous as many people seem to think. Indeed, the US has a long history of buying territory. Back in 1803, the newly formed United States bought the territory of Louisiana from France for $15 million ($341 billion in current prices). Large chunks of what are now Arizona and New Mexico were bought from Mexico in 1854 for $10 million ($305 billion in current prices), whilst in 1867 it bought the territory which now comprises the state of Alaska from the Russian Empire for a total of $7.2 million ($124 billion in current prices).

Moreover, the US has previously tried twice (and failed) to buy Greenland. In 1867 it looked into the possibility of acquiring Iceland and Greenland, and in 1946 President Truman offered Denmark $100 million of gold in exchange for Greenland. Based on the standard purchasing power measure, used in the calculations above, this is equivalent to $1.3 billion in current prices but based on gold price movements over the last 73 years this rises to the equivalent of $4 billion.

From a historical perspective, this is all both fascinating and ironic. It is ironic given the hostility of the United States to imperialism in the first half of the twentieth century that its history is so littered with examples of territorial acquisition. It is also fascinating because it demonstrates the international trade in territory that has taken place in the relatively recent past. However, it is a practice that has died out largely because the expansion of global trade means that countries are able to acquire what they need from elsewhere at a much lower cost. Moreover the issue of inhabitants’ rights mitigates against the practice. It is much more difficult to sell people’s rights to the highest bidder these days following the advent of pesky irritants such as the Universal Declaration of Human Rights, adopted by the United Nations in 1948. Of course, you don’t actually have to buy the outright ownership of territory: You can lease it, as Britain did with large parts of Hong Kong between 1898 and 1997 and as the US still does with the infamous Guantanamo Bay in Cuba. 

Applying corporate valuation methods 

Although Denmark has rejected the idea of selling Greenland, there is nonetheless an interesting debate to be had about how to value the sale of territory. It is thus illustrative to think about how companies are valued. There are essentially three main methods: (i) asset valuation; (ii) the value of revenue streams and (iii) a discounted cash flow approach. We can apply all of these methods in assessing the value of territory. 

(i) Valuing the assets 

One of the standard measures of corporate valuation is the ratio of the market price to the book value of assets. If we assume that this is unity, we can use international data on national balance sheets as a measure of the market value of all financial and non-financial assets. The latter comprises items such as the value of buildings and other fixed assets such as machinery; the value of inventories and natural resources such as land. Financial assets are the net value of all currency holdings, gold, financial instruments and net loans outstanding. In the UK last year, the value of net financial assets was near zero and the total net worth of £9.75 trillion was comprised of net non-financial assets. The US has the world’s highest net worth (chart), measured at $98.2 trillion in 2018 (31% of the world total), followed by China at $51.9 trillion (16.4% of the total). 

 

For the record, Denmark’s net worth was $1.3 trillion (0.4% of the world total). If we allocate Greenland’s share on a pro rata population basis relative to the whole of Denmark, its net worth drops out at $12.5 billion – around what the US Federal government spends on the Disaster Relief Fund, or 1.8% of the defence budget. This is, of course, a rough and ready calculation which takes no account of the expected future value of Greenland’s natural resources but it is a good starting point. 

(ii) Valuing the revenue stream 

What about valuations on a revenue basis? The obvious metric to use is GDP where the US is again ahead of the pack with total output last year recorded at $20.5 trillion. Being generous, Greenland’s GDP last year was around $3 billion. If we are applying corporate valuation methods, the standard measure is to value the company at a multiple of expected earnings. Applying a P/E multiple of 15x, which is in line with most major equity markets, this implies a market valuation for Greenland of $45 billion – slightly short of Montana’s GDP ($49.2 bn last year) but higher than that of Wyoming ($39.8 bn). If the US were engaged in a corporate transaction it would have no real difficulty in finding the funds out of its cash flow. 

(iii) The discounted cash flow 

The discounted cash flow issue is more tricky. Climate change is having a big impact on Greenland’s geography and according to the Brookings Institution in 2014, “due to global warming, Greenland’s mineral and energy resources … are becoming more accessible.” According to one report, oil could contribute around $78 bn to the national coffers over the next 40 years and after accounting for development costs, “a discounted price for future energy and other resources suggests a price in the $30 billion range could be fair value. Even adding the 10X current GDP and the energy resource value together would be a value of about $57 billion.” 

How to fund the acquisition 

So there you have it. On the basis of the estimates produced here, the US would have to stump up somewhere around $50 billion to purchase the territory of Greenland – or about 0.25% of annual GDP. This is rather less than the present value amount of nineteenth century territory purchases. How might it be funded? A straight cash swap, in which the Fed prints the requisite dollars, would require an increase in the value of notes in circulation of 3%. A debt for equity swap, in which the US Treasury issues notes, would require an increase of just 0.3% in the amount of debt held by the public. In financial terms, the US would clearly not have a problem funding the acquisition. 

The resistance of reluctant sellers 

The only trouble is, Denmark is unlikely to sell at any price. Soren Espersen, foreign affairs spokesman for the populist Danish People's Party, said of Trump in a broadcast interview, "if he is truly contemplating this, then this is final proof, that he has gone mad.” But we should not be overly dismissive – like many old ideas coming back into fashion, the notion of selling territory to earn a bit of extra cash could appeal to governments in these straitened economic times.

Indeed, rather than going to war with Iran, the US could attempt a hostile financial takeover by forgoing the annual GDP of a state such as Connecticut to buy it (this would cost around $272 bn on an asset valuation basis). It would come more expensive if we used the 15x P/E multiple, where the GDP of California, Texas and New York would be required to meet the asking price of $6.8 trillion. But let’s face it, we have heard a lot worse ideas from Trump!

Burning down the house

In newsrooms, this time of year is known as the silly season for the fact that there is little of note to report and as a consequence the media is often dominated by trivial news items. As the Brexit debacle continues to unfold, the news is far from trivial but the adjective silly continues to apply.

This week has seen the Labour Party put forward plans to form a temporary government if the current government loses a vote of no confidence, which Labour has promised for September. To that end, Labour leader Jeremy Corbyn sent a letter to the leaders of all the other opposition parties and senior backbench MPs calling on them to support his attempt to bring down the Johnson government and delay Brexit. This raises two questions: (i) is it right that MPs should try to prevent the government from delivering a no-deal Brexit and (ii) what is the best way to ensure that?

With regard to (i) it is highly likely that the government will face a no-confidence motion in September. If it wins, we carry on down the current path to destruction. If it loses, the Fixed-terms Parliament Act of 2011 allows a grace period of 14 days to allow the current administration to form a government which is acceptable to parliament. If after this time no such government can be formed, a general election must be called. If Tory MPs were to vote against their own government, it is constitutionally possible to put a firebreak in the process. Quite how this will play with the electorate is another matter. Brexit supporters will be up in arms, accusing MPs of thwarting the will of the people, and such a course of action will do nothing to heal the divisions that have widened over the course of recent years.

Clearly this process will have to be handled very carefully. Unless instructed to do so by the electorate, a new government would not have a mandate to stop Brexit altogether so those hoping that a new administration will turn back the clock to 22 June 2016 will be disappointed. At best, a new government would only have a temporary mandate to prevent a no-deal Brexit on 31 October. Anything else would open it to the same accusation that has been made of Boris Johnson’s government that it has no authority to pursue its stated course of action.

With regard to (ii), historical convention dictates that the prime minister resigns in the event they lose a no-confidence vote. But the sample size is small: the government has been defeated on such a vote only once in the last 95 years (1979). Indeed, the law is vague as to whether the prime minister will be forced to resign. Moreover, the government has control over the timing of the election date. Thus, if it were to lose a no-confidence vote in early September it would not have to think about calling an election until mid-month. If it were to set the date for early November (a seven week campaign as in 2017), parliament would be dissolved and would not be able to prevent a no-deal Brexit on 31 October. Consequently, the no-confidence motion could backfire on those trying to prevent a no-deal Brexit.

Even if a new government were to be formed, it appears that Jeremy Corbyn would not be the best option to lead it. Jo Swinson, the new leader of the Liberal Democrats, rejected his plan by suggesting, “Jeremy Corbyn is not the person who is going to be able to build an even temporary majority in the House of Commons for this task – I would expect there are people in his own party and indeed the necessary Conservative backbenchers who would be unwilling to support him.”

She is certainly right about that. In the summer of 2016, his own MPs tried to remove him and although Labour did better than expected in the 2017 election, this was as much about rejection of the Tories as about support for Labour and there is a sense that Corbyn’s time has passed. It is not as though Corbyn is a noted Europhile: The 2017 Labour manifesto indeed pledged to implement Brexit, which seemed to have bypassed many younger Labour voters who looked to Labour to reverse the June 2016 decision, and in the three years since the referendum, Corbyn has failed to take a stance on Brexit that Remainers can get behind. From a political standpoint, moderate anti-Brexit Tories have nothing to gain by supporting Corbyn for they will be vilified by party members, even those in constituencies which voted Remain.

Whilst it is positive that at least efforts have been made to come to a cross-party agreement on how to stop a no-deal Brexit, Corbyn is the wrong man for the job. There have been some suggestions that the likes of Ken Clarke could command sufficient support to lead a government of national unity. I have my doubts. But what the events of the last few weeks have shown is that the Remainers do not have a plan to stop a no-deal Brexit and appear to be unwilling to stand up and take the drastic action which would be required to necessitate this. As one Twitter user pointed out, a lot of what has been discussed “seems to be unconditional predictions about what will happen, rather than setting out what the possible permutations of events are.”

I continue to believe that Boris Johnson wants to avoid a no-deal Brexit and is looking for something to thwart his plans so that he can shift the blame elsewhere for not delivering on 31 October. I don’t want a no-deal Brexit either. But sometimes it seems as though the only way Brexiteers can be made to own the consequences of their actions is that they feel the pain of failure and endure the wrath of the electorate. It’s a bit like burning down the house to deal with a vermin infestation: You can get rid of the rats but have nowhere to live. And as I have consistently maintained since I was first questioned on the subject in late-2012, “the EU is far from perfect, but life on the outside may be even harder.”

Fast and loose

According to the new Foreign Secretary Dominic Raab, he made it clear during the 2016 referendum campaign “that we should strive for a good deal, but if that wasn’t available, that we should go on and make a success of Brexit … I was questioned on it by the BBC almost every time I appeared and so was Michael Gove… There’s all sorts of interviews which said that of course we’d prefer a deal, but that there would be a risk.” In Raab’s telling of events, people knew what they were voting for three years ago and as a result the government now has a mandate for a no-deal Brexit.

When challenged in a BBC interview as to the veracity of this statement, Raab responded by suggesting that “the institutional memory of the BBC is a bit sketchy on this as a whole.” Fortunately, those who appear prominently in the media leave a digital trail that can be mined to check whether their claims stand up to scrutiny. Both the BBC and Channel 4 have fact-checked Raab’s media interviews, social media posts, newspaper articles, speeches and Vote Leave campaign material only to conclude that there are no clear examples of Raab’s stated position. His consistent position was that the EU would be likely to offer the UK a trade deal because “it’s certainly not in the Europeans’ interest to erect trade barriers.” Indeed, in February 2016 he wrote a newspaper article suggesting that “The Remain campaign assert the EU would cut off its nose to spite its face, vindictively defying its own interests by shutting Britain out of its markets altogether. That’s not remotely credible.”

There are those who accuse Raab of being a “morally vacuous liar” who shamelessly holds to the view that his government has a mandate for a no-deal Brexit, despite the fact that the evidence points to the contrary. Others have pointed out that those who lie in the course of their job get fired but Raab has been rewarded with a promotion. I couldn’t possibly comment! But in all likelihood, Raab will get away with such falsehoods because the political dynamic has changed. We live in an era of political beliefs, not facts, which makes life difficult for those of us who seek at least some fig-leaf of empirical cover for the positions we hold.

All this is very dangerous because it erodes the lingering basis of trust between politicians and the electorate. It is one thing for politicians to be perceived to be lying; it is quite another to actually do so, particularly when the consequences of politicians’ actions have profound economic consequences. Dominic Raab’s rewriting of history means that voters did not have a chance to inform themselves of the consequences of a no-deal Brexit. Indeed, the evidence suggests that this issue did not impinge on voters’ consciousness until well after the referendum.

In order to look more closely at this issue, I took a look at Google search terms in the UK for Brexit-related keywords, starting with “no-deal Brexit.” The data do not give the exact number of searches but is reported as an index based at 100 for the maximum number of weekly searches. The latest data suggest that the highest value occurs for the week of 10 March 2019. More revealing, however, is that the index registers its first non-zero value only in March 2017 – 9 months after the referendum – and does not start to become a more prominent issue until the latter months of 2017. That is not exactly what you would call an informed electorate. Similarly, Google searches for phrase “hard Brexit” do not start to become more widespread until September 2016 (chart).

In my view, the government will be taking a huge risk in triggering a no-deal Brexit given the extent to which many people seemed unaware of such an outcome at the time they cast their vote. This may not be a problem if there are no adverse economic consequences, but if there are I would not like to be the one explaining why the government has taken such a course of action. As it happens, I maintain that Boris Johnson’s government does not really want to leave the UK without a  deal and that its tactic is designed to appeal to the party faithful in a bid to dissuade voters from defecting to Nigel Farage’s Brexit Party. Indeed, I suspect that Johnson hopes parliament will block his no-deal Brexit plan which in turn will allow him to call a general election.

It is, however, an extremely risky strategy. A no-deal Brexit could be triggered by accident if parliament does not play ball. And it might even be the case that Johnson means what he says. But a look at the evidence makes it clear that voters did not consider the prospect of a no-deal Brexit in 2016 and they may be reluctant to support a government that mismanages the UK’s exit from the EU. If Johnson wants to remain in office for any length of time, which surely is his aim, he either has to tone down the rhetoric or ensure that a no-deal Brexit does not result in the disruption that many fear. Unfortunately, he cannot guarantee the latter.

Bayes says "no" to no-deal

One of the questions most frequently asked of me is what are the chances of a no-deal Brexit? In common with most analysts I tend to give an answer couched in subjective probability terms. This has the advantage that it is my view – nobody can say it is definitively wrong. Others may not agree with it, but they have the right to apply their own subjective assessments. However, this does strike me as a bit imprecise and led me to wonder whether it might be possible to derive a more accurate data-driven assessment of the odds of no deal.

One way to approach the problem is in terms of Bayesian statistics. In simple terms, Bayesian statistics assesses probability in terms of the degree of belief in an event. This contrasts with the more traditional frequentist school of statistics which represents probability as the number of times an event will occur based on an infinite number of representations of the process (I looked at this issue in more detail here). Bayesian statistics has always struck me as a sensible way to approach problems like Brexit where belief plays a big role and where the frequentist approach, which is based on the assumption that an event can be repeated, is unrealistic.

Bayesian statistics is based on Bayes’ Theorem which describes the conditional probability of an event based upon prior beliefs (or information) and which is written thus:

P(A | B) = P(B | A) . P(A)

  P(B)

This says that P(A | B), which is the probability of event A conditional on event B, depends on the probability of the event B given that A is true (the so-called posterior probability), and the prior probabilities of A and B.

To put this into Brexit terms, let us assume that event A is a no-deal Brexit and B is the event Remain. We are interested in the probability of a no-deal Brexit, P(A). We can rewrite this:

P(A) = P(A | B) . P(B)

P(B | A)

or

P(No-deal Brexit) = P(No-deal Brexit | Remain) . P(Remain)

P(Remain | No-deal Brexit)

Using data from the website What UK Thinks, we can use survey data to provide some of the evidence. Based on the question of how people would be likely to vote in a second referendum, we can derive a value for P(Remain) which is currently 44% (or 51% once we strip out those voters who either do not intend to vote or who have reported as “don’t know”). We proxy the value for P(Remain | No deal Brexit) by looking at the survey evidence which asks respondents to choose between no-deal and Remain. Faced with this choice, 44% of respondents indicated that they would vote Remain (54% once we strip out don’t knows). Similarly, we estimate a value for P(No deal | Remain) by looking at the proportion who would vote for no-deal if the alternative is Remain (38%, or 46% after adjusting for “don’t knows”).

Putting these numbers together gives a constrained probability of no-deal of 44% (where the constrained probability is derived by stripping out “don’t knows” and constraining the remaining categories to sum to 100%). The unconstrained probability, where we do not adjust for the “don’t knows”, comes out around 36%. The good news is that however we slice it, the numbers come out at less than 50%; the bad news is that they are higher than my subjective probability of 30%.

To the extent that politicians are looking at the polling numbers to assess whether a no-deal policy makes sense, this Bayesian interpretation of the evidence suggests that there is more support for a no-deal Brexit than is often supposed. However, it is not high enough to push through with it in the event that it proves to be economically disastrous, since more than 50% of voters do not support it and the backlash from the disaffected half is likely to be severe. One caveat is that some of the surveys have not been updated for a few weeks and therefore do not reflect any possible change of stance since Boris Johnson became prime minister. Moreover, Bayesian probabilities change as more information becomes available, so these are not set in stone by any means.

Bayesian statistics are the big thing these days but as the pollster Nate Silver pointed out, “under Bayes' theorem, no theory is perfect. Rather, it is a work in progress, always subject to further refinement and testing.” The prime minister’s new chief adviser, Dominic Cummings, pointed out in a blog post in 2017 “Rationality is more than ‘Bayesian updating’”. But cold hard statistics do catch up with you eventually and the evidence suggests that support for a no-deal Brexit is limited. If I were a politician it would not be the ground on which I would want to fight a battle – irrespective of what the prime minister says these days.

Right-ho!

The ascent of Boris Johnson to the top of British politics has energised and enraged in equal measure but his cabinet appointments indicate a major shift in the direction of British politics, and not one that is universally welcomed. There were a record 17 changes to the cabinet in what was described as the most brutal purge in modern British political history, with all of them required to commit to taking Britain out of the EU by 31 October. There is a widespread belief that the composition of this cabinet is one of the most right-wing in British history. Whilst we can argue about that, it is undeniable that although the current government goes under the name of Conservative, it is anything but. 

A few weeks ago, The Economist published a thoughtful article on the global crisis in conservatism. One of the key arguments made in this article is that in the Anglo Saxon world, the creed of conservatism arose as a response to the radicalism triggered by the French revolution of 1789. It has historically acted as a brake on some of the more radical economic and social ideas of the last 200 years. Arguably it is one of the reasons why the UK enjoyed relative social stability during the nineteenth and twentieth centuries when many other European countries experienced significant upheaval. Conservatism has also traditionally championed individual property rights and entrepreneurship, and in the last 40 years has blazed a trail towards reducing the role of the state. But something has flipped. As The Economist put it “the new right is not an evolution of conservatism, but a repudiation of it. The usurpers are aggrieved and discontent. They are pessimists and reactionaries.”

The centre-right Republican Party in the US has been hijacked by the Tea Party movement which espouses a low tax, pro-business agenda, but is increasingly defined by a nationalist agenda that puts American interests first. Donald Trump’s recent comments inviting female politicians of colour to “go back” to “their countries” portends a much uglier turn of events. To quote The Economist once again, “the right is changing what it means to belong. In Hungary and Poland  the right exults in blood-and-soil nationalism, which excludes and discriminates.” It goes on to point out that “Hungary’s prime minister, Viktor Orban, paints himself as a low-tax economic conservative, but undermines the rule of law on which business depends.” And here is the nub of the problem: business interests are increasingly coming a distant second to the ideological requirements of the movement. 

It is in this light that we have to see Brexit. The warnings by business regarding the damage that a no-deal Brexit will cause can be ignored, so long as the small coterie of true believers on which the Conservative Party leader depends is satisfied. After all, the man who is now PM is widely reported as having said “f*** business” when challenged about business claims that a hard Brexit will lead to a loss of jobs and a reduction in investment. Despite his recent attempt to convince business leaders that he will be the “most pro-business PM” ever, the business community cannot afford to take him on trust. This is not the form of British conservatism that Margaret Thatcher would recognise. 

A closer look at Johnson’s cabinet illustrates the extent to which the nature of the domestic debate has changed. Two of those appointed (Home Secretary Priti Patel and Education Secretary Gavin Williamson) were fired by Theresa May for disloyalty to the government in acts that in times past might have been regarded as treasonous. Patel is particularly controversial for the nature of some of her political beliefs, including having in the recent past advocated the return of the death penalty. Everyone is allowed to change their opinions, as indeed Patel is reported as having done, but the worrying thing is that her view was no youthful indiscretion – it was espoused whilst she was an MP – which raises the question as to whether it is a Damascene conversion or merely one of convenience.

To further add to the controversy Johnson has appointed Dominic Cummings, campaign director of Vote Leave, as his special adviser. Cummings is regarded as intelligent, effective, albeit abrasive and one whose relationship with the truth is as strained as that of his boss. He has in the past been deeply scathing of government and is on record as suggesting that the May government’s approach to triggering Article 50 was a huge mistake. Whatever else he may be, Cummings is the antithesis of conservatism: He is a radical. Consequently, it is widely believed to be only a matter of time before Cummings is involved in a spectacular falling out with his boss – who is not a true radical. He was also recently ruled to be in contempt of parliament after failing to appear before a parliamentary committee investigating fake news. We therefore have two ministers in cabinet who undermined their previous boss and a special adviser who has been held in contempt. It’s not a good look. As an aside, the next time your employer reminds you of the ethical standards to which you are expected to adhere, you might want to point out that fish rots from the head.

The last few days have also sent a signal that UK politics has changed irrevocably. There is no obvious sign that a centrist such as Tony Blair or David Cameron is about to come riding over the hill to save us. This may change if Brexit turns out to be the disaster that is widely feared, but that won’t be any time soon. The rest of Europe should take note: The AfD is running neck-and-neck with the SPD in German opinion polls; the radical Lega is part of the Italian governing coalition and even in Sweden, the right wing populist Sweden Democrats are now the third largest parliamentary party.

In many ways, the rise of the radical right reflects the failure of the moderate centre to address the concerns of the electorate in the wake of the recession of 2008-09. Precisely because the “old politics” has been seen to fail, electorates are ready to listen to more radical solutions whether from the left or the right. In truth, the shock of 2008 was so great that it was always going to take a long time to recover, and it is more accurate to say that the policies implemented a decade ago were either not given long enough to succeed or were poorly implemented (certainly true of fiscal austerity). But the damage has now been done and the moderates may struggle to make their voices heard in the near future. Unfortunately, it may require the spectacular failure triggered by populist policies to force a change of tack. The economic costs in the meantime could be very severe.