Have a read through:
http://blogs.reuters.com/felix-salmon/2014/04/25/the-piketty-pessimist/
Felix Salmon
-----------
Thomas Piketty's book on Capital challenged that assumption that capitalism is a good thing, by showing that even if
everybody plays by the rules, inequality is very likely to increase to
obscene levels. It’s not the corrupt and venal robber barons who are the
problem, it’s rather that unless we make a concerted effort to impede
capitalism’s natural tendencies, the entire middle class is likely to
get hollowed out.
And Felix Salmon, in his blog, sets out a summary of the views for and against this argument.
But it is the truth of Piketty's data that is most depressing - capitalism can continue to deliver greater and greater wealth inequality, as it supports individual ambitions to gain short term political power. So there is little incentive to find a solution.
".. right now we’re reverting to a state of affairs which is highly unfair
but also both sustainable and, in its own way, unsurprising. Piketty has
diagnosed a nasty condition. But I don’t think there’s a cure." - Felix Salmon
Here I disagree. I think that a tax on wealth, by taxing the use of money, could be implemented for two broad reasons.
Firstly - mainstream economics, and the banking industry, do understand the underlying problems with the nature of capitalism; of fractional reserve banking; and of the social problems generated by income and wealth inequality. So while many in these camps and industries will resist attempts to widen the tax base, many will also welcome the chance to be part of the solution.
Secondly - gaining short term political power and ascendancy, quickly pales when it translates into little social good. And much of western democratic government is aware that vested interests and lobby groups currently supply the majority of the data that is used in policy formulation.
So introducing a tax on the use of money is a "saleable" option if the debate focusses on three key points - Fair - Efficient - Wise
Fairness is easy to explain, and would be politically a huge bonus in the promise of a tiny tax for low wage earners.
Efficiency appeals to small and medium business, as it makes calculating and paying their tax burden both easy and nearly painless. It also appeals to the banking industry as it adds next to no cost to their IT systems, yet entrenches their interests as a key service supplier to the government.
Wisdom stems from the data that governments can access on the economic activity of their nation.
An insignificant tax on the use of money would be worth implementing for this data alone, any actual tax revenue being a bonus. To be able to drill down to regional and industry data, with next to live feeds, would vastly improve policy making and planning.
Showing posts with label banking. Show all posts
Showing posts with label banking. Show all posts
Saturday, August 22, 2015
Tuesday, June 23, 2015
The Inventions of Depressions
Finance had always been a bit risky. Funds invested in agriculture, trade, and mining were often lost due to bad weather, drought, physical hardship and ill-health, war and banditry.
But the invention of banking and the creation of State sanctioned central banks, with the ability to issue bank notes only vaguely related to actual gold reserves, created the conditions for booms and busts on whole community, whole region, and entire State based scale.
Mercantile based booms and busts started to appear in the 1600's as banking services made it possible to get credit and funds in exchange for debt, and notes against trade and goods. The first major boom was the Netherlands 1630's speculation in tulip bulbs. Money poured into Holland, and initial speculators made enormous profits, triggering ruinous investment by later speculators. The availability of bank notes made it possible for working class people, and minor merchants, to invest, so the crash affected whole communities and ruined land holders and nobles alike.
In 1717 a Scottish financier John Law, persuaded the French Government to establish the Banque Royale, which issued bank notes underpinned by his speculative Mississippi Company. He paid navvies to march through Paris supposedly on their way to dig up gold in South America, and managed to create a long run on the shares. It created such a bubble that he was able to take on the entire French national debt, and turn it into paper notes, which he issued to the french population.
In 1720 the bubble burst.
At the same time 1711, the South Sea Company was created as a public–private partnership to consolidate and reduce the cost of UK national debt. The company was granted a monopoly to trade with Spain controlled South America. There was no realistic prospect that trade would take place and the company never realised any significant profit from its monopoly. Company stock rose to ten times its orginal value as it expanded its operations dealing in government debt, peaking in 1720 before collapsing, ruining many who had taken on debt, via bank notes to buy share.
In the 1840's there was similar speculative booms and busts in railway shares in England, the US and Europe. In each case there is belief in some technological or economic breakthrough that will permanently change the market - but it is the ready expansion of bank notes to meet the speculative urge that created the boom.
In 1929 the new US Federal Reserve was widely believed to be the perfect financial safety net, controlling interest rates and money supply by buying and selling government bonds.
A new investment house opened every day of 1929 issuing $2.5 billion of securities, financing both businesses and the purchase of shares. Shares "bought" using the bank notes issued, were used as security for further loans. Until in October 1929 when a number of minor shocks triggered the collapse of confidence and the rush to sell triggered wholesale collapse.
The fragility of such a boom is highlighted by some of these minor shocks - the arrest of a London based stock broker over fraud; the tabling of a bill to introduce tariffs on imported goods; and the discovery by public investors that the ticker tape method of reporting on share trading and share values was running hours later than the actual trades.
Junk Bonds
Junk Bonds took speculative investment, supported by banks issuing notes and demand debt, to a new level. The credit risk of a bond issued by a company ( an agreement to pay a specific sum on a specific date in return for a loan ), refers to the probability and probable loss upon a credit event (eg: default on scheduled payments, bankruptcy, or bond restructure) or a credit quality change issued by a rating agency. A high risk bond offers high interest or returns to the holder making them attractive where a loss can be borne, and these were called junk bonds.
In the 1980's bank and finance deregulation allowed traders to create junk bonds in one company, based on the promise to buy another company and fund the bond from the cash reserves, or sale of assets of the second company. Again this novel "innovation" started speculation, but it was the banks compliance in issuing notes and debt that spurred the boom.
A second innovation in the 2000's was the creation of Collateralised Debt Obligations (CDO) where bonds, mortgages, and other debt agreements are bundled so that the nett risk rating meets the minimum levels of institutional, and conservative investors. In some cases the bundles are rebundled, so that accurate audit and risk assessment becomes difficult. Again a boom was created by banks being prepared to create debt and issue notes to support the speculation, and in fact further bank deregulation had made it possible to be both an investment advisor and the debt creator.
Derivatives
If you find the idea of CDO's and Junk Bonds a worry, you will love derivatives.
This is a contract that gets its value from the performance ( not the value ) of an underlying entity. This can be an asset, index, or interest rate. Derivatives can be used to insure against price movements (hedging), but more often pure speculation on price movements for speculation - eg: forwards & futures (the right to buy in the future at a set price), options, swaps, synthetic collateralized debt obligations and credit default swaps (the risk that someone won't be paid by someone else).
Again, the preparedness of banks to support investment in derivatives, and the banks ability to create the debt out of thin air - fractional reserve banking - drove speculation in this new innovation. In 2001 it was estimated that $44,000 billion was invested in derivatives in Wall Street, and to put this into perspective, the world wide losses on stock market adjusts over 2000-2003 was $7,000 billion
The size of the derivatives market is obscured because much of the activity take place within hedge funds. In 2010-12 the majority of countries cooperated to create and legislate bodies to make derivative trading more transparent and subject to regulation. This was driven in part by the reported $39.5 billion in derivative trade losses due to fraud and market collapse in the decade 2000-2010.
But the invention of banking and the creation of State sanctioned central banks, with the ability to issue bank notes only vaguely related to actual gold reserves, created the conditions for booms and busts on whole community, whole region, and entire State based scale.
Mercantile based booms and busts started to appear in the 1600's as banking services made it possible to get credit and funds in exchange for debt, and notes against trade and goods. The first major boom was the Netherlands 1630's speculation in tulip bulbs. Money poured into Holland, and initial speculators made enormous profits, triggering ruinous investment by later speculators. The availability of bank notes made it possible for working class people, and minor merchants, to invest, so the crash affected whole communities and ruined land holders and nobles alike.
In 1717 a Scottish financier John Law, persuaded the French Government to establish the Banque Royale, which issued bank notes underpinned by his speculative Mississippi Company. He paid navvies to march through Paris supposedly on their way to dig up gold in South America, and managed to create a long run on the shares. It created such a bubble that he was able to take on the entire French national debt, and turn it into paper notes, which he issued to the french population.
In 1720 the bubble burst.
At the same time 1711, the South Sea Company was created as a public–private partnership to consolidate and reduce the cost of UK national debt. The company was granted a monopoly to trade with Spain controlled South America. There was no realistic prospect that trade would take place and the company never realised any significant profit from its monopoly. Company stock rose to ten times its orginal value as it expanded its operations dealing in government debt, peaking in 1720 before collapsing, ruining many who had taken on debt, via bank notes to buy share.
In the 1840's there was similar speculative booms and busts in railway shares in England, the US and Europe. In each case there is belief in some technological or economic breakthrough that will permanently change the market - but it is the ready expansion of bank notes to meet the speculative urge that created the boom.
In 1929 the new US Federal Reserve was widely believed to be the perfect financial safety net, controlling interest rates and money supply by buying and selling government bonds.
A new investment house opened every day of 1929 issuing $2.5 billion of securities, financing both businesses and the purchase of shares. Shares "bought" using the bank notes issued, were used as security for further loans. Until in October 1929 when a number of minor shocks triggered the collapse of confidence and the rush to sell triggered wholesale collapse.
The fragility of such a boom is highlighted by some of these minor shocks - the arrest of a London based stock broker over fraud; the tabling of a bill to introduce tariffs on imported goods; and the discovery by public investors that the ticker tape method of reporting on share trading and share values was running hours later than the actual trades.
Junk Bonds
Junk Bonds took speculative investment, supported by banks issuing notes and demand debt, to a new level. The credit risk of a bond issued by a company ( an agreement to pay a specific sum on a specific date in return for a loan ), refers to the probability and probable loss upon a credit event (eg: default on scheduled payments, bankruptcy, or bond restructure) or a credit quality change issued by a rating agency. A high risk bond offers high interest or returns to the holder making them attractive where a loss can be borne, and these were called junk bonds.
In the 1980's bank and finance deregulation allowed traders to create junk bonds in one company, based on the promise to buy another company and fund the bond from the cash reserves, or sale of assets of the second company. Again this novel "innovation" started speculation, but it was the banks compliance in issuing notes and debt that spurred the boom.
A second innovation in the 2000's was the creation of Collateralised Debt Obligations (CDO) where bonds, mortgages, and other debt agreements are bundled so that the nett risk rating meets the minimum levels of institutional, and conservative investors. In some cases the bundles are rebundled, so that accurate audit and risk assessment becomes difficult. Again a boom was created by banks being prepared to create debt and issue notes to support the speculation, and in fact further bank deregulation had made it possible to be both an investment advisor and the debt creator.
Derivatives
If you find the idea of CDO's and Junk Bonds a worry, you will love derivatives.
This is a contract that gets its value from the performance ( not the value ) of an underlying entity. This can be an asset, index, or interest rate. Derivatives can be used to insure against price movements (hedging), but more often pure speculation on price movements for speculation - eg: forwards & futures (the right to buy in the future at a set price), options, swaps, synthetic collateralized debt obligations and credit default swaps (the risk that someone won't be paid by someone else).
Again, the preparedness of banks to support investment in derivatives, and the banks ability to create the debt out of thin air - fractional reserve banking - drove speculation in this new innovation. In 2001 it was estimated that $44,000 billion was invested in derivatives in Wall Street, and to put this into perspective, the world wide losses on stock market adjusts over 2000-2003 was $7,000 billion
The size of the derivatives market is obscured because much of the activity take place within hedge funds. In 2010-12 the majority of countries cooperated to create and legislate bodies to make derivative trading more transparent and subject to regulation. This was driven in part by the reported $39.5 billion in derivative trade losses due to fraud and market collapse in the decade 2000-2010.
Sunday, May 31, 2015
The Invention of Banking
First - Ancient History
The history of banking ( http://en.wikipedia.org/wiki/History_of_banking ) starts with record keeping of promises and transactions around goods, services and trade.
Probably the earliest forms were the holding and transport of animals, edible grains, and pelts and skins on behalf of others.
Inscribed records date from 4000 BC, and used mnemonics or symbols as short hand for the transaction and promissory details and contracts.
As precious gems, gold, silver, and bronze tools and artefacts became the currency of exchange, safe storage facilities were built - initially in the style of the granaries they were replacing, and gradually as treasuries to reflect the wealth and power of the rulers who controlled them.
Around 1000 BC in Egypt and Mesopotamia there are accounts of entrepreneurship similar to today's deposit banking - the lending of funds, and the holding of funds for a percentage payment.
In later ancient Egypt and Greece, the treasuries became better organised in record keeping, and codes of conduct raised them above the local rulers and politicians. So that deposits from private individuals and traders from outside the banks region were being made.
Rome refined the idea of deposit banking, and the concept of private capitalism. Bankers were appointed to collect taxes, or licensed to operate private treasuries or banks. Bankers also exchanged foreign coin and goods for Roman minted coin - the only legal tender in the empire.
The idea of charging interest (usury) on loans ebbed and flowed. Most societies realised that it placed a burden on the borrower, some set the upper limits, some banned it ( but allowed fees for creating the loan ), some only allowed interest to be charged against "outsiders".
By Medieval times deposit banking had evolved into private merchant families acting as banks, and also the financing of agriculture - a crop loan at the beginning of the growing season. Underwriting in the form of a crop, or commodity, insurance to guarantee the delivery of the crop to the buyer, and making arrangements to supply the buyer of the crop through alternative sources in the event of crop failure.
The size of medieval kingdoms, the growth of papal rule, and the increasing literacy of the public, allowed the expansion of promissory notes, letters of credit, and other documents of exchange.
Innovations evolved like the charging of an insurance "fee" in place of interest to avoid usury, or of selling and "interest" in the trade event that the loan made possible.
Now - The Invention of Banking
Up until the 1600's banking was mainly using actual deposits and treasuries. There was some use of confidence in the lender to underpin loans and insurance, and in the value of notes and letters of credit.
Goldsmiths and wealthy merchant families were storing gold, and other valuables, in their vaults.
They were charging a fee for this service, and issued receipts certifying the quantity and purity of the metal they held as a bailee; these receipts could not be assigned, only the original depositor could collect the stored goods - so far nothing too different from the past.
But gradually the goldsmiths began to lend the money out on behalf of the depositor issuing promissory notes backed by the gold deposited with the goldsmith.
This was a new kind of "money" - goldsmiths' debt to the depositor rather than actual silver or gold coin, issued and regulated by the monarchy.
This development required the acceptance in trade of the goldsmiths' promissory notes, payable on demand; a general belief that coin would be available; and required that the holders of debt be able legally to enforce an unconditional right to payment; it required that the notes be negotiable instruments.
This was in competition to the monarchy, so this new kind of money swung in and out of popularity until in the 1700's an acts of Parliament locked in the "customs of merchants", and the notes became fully negotiable.
Modern Banking was invented.
The new Bank of England started issuing promissory notes that looked like today's bank notes in stepped denominations in 1695. These were standardised by the 1750's and fully printed bank notes by 1850's. Cheques were invented to enable banking house to banking house payments, and this lead to central clearing houses.
William Paterson had proposed a private banking structure in 1691 of a loan of £1.2M to the government (which needed cash to rebuild the army and navy) in return the subscribers would be incorporated as The Governor and Company of the Bank of England with long-term banking privileges including the issue of notes. This was granted in 1694 through the passage of an Act of Parliament (The Tonnage Act) establishing the now Bank of England. The act also described the notes as legal tender - everyone was compelled to accept them in payment of a money debt.
Two years later 1696, with the Bank of England bankrupt - notes issues equaled UKP 760,000 and cash and gold reserves equal to UKP 36,000 - Parliament ( most of whom were shareholders in the Bank ) allowed the Bank of England to suspend paying out in gold in exchange for printed bank notes. And in 1697 Parliament also passed a law prohibiting the establishment of any new corporate banks, making the shareholder owned Bank of England the "Reserve Bank".
Although the Bank was originally a private institution, by the end of
the 18th century it was increasingly being regarded as a public
authority with civic responsibility toward the upkeep of a healthy
financial system.
Henry Thornton wrote in 1802 An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, in which he argued that the increase in paper credit did not cause a banking confidence crisis, and he outlined ways a central bank might influence and control the monetary system and the value of the currency.
The Bank Charter Act of 1844 gave the Bank of England an effective monopoly on the printing of new notes since authorisation to issue new banknotes was restricted to the Bank of England. It also assumed the role of "bank of last resort" to the regional and smaller banks.
A similar pattern evolved in the USA - 1781 Congress established the Bank of North America with the task of funding mercantile expansion and to build the navy. Gold lent to the USA by the French was appropriated by Robert Morris as reserves for the new bank, and notes were then issued to finance the war contracts held by his business associates, governors and senators.
1791 Hamilton pushed through legislation establishing the First Bank of the United States with their notes being legal tender and able to be used to pay taxes. Millions was issued and 18 new banks established to funnel the money to mercantile and property investment businesses.
The War of 1812 saw many millions in new notes to pay for military goods and services. Between 1811 and 1815, gold reserves fell from 15 million to 13 million, but notes issued rose from 42 million to 79 million. In 1814 Congress ruled that new banks did not have to make payment in gold against a note based demand.
By 1818 there were 338 separate banks in the US - up 40% in 2 years - and $95 million had been issued in new bank notes.
Important Banking Precedents
In 1811 the English Courts ruled that money deposited into a bank, other than into a specific security box or bag, was a loan to the bank and not bailment ( or warehousing your money for you ). In 1848 this was reinforced by a second ruling that said that money paid into a bank becomes the property of the bank, though with an obligation to pay a similar amount to the depositor on demand.
So a bank is under no obligation to keep it safe, and can engage in speculative activities. The bank is also absolved of meeting the obligation to pay, if they are legitimately insolvent - a true form of "bankrupt".
Later Developments
Despite a regular history of boom and bust, of inflation and bank failure, the model of a central bank with the monopoly to issue legal tender, and as the "lender of last resort" to junior banks had huge political credibility and value. The US Federal Reserve was created by the U.S. Congress through the passing of The Federal Reserve Act in 1913; Australia in 1920; Colombia 1923; Mexico and Chile 1925; Canada and New Zealand 1934.
REF: Mystery of Banking - Murray Rothbard
and download the free pdf or epub edition for more history and detail
The history of banking ( http://en.wikipedia.org/wiki/History_of_banking ) starts with record keeping of promises and transactions around goods, services and trade.
Probably the earliest forms were the holding and transport of animals, edible grains, and pelts and skins on behalf of others.
Inscribed records date from 4000 BC, and used mnemonics or symbols as short hand for the transaction and promissory details and contracts.
As precious gems, gold, silver, and bronze tools and artefacts became the currency of exchange, safe storage facilities were built - initially in the style of the granaries they were replacing, and gradually as treasuries to reflect the wealth and power of the rulers who controlled them.
Around 1000 BC in Egypt and Mesopotamia there are accounts of entrepreneurship similar to today's deposit banking - the lending of funds, and the holding of funds for a percentage payment.
In later ancient Egypt and Greece, the treasuries became better organised in record keeping, and codes of conduct raised them above the local rulers and politicians. So that deposits from private individuals and traders from outside the banks region were being made.
Rome refined the idea of deposit banking, and the concept of private capitalism. Bankers were appointed to collect taxes, or licensed to operate private treasuries or banks. Bankers also exchanged foreign coin and goods for Roman minted coin - the only legal tender in the empire.
The idea of charging interest (usury) on loans ebbed and flowed. Most societies realised that it placed a burden on the borrower, some set the upper limits, some banned it ( but allowed fees for creating the loan ), some only allowed interest to be charged against "outsiders".
By Medieval times deposit banking had evolved into private merchant families acting as banks, and also the financing of agriculture - a crop loan at the beginning of the growing season. Underwriting in the form of a crop, or commodity, insurance to guarantee the delivery of the crop to the buyer, and making arrangements to supply the buyer of the crop through alternative sources in the event of crop failure.
The size of medieval kingdoms, the growth of papal rule, and the increasing literacy of the public, allowed the expansion of promissory notes, letters of credit, and other documents of exchange.
Innovations evolved like the charging of an insurance "fee" in place of interest to avoid usury, or of selling and "interest" in the trade event that the loan made possible.
Now - The Invention of Banking
Up until the 1600's banking was mainly using actual deposits and treasuries. There was some use of confidence in the lender to underpin loans and insurance, and in the value of notes and letters of credit.
Goldsmiths and wealthy merchant families were storing gold, and other valuables, in their vaults.
They were charging a fee for this service, and issued receipts certifying the quantity and purity of the metal they held as a bailee; these receipts could not be assigned, only the original depositor could collect the stored goods - so far nothing too different from the past.
But gradually the goldsmiths began to lend the money out on behalf of the depositor issuing promissory notes backed by the gold deposited with the goldsmith.
This was a new kind of "money" - goldsmiths' debt to the depositor rather than actual silver or gold coin, issued and regulated by the monarchy.
This development required the acceptance in trade of the goldsmiths' promissory notes, payable on demand; a general belief that coin would be available; and required that the holders of debt be able legally to enforce an unconditional right to payment; it required that the notes be negotiable instruments.
This was in competition to the monarchy, so this new kind of money swung in and out of popularity until in the 1700's an acts of Parliament locked in the "customs of merchants", and the notes became fully negotiable.
Modern Banking was invented.
The new Bank of England started issuing promissory notes that looked like today's bank notes in stepped denominations in 1695. These were standardised by the 1750's and fully printed bank notes by 1850's. Cheques were invented to enable banking house to banking house payments, and this lead to central clearing houses.
William Paterson had proposed a private banking structure in 1691 of a loan of £1.2M to the government (which needed cash to rebuild the army and navy) in return the subscribers would be incorporated as The Governor and Company of the Bank of England with long-term banking privileges including the issue of notes. This was granted in 1694 through the passage of an Act of Parliament (The Tonnage Act) establishing the now Bank of England. The act also described the notes as legal tender - everyone was compelled to accept them in payment of a money debt.
Two years later 1696, with the Bank of England bankrupt - notes issues equaled UKP 760,000 and cash and gold reserves equal to UKP 36,000 - Parliament ( most of whom were shareholders in the Bank ) allowed the Bank of England to suspend paying out in gold in exchange for printed bank notes. And in 1697 Parliament also passed a law prohibiting the establishment of any new corporate banks, making the shareholder owned Bank of England the "Reserve Bank".
Henry Thornton wrote in 1802 An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, in which he argued that the increase in paper credit did not cause a banking confidence crisis, and he outlined ways a central bank might influence and control the monetary system and the value of the currency.
The Bank Charter Act of 1844 gave the Bank of England an effective monopoly on the printing of new notes since authorisation to issue new banknotes was restricted to the Bank of England. It also assumed the role of "bank of last resort" to the regional and smaller banks.
A similar pattern evolved in the USA - 1781 Congress established the Bank of North America with the task of funding mercantile expansion and to build the navy. Gold lent to the USA by the French was appropriated by Robert Morris as reserves for the new bank, and notes were then issued to finance the war contracts held by his business associates, governors and senators.
1791 Hamilton pushed through legislation establishing the First Bank of the United States with their notes being legal tender and able to be used to pay taxes. Millions was issued and 18 new banks established to funnel the money to mercantile and property investment businesses.
The War of 1812 saw many millions in new notes to pay for military goods and services. Between 1811 and 1815, gold reserves fell from 15 million to 13 million, but notes issued rose from 42 million to 79 million. In 1814 Congress ruled that new banks did not have to make payment in gold against a note based demand.
By 1818 there were 338 separate banks in the US - up 40% in 2 years - and $95 million had been issued in new bank notes.
Important Banking Precedents
In 1811 the English Courts ruled that money deposited into a bank, other than into a specific security box or bag, was a loan to the bank and not bailment ( or warehousing your money for you ). In 1848 this was reinforced by a second ruling that said that money paid into a bank becomes the property of the bank, though with an obligation to pay a similar amount to the depositor on demand.
So a bank is under no obligation to keep it safe, and can engage in speculative activities. The bank is also absolved of meeting the obligation to pay, if they are legitimately insolvent - a true form of "bankrupt".
Later Developments
Despite a regular history of boom and bust, of inflation and bank failure, the model of a central bank with the monopoly to issue legal tender, and as the "lender of last resort" to junior banks had huge political credibility and value. The US Federal Reserve was created by the U.S. Congress through the passing of The Federal Reserve Act in 1913; Australia in 1920; Colombia 1923; Mexico and Chile 1925; Canada and New Zealand 1934.
REF: Mystery of Banking - Murray Rothbard
and download the free pdf or epub edition for more history and detail
Sunday, May 24, 2015
The Invention of Debt and Inflation
Debt
In early society a debt was generally a moral or social obligation to repay someone for a good or service rendered.
Once money became the dominant form of exchange ( a commodity ), a debt came to refer to money owed by one party, the borrower or debtor, to a second party, the lender or creditor.
And these debts are commonly subject to contractual terms regarding the amount and timing of repayments of principal ( the amount borrowed ) and interest ( the extra money charged for making the loan ).
As the Rule of Law and the concept of Property Rights expanded, so did the idea of requesting a security over the money lent - a guarantee asset to be offered in place of the commodity money should there be a failure to repay all or part of the loan.
This securitisation of the debt shifted the idea of a loan away from the personal and short term - from having trust in the person or venture receiving the loan, from carrying some of the risk that the future status matched the planned outcome, to one that was both impersonal and low risk.
Debt became a business, and markets in Debt evolved.
The first step was to use the Rule of Law to allow the loan agreement, and its attached security, to be passed to another legal entity ( person or business ). Once this concept was established, loan agreements could be legislated as Bonds and these could be traded, and regarded as assets.
Dealing with individual loans and their securities was seen as inefficient and limited the scale of debt markets - so loans were pooled, sold to securitisation trusts, who bought them using Bonds ( Securities ) sold, in turn, into the Debt Markets.
## [ http://en.wikipedia.org/wiki/Debt ]
The critism of debt as a business is two-fold - firstly, that divorcing the lender from sharing the consequences of a future that does not match that envisaged on creation of the loan, unfairly pushes those consequences back onto the community and society that supports the borrower ( ie: can create public debt, environmental damage, social disruption ), and secondly, that as the Debt Market is a source of wealth creation, there is pressure to create levels of debt in excess of real and reasonable needs.
Inflation
Economists historically identify three factors that cause a rise in the price of goods and services:
Basically each unit of currency buys fewer goods and services - a reduction in the purchasing power per unit of money – a loss of real value. The measure of price inflation is the inflation rate, the percentage change in a price index, usually the consumer price index or similar basket of goods.
Negative effects of inflation include:
## [ http://en.wikipedia.org/wiki/Inflation ]
This is all historical information, and internally logical if simplistic. However, recent trends in country and global economies have not followed the expected patterns. Interest rates have been close to zero, wages growth is zero or negative, and in theory the increased money supply ( quantitative easing ) should have caused mild inflation and economic stimulation.
Investment in infrastructure, education, and preventative or primary health care can grow an economy in greater amounts than the investment spending. They act by reducing the cost of living, or increasing the apparent purchasing power of currency won through wages.
However, current government policy, in the face of slowing economies, is to reduce government spending, limit wages growth, and encourage private spending funded by increased debt.
One half of government is acting as if inflation was rising - using fiscal policy to reduce wages growth, and cut back on government spending on community; and the other half is using monetary policy, as if we are in recession - boosting public debt by transfers to private corporations.
In early society a debt was generally a moral or social obligation to repay someone for a good or service rendered.
Once money became the dominant form of exchange ( a commodity ), a debt came to refer to money owed by one party, the borrower or debtor, to a second party, the lender or creditor.
And these debts are commonly subject to contractual terms regarding the amount and timing of repayments of principal ( the amount borrowed ) and interest ( the extra money charged for making the loan ).
As the Rule of Law and the concept of Property Rights expanded, so did the idea of requesting a security over the money lent - a guarantee asset to be offered in place of the commodity money should there be a failure to repay all or part of the loan.
This securitisation of the debt shifted the idea of a loan away from the personal and short term - from having trust in the person or venture receiving the loan, from carrying some of the risk that the future status matched the planned outcome, to one that was both impersonal and low risk.
Debt became a business, and markets in Debt evolved.
The first step was to use the Rule of Law to allow the loan agreement, and its attached security, to be passed to another legal entity ( person or business ). Once this concept was established, loan agreements could be legislated as Bonds and these could be traded, and regarded as assets.
Dealing with individual loans and their securities was seen as inefficient and limited the scale of debt markets - so loans were pooled, sold to securitisation trusts, who bought them using Bonds ( Securities ) sold, in turn, into the Debt Markets.
## [ http://en.wikipedia.org/wiki/Debt ]
The critism of debt as a business is two-fold - firstly, that divorcing the lender from sharing the consequences of a future that does not match that envisaged on creation of the loan, unfairly pushes those consequences back onto the community and society that supports the borrower ( ie: can create public debt, environmental damage, social disruption ), and secondly, that as the Debt Market is a source of wealth creation, there is pressure to create levels of debt in excess of real and reasonable needs.
Inflation
Economists historically identify three factors that cause a rise in the price of goods and services:
- a change in the value or production costs of the goods,
- a change in the price of money, which occurs when either the coins themselves are debased or an inflow of similar commodity dilutes the value ( eg: gold and silver flooding Europe from the Spanish invasions of South America ),
- or currency depreciation - an increased supply of currency, usually note printing.
Basically each unit of currency buys fewer goods and services - a reduction in the purchasing power per unit of money – a loss of real value. The measure of price inflation is the inflation rate, the percentage change in a price index, usually the consumer price index or similar basket of goods.
Negative effects of inflation include:
- an increase in the opportunity cost of holding money, making spending cash a priority,
- uncertainty over future inflation which may discourage investment and savings, and
- if rapid inflation, shortages of goods as consumers both hoard out of concern that goods will disappear, and buy goods as inflation resistant assets or as barter items for future use.
- it gives everyone an incentive to invest, as their money will be worth less in the future.
- it reduces the real burden of debt, but only if salary or income increases over time due to inflation, but outgoings or mortgage payments stay the same.
- it can keep nominal interest rates above zero, allowing central banks to reduce interest rates as a means to stimulate the economy.
- it can reduce unemployment by reducing the real value of wages, increases the demand for labor.
## [ http://en.wikipedia.org/wiki/Inflation ]
This is all historical information, and internally logical if simplistic. However, recent trends in country and global economies have not followed the expected patterns. Interest rates have been close to zero, wages growth is zero or negative, and in theory the increased money supply ( quantitative easing ) should have caused mild inflation and economic stimulation.
Investment in infrastructure, education, and preventative or primary health care can grow an economy in greater amounts than the investment spending. They act by reducing the cost of living, or increasing the apparent purchasing power of currency won through wages.
However, current government policy, in the face of slowing economies, is to reduce government spending, limit wages growth, and encourage private spending funded by increased debt.
One half of government is acting as if inflation was rising - using fiscal policy to reduce wages growth, and cut back on government spending on community; and the other half is using monetary policy, as if we are in recession - boosting public debt by transfers to private corporations.
Sunday, April 12, 2015
Taxing The Use of Money
Summary: Modern developed economies now consist of three sectors - manufacture, service, and finance. Current tax regimes primarily collect from the first two sectors, leading to an impoverishment of both those sectors, and the government that uses that revenue. The proposed tax on the use of money would effectively and efficiently tax all three sectors. Such a tax is feasible due to the high level of computerisation of the banking system, and the decline in the use of cash in day to day transactions.
Background:
* Manufacture includes all the ways things are processed and transformed;
* Service includes activities that support manufacture and society itself; and
Finance includes all the ways money is used as a commodity and a source of profit, rather than money being the lubricant to facilitate manufacture and service processes.
The tax system evolved along two principles - identify the processes that generate wealth, and find a way to efficiently collect a part of that wealth. This revenue was then used to finance processes that support the population as a whole ( according to the dominant social model for that time ).
Early taxation identified manufacture as the dominant source of wealth creation, and the goods created, excavated, or grown could be measured, valued and a tax collected on their transfer as property.
As society evolved, services grew, first as a part of manufacture - bookkeeping, goods handling and freight, machine servicing, labour support, etc. And these services were efficiently taxed by taxing the goods that they supported.
As ex-manufacture services grew - health, education, personal services - and as the previously internal services became outsourced, the concept of a GST developed to capture these less concrete sources of wealth. These taxes still relied on the practicality of taxing the transfer of goods, but the concept of an invoice enabled a form of virtual taxation that was equally effective and economical to collect.
Now it is estimated that Finance transactions are approximated 10% of the GDP ( and growing at around 3% pa ) and that these predominantly use money as the commodity of wealth generation - trade in money, debt, and securities being used to earn money.
This source of wealth is very poorly taxed - only declared profits being measured. Yet the impact on society ( and the environment ) of this use of money is a profound as strip mining or irrigation on the natural environment, or industrialisation on human society and towns.
This might sound an extreme analogy, but the use of money to generate money means that only those chosen to participate by the managers of those financial institutions, get any benefit, for the wealth generated by money debt today, comes by bringing future concrete wealth into the present, impoverishing those who did not gain ownership of that concrete wealth.
Proposal: Tax the Use of Money
Almost all financial and business transactions now involve a digital exchange. Most involve the deposit and withdrawal of a money amount in a legally defined and regulated financial organisation.
It would be relatively inexpensive to require all these financial organisations to modify their computer systems so that a percentage of these transactions are passed to a government account(s).
This source of revenue could replace all current taxes and levies, simplifying both the tax payment and the tax monitoring systems.
It would not have to be an exclusive tax - in fact, a gradual introduction, with concurrent reductions in other forms of taxation would ensure a smooth transition, and opportunities for industries and social organisations to monitor and adjust to the change.
The advantages of taxing the use of money would be:
government budgets would be easier to formulate from the smaller number of data inputs from financial organisations - much available in real time.
short term budget needs could be met with tiny increases and decreases in the transfer percentage.
the payment of tax would be daily or hourly ( or less ) in tiny amounts, so much easier to match to cash flow for business and individuals.
low-incomes could be supported by similar tiny frequent deposits from the government account(s)
over-seas purchases and transfers would be taxed as withdrawals in the local regime.
currency speculation and micro-trades would be taxed, and discouraged unless truly of value, leading to reduced volatility in the markets.
The disadvantages would include the taxing of investments, cash used to establish a business or venture, and research and development costs. But these could be treated as special investments in the common good, and supported by government grants.
The primary advantage would be that the tax burden would be more fairly shared across all three sectors of the economy, and the tax revenue would strengthen the sovereign government, and reduce the negative impacts of globalisation on society and the environment.
Background:
* Manufacture includes all the ways things are processed and transformed;
* Service includes activities that support manufacture and society itself; and
Finance includes all the ways money is used as a commodity and a source of profit, rather than money being the lubricant to facilitate manufacture and service processes.
The tax system evolved along two principles - identify the processes that generate wealth, and find a way to efficiently collect a part of that wealth. This revenue was then used to finance processes that support the population as a whole ( according to the dominant social model for that time ).
Early taxation identified manufacture as the dominant source of wealth creation, and the goods created, excavated, or grown could be measured, valued and a tax collected on their transfer as property.
As society evolved, services grew, first as a part of manufacture - bookkeeping, goods handling and freight, machine servicing, labour support, etc. And these services were efficiently taxed by taxing the goods that they supported.
As ex-manufacture services grew - health, education, personal services - and as the previously internal services became outsourced, the concept of a GST developed to capture these less concrete sources of wealth. These taxes still relied on the practicality of taxing the transfer of goods, but the concept of an invoice enabled a form of virtual taxation that was equally effective and economical to collect.
Now it is estimated that Finance transactions are approximated 10% of the GDP ( and growing at around 3% pa ) and that these predominantly use money as the commodity of wealth generation - trade in money, debt, and securities being used to earn money.
This source of wealth is very poorly taxed - only declared profits being measured. Yet the impact on society ( and the environment ) of this use of money is a profound as strip mining or irrigation on the natural environment, or industrialisation on human society and towns.
This might sound an extreme analogy, but the use of money to generate money means that only those chosen to participate by the managers of those financial institutions, get any benefit, for the wealth generated by money debt today, comes by bringing future concrete wealth into the present, impoverishing those who did not gain ownership of that concrete wealth.
Proposal: Tax the Use of Money
Almost all financial and business transactions now involve a digital exchange. Most involve the deposit and withdrawal of a money amount in a legally defined and regulated financial organisation.
It would be relatively inexpensive to require all these financial organisations to modify their computer systems so that a percentage of these transactions are passed to a government account(s).
This source of revenue could replace all current taxes and levies, simplifying both the tax payment and the tax monitoring systems.
It would not have to be an exclusive tax - in fact, a gradual introduction, with concurrent reductions in other forms of taxation would ensure a smooth transition, and opportunities for industries and social organisations to monitor and adjust to the change.
The advantages of taxing the use of money would be:
government budgets would be easier to formulate from the smaller number of data inputs from financial organisations - much available in real time.
short term budget needs could be met with tiny increases and decreases in the transfer percentage.
the payment of tax would be daily or hourly ( or less ) in tiny amounts, so much easier to match to cash flow for business and individuals.
low-incomes could be supported by similar tiny frequent deposits from the government account(s)
over-seas purchases and transfers would be taxed as withdrawals in the local regime.
currency speculation and micro-trades would be taxed, and discouraged unless truly of value, leading to reduced volatility in the markets.
The disadvantages would include the taxing of investments, cash used to establish a business or venture, and research and development costs. But these could be treated as special investments in the common good, and supported by government grants.
The primary advantage would be that the tax burden would be more fairly shared across all three sectors of the economy, and the tax revenue would strengthen the sovereign government, and reduce the negative impacts of globalisation on society and the environment.
Tuesday, April 7, 2015
Structural Change in the Australian Economy
The large growth in Services ( excluding Distribution ) reflects three trends.
Firstly - the growth of two income families has created demand for services that previously were conducted in the home - child care, pre-schooling, home maintenance and servicing, aged care, and cooking - and hence not previously included in the GDP data;
Secondly - there has been an increased demand for health, educational, recreational and financial services with increased incomes, and pressure for employment;
Thirdly - many activities that used to be run in-house in manufacturing, agriculture, mining, construction, and distribution, are now outsourced and re-classified as services.
So from a structural change view, the growth in services is not as dramatic as it first seems, but from a taxation or government finance point of view, it is a significant change with long term consequences.
Around 1900 - it made sense to tax goods as this collected the bulk of the financial activity in a format that made assessment easy and collection efficient.
Around 1950 ( and later ) - the growth in combined services encouraged the additional of a VAT or GST to both goods and services, as a practical way to tap into the increasing share of financial activity that was service based.
Around 2000 - it seemed appropriate to increase the VAT/GST rate, and/or extend it to include previously exempt services and goods - typically education, fresh food, and some health services.
However, Finance and Insurance currently contributes about 10% of GDP ( and is growing at around 3% ) and a VAT/GST typically fails to collect tax revenue from this activity. Part of the reason is the strong political lobbying from the industry in general, and the small number of powerful and wealthy individuals who benefit from the trading in finance. Part is also the difficulty in defining the service that should be taxed.
This problem has encouraged proposals for an alternative tax on the use of money - a tax that would replace all current taxes - VAT/GST, sales taxes, and levies - and be based entirely on the interface of money exchange. ie: levied at the point of deposit and withdrawal at financial institutions.
The argument is that this captures the true overall economic activity as based for taxation ( as revenue for government ) and is capable of responding to any future structural change in the economy.
There are also moral and environmental arguments for such a tax on the use of money, and these will be discussed in later posts.
Saturday, March 21, 2015
The Mystery of Banking and Capital in the 21st Century
18 months between posts might seem excessive, but I have been reading books by some impressive economists - Murray Rothbard - The Mystery of Banking, and Thomas Piketty - Capital in the Twenty-First Century. Both authors come from Europe - Rothbard from Austria and Switzerland, and Piketty from France, and their european perspectives are enlightening.
Rothbard's focus is on how money and money supply works, and how the demand for loans led to the concept of Central Banking, and how this has become organisations ( Reserve Bank, Federal Reserve, etc. ) with their own commercial and political agendas that run counter to the aims and needs of the wider community and societies that they supposedly serve.
Piketty has collated and analyzed the records on property ownership, tax payments, deaths duties, and company shareholdings, from 20 countries, the oldest data from the 1700s in France and England, to build a model of how capital builds over time, and how it is used and distributed.
Piketty's key finding is that capital always tends to create returns in excess of the rate of economic growth, and that only in the immediate post WW2 period, did technology allow wage earners to match the earnings of capital ( itself temporarily reduced by the costs and damages of WW2 ).
Piketty expands his argument to include financial inequality ( income and wealth ) as a key factor in social unrest, and rebellion. Critics have been quick to point to capitalism as the source of equality of opportunity, and of improved health, education and social equality, especially in developing countries.
However, Piketty has already pointed out that we are just leaving the "abnormal" post WW2 period, and that he is warning about returning to the long term trend line, where capital creates capital ( or wealth ), faster than wages can create capital. And he notes that there is no clear correlation between increased capital and increased social equality, except in situations where improvement of the skills and health of the workforce generate productivity increases and so raises the return on the capital.
The key point that I take from these two books is the realisation that the actions of the expanded central banking system has both increased the growth in returns from capital, and through fractional reserve banking, decreased the ability for wage earners ( and governments that rely on them for tax revenue ) to build up capital.
This might not be a serious problem if the form of capital, and the uses made of it to generate returns, where similar that of the 1700-1900s.
Over this period, labour was a key component in the sources of returns on capital invested.
In the cases of using capital to invest in colonial trade and industries, the labour component was small, slavery was often part of the "capital" owned, and wages were tiny. But in most developed economies the return relied on skilled labour, whether in agricultural, industry, or mineral or timber extractions. So wages were a necessary "cost" and proportional to the nett return.
However, the last 60 years have seen a shift towards money being a commodity in its on right, rather than just the mechanism of exchange, or temporary store of value - the "oil in the cogs of the economy", or the "catalyst in the process of production".
The percentage that financial services contribute to the economy is also growing at around 5% per year - from a current 9% ( 2013/14 ABS ) - and half our overseas "trade" is transfers of money to related companies ( globalisation ).
The nett effect is that money is increasingly a form of capital ( rather than a measure of capital ), and one that can generate a return on itself with very little labour required.
Combine this with fractional reserve banking, and you have a system that shifts wealth to the more wealthy by diluting the existing wealth of the less wealthy, and reducing the capital creation ability of wage earners - an efficient source of the inequality that Thomas Piketty is concerned by.
Rothbard's focus is on how money and money supply works, and how the demand for loans led to the concept of Central Banking, and how this has become organisations ( Reserve Bank, Federal Reserve, etc. ) with their own commercial and political agendas that run counter to the aims and needs of the wider community and societies that they supposedly serve.
Piketty has collated and analyzed the records on property ownership, tax payments, deaths duties, and company shareholdings, from 20 countries, the oldest data from the 1700s in France and England, to build a model of how capital builds over time, and how it is used and distributed.
Piketty's key finding is that capital always tends to create returns in excess of the rate of economic growth, and that only in the immediate post WW2 period, did technology allow wage earners to match the earnings of capital ( itself temporarily reduced by the costs and damages of WW2 ).
Piketty expands his argument to include financial inequality ( income and wealth ) as a key factor in social unrest, and rebellion. Critics have been quick to point to capitalism as the source of equality of opportunity, and of improved health, education and social equality, especially in developing countries.
However, Piketty has already pointed out that we are just leaving the "abnormal" post WW2 period, and that he is warning about returning to the long term trend line, where capital creates capital ( or wealth ), faster than wages can create capital. And he notes that there is no clear correlation between increased capital and increased social equality, except in situations where improvement of the skills and health of the workforce generate productivity increases and so raises the return on the capital.
The key point that I take from these two books is the realisation that the actions of the expanded central banking system has both increased the growth in returns from capital, and through fractional reserve banking, decreased the ability for wage earners ( and governments that rely on them for tax revenue ) to build up capital.
This might not be a serious problem if the form of capital, and the uses made of it to generate returns, where similar that of the 1700-1900s.
Over this period, labour was a key component in the sources of returns on capital invested.
In the cases of using capital to invest in colonial trade and industries, the labour component was small, slavery was often part of the "capital" owned, and wages were tiny. But in most developed economies the return relied on skilled labour, whether in agricultural, industry, or mineral or timber extractions. So wages were a necessary "cost" and proportional to the nett return.
However, the last 60 years have seen a shift towards money being a commodity in its on right, rather than just the mechanism of exchange, or temporary store of value - the "oil in the cogs of the economy", or the "catalyst in the process of production".
The percentage that financial services contribute to the economy is also growing at around 5% per year - from a current 9% ( 2013/14 ABS ) - and half our overseas "trade" is transfers of money to related companies ( globalisation ).
The nett effect is that money is increasingly a form of capital ( rather than a measure of capital ), and one that can generate a return on itself with very little labour required.
Combine this with fractional reserve banking, and you have a system that shifts wealth to the more wealthy by diluting the existing wealth of the less wealthy, and reducing the capital creation ability of wage earners - an efficient source of the inequality that Thomas Piketty is concerned by.
Saturday, December 21, 2013
Retirement Savings, Superannuation and Bank Deposits
The Australian Federal Government has set up the Murry enquiry to look at bank deposits, insurance, retirement savings and home loans, and the key issue seems to be the role of deposits versus other sources of funding.
Bank deposits have risen from around 40% in 2008 to 60% in light of the crash and slow thaw in wholesale money markets. Superannuation savings have grown to more than A$1.7 trillion and half of that has been invested in shares in the absence of a pathway into tax effective interest bearing deposits.
So curiously, we are at a stage where the banks themselves may lobby for a much larger real deposit backed lending process, drawing on the superannuation funds, and a move away from creating loans backed by the borrower's future access to wealth (- see the earlier blogs).
This would be a very good thing. In the short term the interest rate paid on deposits would fall or flat line due to the increase in funds available, but long term the depositors would start to demand better returns, and while this would raise the cost of borrowing, it would also raise the level of consumer demand for goods and services.
But more importantly, it would base investment on already generated wealth of the lender instead of mortgaging the future generation of wealth of the borrower. And it would free to borrower from living up to the model of the future envisaged by the lending institution.
This may sound a little odd, but that is one problem with the current ability of banks to lend more than they hold in real deposits. That phantom money becomes real when you agree to borrow it because you are agreeing to give the bank your ability in the future to generate wealth, but the future you are signing up to is that that suits the bank - a future that they think will be favourable for them to make more money. This is why housing, property and development get such favourable rates, and ethical and sustainable projects struggle. The banks may not be especially mean over this, it is just that they can not model a green future, so they can not accept such an unknown future.
Bank deposits have risen from around 40% in 2008 to 60% in light of the crash and slow thaw in wholesale money markets. Superannuation savings have grown to more than A$1.7 trillion and half of that has been invested in shares in the absence of a pathway into tax effective interest bearing deposits.
So curiously, we are at a stage where the banks themselves may lobby for a much larger real deposit backed lending process, drawing on the superannuation funds, and a move away from creating loans backed by the borrower's future access to wealth (- see the earlier blogs).
This would be a very good thing. In the short term the interest rate paid on deposits would fall or flat line due to the increase in funds available, but long term the depositors would start to demand better returns, and while this would raise the cost of borrowing, it would also raise the level of consumer demand for goods and services.
But more importantly, it would base investment on already generated wealth of the lender instead of mortgaging the future generation of wealth of the borrower. And it would free to borrower from living up to the model of the future envisaged by the lending institution.
This may sound a little odd, but that is one problem with the current ability of banks to lend more than they hold in real deposits. That phantom money becomes real when you agree to borrow it because you are agreeing to give the bank your ability in the future to generate wealth, but the future you are signing up to is that that suits the bank - a future that they think will be favourable for them to make more money. This is why housing, property and development get such favourable rates, and ethical and sustainable projects struggle. The banks may not be especially mean over this, it is just that they can not model a green future, so they can not accept such an unknown future.
Monday, December 9, 2013
Mr. Soddy’s Ecological Economy
Frederick Soddy, born in 1877 in England, was a chemist with Ernest Rutherford when they jointly determined that radioactivity was atom decay and transformation. Back in Scotland, he described and named the concept of an isotope, and determined the changes in atomic number brought about by radioactivity. He received the 1921 Nobel laureate in Chemistry for his work on radioactive decay, and foresaw the energy potential of atomic fission.
He turned to economics, revolted by the mass chemical deaths of World War I, published four books from 1921 to 1934, and campaigned for a radical restructuring of global monetary relationships, but was dismissed as a crank.
He saw economics as a physical machine that must draw energy from outside itself.
The first and second laws of thermodynamics forbid perpetual motion - systems that create energy out of nothing or recycle it forever. He criticized the prevailing belief of the economy capable of generating infinite wealth.
Current economists model the economy as a living system. drawing from its environment valuable (or “low entropy”) matter and energy, ores, the raw materials provided by plants and animals. And like all life, an economy emits a high-entropy wake — it spews degraded matter and energy: waste heat, waste gases, toxic byproducts, apple cores, the molecules of iron lost to rust and abrasion. High entropy emissions include trash and pollution in all their forms, including yesterday’s newspaper, last year’s sneakers, last decade’s rusted automobile.
Matter taken up into the economy can be recycled, using energy; but energy, used once, is forever unavailable to us at that level again. The law of entropy commands a one-way flow downward from more to less useful forms. An animal can’t live perpetually on its own excreta. Neither can you fill the tank of your car by pushing it backwards. Thus, Georgescu-Roegen, paraphrasing the economist Alfred Marshall, said: “Biology, not mechanics, is our Mecca.”
Following Soddy, Georgescu-Roegen and other ecological economists argue that wealth is real and physical. It’s the stock of cars and computers and clothing, of furniture and French fries, that we buy with our dollars.
The dollars aren’t real wealth, but only symbols that represent the bearer’s claim on an economy’s ability to generate wealth.
Debt, for its part, is a claim on the economy’s ability to generate wealth in the future.
Soddy said that the ruling passion of the age, is to convert wealth into debt — to exchange a thing with present-day real value (a thing that could be stolen, or broken, or rust or rot before you can manage to use it) for something immutable and unchanging, a claim on wealth that has yet to be made.
Problems arise when wealth and debt are not kept in proper relation.
The amount of wealth that an economy can create is limited by the amount of low-entropy energy that it can sustainably suck from its environment — and by the amount of high-entropy effluent from an economy that the environment can sustainably absorb. Debt, being imaginary, has no such natural limit. It can grow infinitely, compounding at any rate we decide to accept.
Whenever an economy allows debt to grow faster than wealth can be created, that economy has a need for debt repudiation. Inflation can do the job, decreasing debt gradually by eroding the purchasing power, the claim on future wealth, that each of your saved dollars represents. But when there is no inflation, an economy with overgrown claims on future wealth will experience regular crises of debt repudiation — stock market crashes, bankruptcies and foreclosures, defaults on bonds or loans or pension promises, the disappearance of paper assets.
It’s like musical chairs — in the wake of some shock (say, the run-up of the price of gas to $4 a gallon), holders of abstract debt suddenly want to hold money or real wealth instead.
But not all of them can. One person’s loss causes another’s, and the whole system cascades into crisis. Each and every one of the crises that has beset the American economy in recent years has been, at heart, a crisis of debt repudiation. And we are unlikely to avoid more of them until we stop allowing claims on income to grow faster than income.
The problem isn’t simply greed, or ignorance, or a failure of regulatory diligence, but a systemic flaw in how our economy finances itself. As long as growth in claims on wealth outstrips the economy’s capacity to increase its wealth, market capitalism creates a niche for entrepreneurs who are willing to invent instruments of debt that will someday need to be repudiated.
Soddy suggested five policy prescriptions - taken at the time as evidence that his theories were unworkable. And yet these four are now conventional practice:
abandon the gold standard,
let international exchange rates float,
use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and
establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort.
Soddy’s fifth proposal, was to stop banks from creating money (and debt) out of nothing.
Banks do this by lending out more than they physically hold of their depositors’ money at interest — creating debt ( a claim on real wealth in the future ) and creating apparent debit balances in the borrower’s demand deposit (checking) account, where it can be lent out again to create more debt and demand deposits, and so on, almost ad infinitum.
Herman Daly, an ecological economist, and many others have proposed a gradual, legislated move to 100-percent reserve requirement on demand deposits.
Banks could still support themselves by charging fees for safekeeping, check clearing and all the other legitimate financial services they provide. They could still make loans and still be able to lend at interest, but based on the real money of real depositors. This would re-establish a one-to-one correspondence between the real wealth of the community and the claims on that real wealth.
The immediate response to this economic theory and its fifth proposal, is horror at the impact it would have on GDP, the share market, and economic activity.
But real debts do exist. These are mainly the real world matter and energy high entropy emissions and environmental impacts. The currently, un-costed, costs of removing CO2 from the atmosphere and oceans; of repairing degraded land and water supplies; of neutralising the toxins and organochlorides; and of redressing social inequity and poverty caused by the debt process.
And the problem is that these real debts have to be paid from current wealth generation.
They are not a claim on future real wealth. And they have physical priority over the interest created and charged from debt creation.
We are at a stage where real debts are increasing eroding our current wealth creation, making us all a little poorer each year, and throwing into doubt our ability to create wealth in the future, and so seriously weakening the claims by debt to that wealth.
This is both creating social and personal dissatisfaction and tension, and bringing forward the likelihood of financial crisis and collapse - debt repudiation.
It is increasingly likely that Soddy’s fifth proposal will also become conventional practice.
He turned to economics, revolted by the mass chemical deaths of World War I, published four books from 1921 to 1934, and campaigned for a radical restructuring of global monetary relationships, but was dismissed as a crank.
He saw economics as a physical machine that must draw energy from outside itself.
The first and second laws of thermodynamics forbid perpetual motion - systems that create energy out of nothing or recycle it forever. He criticized the prevailing belief of the economy capable of generating infinite wealth.
Current economists model the economy as a living system. drawing from its environment valuable (or “low entropy”) matter and energy, ores, the raw materials provided by plants and animals. And like all life, an economy emits a high-entropy wake — it spews degraded matter and energy: waste heat, waste gases, toxic byproducts, apple cores, the molecules of iron lost to rust and abrasion. High entropy emissions include trash and pollution in all their forms, including yesterday’s newspaper, last year’s sneakers, last decade’s rusted automobile.
Matter taken up into the economy can be recycled, using energy; but energy, used once, is forever unavailable to us at that level again. The law of entropy commands a one-way flow downward from more to less useful forms. An animal can’t live perpetually on its own excreta. Neither can you fill the tank of your car by pushing it backwards. Thus, Georgescu-Roegen, paraphrasing the economist Alfred Marshall, said: “Biology, not mechanics, is our Mecca.”
Following Soddy, Georgescu-Roegen and other ecological economists argue that wealth is real and physical. It’s the stock of cars and computers and clothing, of furniture and French fries, that we buy with our dollars.
The dollars aren’t real wealth, but only symbols that represent the bearer’s claim on an economy’s ability to generate wealth.
Debt, for its part, is a claim on the economy’s ability to generate wealth in the future.
Soddy said that the ruling passion of the age, is to convert wealth into debt — to exchange a thing with present-day real value (a thing that could be stolen, or broken, or rust or rot before you can manage to use it) for something immutable and unchanging, a claim on wealth that has yet to be made.
Problems arise when wealth and debt are not kept in proper relation.
The amount of wealth that an economy can create is limited by the amount of low-entropy energy that it can sustainably suck from its environment — and by the amount of high-entropy effluent from an economy that the environment can sustainably absorb. Debt, being imaginary, has no such natural limit. It can grow infinitely, compounding at any rate we decide to accept.
Whenever an economy allows debt to grow faster than wealth can be created, that economy has a need for debt repudiation. Inflation can do the job, decreasing debt gradually by eroding the purchasing power, the claim on future wealth, that each of your saved dollars represents. But when there is no inflation, an economy with overgrown claims on future wealth will experience regular crises of debt repudiation — stock market crashes, bankruptcies and foreclosures, defaults on bonds or loans or pension promises, the disappearance of paper assets.
It’s like musical chairs — in the wake of some shock (say, the run-up of the price of gas to $4 a gallon), holders of abstract debt suddenly want to hold money or real wealth instead.
But not all of them can. One person’s loss causes another’s, and the whole system cascades into crisis. Each and every one of the crises that has beset the American economy in recent years has been, at heart, a crisis of debt repudiation. And we are unlikely to avoid more of them until we stop allowing claims on income to grow faster than income.
The problem isn’t simply greed, or ignorance, or a failure of regulatory diligence, but a systemic flaw in how our economy finances itself. As long as growth in claims on wealth outstrips the economy’s capacity to increase its wealth, market capitalism creates a niche for entrepreneurs who are willing to invent instruments of debt that will someday need to be repudiated.
Soddy suggested five policy prescriptions - taken at the time as evidence that his theories were unworkable. And yet these four are now conventional practice:
abandon the gold standard,
let international exchange rates float,
use federal surpluses and deficits as macroeconomic policy tools that could counter cyclical trends, and
establish bureaus of economic statistics (including a consumer price index) in order to facilitate this effort.
Soddy’s fifth proposal, was to stop banks from creating money (and debt) out of nothing.
Banks do this by lending out more than they physically hold of their depositors’ money at interest — creating debt ( a claim on real wealth in the future ) and creating apparent debit balances in the borrower’s demand deposit (checking) account, where it can be lent out again to create more debt and demand deposits, and so on, almost ad infinitum.
Herman Daly, an ecological economist, and many others have proposed a gradual, legislated move to 100-percent reserve requirement on demand deposits.
Banks could still support themselves by charging fees for safekeeping, check clearing and all the other legitimate financial services they provide. They could still make loans and still be able to lend at interest, but based on the real money of real depositors. This would re-establish a one-to-one correspondence between the real wealth of the community and the claims on that real wealth.
The immediate response to this economic theory and its fifth proposal, is horror at the impact it would have on GDP, the share market, and economic activity.
But real debts do exist. These are mainly the real world matter and energy high entropy emissions and environmental impacts. The currently, un-costed, costs of removing CO2 from the atmosphere and oceans; of repairing degraded land and water supplies; of neutralising the toxins and organochlorides; and of redressing social inequity and poverty caused by the debt process.
And the problem is that these real debts have to be paid from current wealth generation.
They are not a claim on future real wealth. And they have physical priority over the interest created and charged from debt creation.
We are at a stage where real debts are increasing eroding our current wealth creation, making us all a little poorer each year, and throwing into doubt our ability to create wealth in the future, and so seriously weakening the claims by debt to that wealth.
This is both creating social and personal dissatisfaction and tension, and bringing forward the likelihood of financial crisis and collapse - debt repudiation.
It is increasingly likely that Soddy’s fifth proposal will also become conventional practice.
Tuesday, November 26, 2013
What is Money?
I was going to write on redefining the financial institutions and the financial products they produce, but realised that you need to start with an understanding of money first.
So what is money? The problem here is that the one word - money - is used for quite different things.
They are all real things, but they are not the same, and they all have different functions.
Economists talk of three functions - as a store of value; as a standard or unit of exchange; and as a medium of exchange.
Money started as a gift between people. It could be a gold object, or a pig, or pottery, or shells, but each was a symbol of good will. Over time this changed. As societies grew, the pathway between the doer of, and the receiver of, any service or action got longer, and with new surpluses in agricultural products, these, like corn in Egypt, became the form of money - (this is called commodity money)
Farmers in Egypt could deposit their crops in government run warehouses, in exchange for receipts that showed the amount, quality and date. The farmers could then write a transfer for some of this grain to some-one else in exchange for goods or to pay rent. The various warehouses balanced these transfers and moved grain from one warehouse to another if needed. Other crops were also used in this way, like tobacco in the USA. These were efficient systems. The crops held their value, it was easy to understand and record, and the transfer dockets allowed small and large transfers to happen. It was also efficient in that the grains would deteriorate with time, and could be eaten, so there was an incentive to use it, to circulate the value through the society. Strangely this was like earlier times. Money was only useful as a "gift" to other people. If you did not spend it, it would disappear.
Things changed a bit with the invention of coins ( though the first coins were little metal toy tools, shells, and animals to mimic the exchange of the real things ). At first the coins were issued in parcels that made up the receipts as before, and the individual coins could be used for the smaller exchanges and transfers.
As trade between kingdoms and peoples developed, these coins became useful as they extended the range of valid exchanges. They also helped cities manage the industrial revolution. As people specialised in the work they did, they also narrowed the range of goods they produced and so found direct barter harder to achieve. A neutral store of value was very handy.
The first coins were made and issued by the government of the region ( king, duke, war-lord ) They were usually made in gold, silver or bronze - metals both soft enough to mint, and relatively rare.
They were also issued in proportion to the underlying commodities. However, that soon changed.
Governments found that they could mint and issue a little more than what was supported by the commodities they held, so long as they were powerful enough to convince people the coins had value, though in part, the amount of gold and silver in the coins influenced this value ( because the coins could be melted and re-minted in the name of the receiving government ).
As the supply of coins increased, the problem of safely storing them arose. The government goldsmiths started to offer to store the coins, in exchange for letters of credit. This evolved into paper money, official documents that state that the person holding the letter, or note, has that amount of money. People had to trust that these notes had value - this is fiat money.
Now it got sneaky - the goldsmiths and the governments realised that the chance of all the people with letters of credit asking for their gold or grain at the same time was very slim. So they could issue many more paper money notes than they held reserves, and they could do this as loans to people without the reserves, and charge interest on those loans.
At the same time - merchants were using Bills Of Exchange or Promissory Notes - the merchant's promise to make payment for goods supplied at some specified future date. Provided that the merchant was reputable or the bill was endorsed by a credible guarantor, the supplier could then present the bill to a merchant banker and redeem it in money at a discounted value before it actually became due - an early form of credit – a medium of exchange and a medium for storage of value.
Kings and Dukes used similar bills to both record current taxes paid and taxes due to be paid. They then found that they could exchange these Bills, or Tallys, for gold or coin or services or supplies in advance of the actual tax collection, and then, of course, realised that they could create bills against assumed or estimated, future tax collections.
This acceptance of symbolic forms of money - coins, and paper money - meant money could represent something of value - a reserve - that was available in physical storage somewhere else in space, such as grain in the warehouse. As a bill or promissory note it could also be used to represent something of value that would be available later in time, a document ordering someone to pay a certain sum of money to another on a specific date or when certain conditions have been fulfilled.
##[ http://en.wikipedia.org/wiki/History_of_money ]
This was the first divide between real money ( RM - money used as daily exchange and based on current real reserves ) and money that only became real in the future, and required trust that the future would be as described in the bill or note.
Essentially, both the paper money issued in excess of the actual reserves held, and the bills and promissory notes issued based on future creation of reserves meant that those people who accepted this form of money ( model money MM ) locked in their future to fit the model described by the issuer of that money. ## [ TD ]
For example, most of the money offered when you apply for a mortgage is model money - only a fraction is based on real money that matches cash reserves at the bank. But the moment you sign the agreement, this model money becomes real money to be extracted from your future reserves - you sign your future over to the issuer of the loan.
This can be hard to see, but it means that your future becomes something that can be bought, sold and exchanged - this model money - now real money - becomes a commodity itself.
And as profits can be made trading commodities, what was earlier a bit of a fiddle issuing paper money and bills based on a near and likely future, has now become an industry as big as the real money world it overshadows. And why the financial industry can have such a large impact on ordinary lives and businesses.
So what is money? The problem here is that the one word - money - is used for quite different things.
They are all real things, but they are not the same, and they all have different functions.
Economists talk of three functions - as a store of value; as a standard or unit of exchange; and as a medium of exchange.
Money started as a gift between people. It could be a gold object, or a pig, or pottery, or shells, but each was a symbol of good will. Over time this changed. As societies grew, the pathway between the doer of, and the receiver of, any service or action got longer, and with new surpluses in agricultural products, these, like corn in Egypt, became the form of money - (this is called commodity money)
Farmers in Egypt could deposit their crops in government run warehouses, in exchange for receipts that showed the amount, quality and date. The farmers could then write a transfer for some of this grain to some-one else in exchange for goods or to pay rent. The various warehouses balanced these transfers and moved grain from one warehouse to another if needed. Other crops were also used in this way, like tobacco in the USA. These were efficient systems. The crops held their value, it was easy to understand and record, and the transfer dockets allowed small and large transfers to happen. It was also efficient in that the grains would deteriorate with time, and could be eaten, so there was an incentive to use it, to circulate the value through the society. Strangely this was like earlier times. Money was only useful as a "gift" to other people. If you did not spend it, it would disappear.
Things changed a bit with the invention of coins ( though the first coins were little metal toy tools, shells, and animals to mimic the exchange of the real things ). At first the coins were issued in parcels that made up the receipts as before, and the individual coins could be used for the smaller exchanges and transfers.
As trade between kingdoms and peoples developed, these coins became useful as they extended the range of valid exchanges. They also helped cities manage the industrial revolution. As people specialised in the work they did, they also narrowed the range of goods they produced and so found direct barter harder to achieve. A neutral store of value was very handy.
The first coins were made and issued by the government of the region ( king, duke, war-lord ) They were usually made in gold, silver or bronze - metals both soft enough to mint, and relatively rare.
They were also issued in proportion to the underlying commodities. However, that soon changed.
Governments found that they could mint and issue a little more than what was supported by the commodities they held, so long as they were powerful enough to convince people the coins had value, though in part, the amount of gold and silver in the coins influenced this value ( because the coins could be melted and re-minted in the name of the receiving government ).
As the supply of coins increased, the problem of safely storing them arose. The government goldsmiths started to offer to store the coins, in exchange for letters of credit. This evolved into paper money, official documents that state that the person holding the letter, or note, has that amount of money. People had to trust that these notes had value - this is fiat money.
Now it got sneaky - the goldsmiths and the governments realised that the chance of all the people with letters of credit asking for their gold or grain at the same time was very slim. So they could issue many more paper money notes than they held reserves, and they could do this as loans to people without the reserves, and charge interest on those loans.
At the same time - merchants were using Bills Of Exchange or Promissory Notes - the merchant's promise to make payment for goods supplied at some specified future date. Provided that the merchant was reputable or the bill was endorsed by a credible guarantor, the supplier could then present the bill to a merchant banker and redeem it in money at a discounted value before it actually became due - an early form of credit – a medium of exchange and a medium for storage of value.
Kings and Dukes used similar bills to both record current taxes paid and taxes due to be paid. They then found that they could exchange these Bills, or Tallys, for gold or coin or services or supplies in advance of the actual tax collection, and then, of course, realised that they could create bills against assumed or estimated, future tax collections.
This acceptance of symbolic forms of money - coins, and paper money - meant money could represent something of value - a reserve - that was available in physical storage somewhere else in space, such as grain in the warehouse. As a bill or promissory note it could also be used to represent something of value that would be available later in time, a document ordering someone to pay a certain sum of money to another on a specific date or when certain conditions have been fulfilled.
##[ http://en.wikipedia.org/wiki/History_of_money ]
This was the first divide between real money ( RM - money used as daily exchange and based on current real reserves ) and money that only became real in the future, and required trust that the future would be as described in the bill or note.
Essentially, both the paper money issued in excess of the actual reserves held, and the bills and promissory notes issued based on future creation of reserves meant that those people who accepted this form of money ( model money MM ) locked in their future to fit the model described by the issuer of that money. ## [ TD ]
For example, most of the money offered when you apply for a mortgage is model money - only a fraction is based on real money that matches cash reserves at the bank. But the moment you sign the agreement, this model money becomes real money to be extracted from your future reserves - you sign your future over to the issuer of the loan.
This can be hard to see, but it means that your future becomes something that can be bought, sold and exchanged - this model money - now real money - becomes a commodity itself.
And as profits can be made trading commodities, what was earlier a bit of a fiddle issuing paper money and bills based on a near and likely future, has now become an industry as big as the real money world it overshadows. And why the financial industry can have such a large impact on ordinary lives and businesses.
Monday, July 14, 2008
On Sources of Wealth
Wealth is embodied energy. Traditionally we have taken solar energy in plants, animals, and fossil fuels, and gravitational energy in minerals, water and thermal heat, and turned it into products. We have “value added” and our wealth reflects the energy we transformed. We are wealthier than past generations, and this is seen in the captured energy in our schools, hospitals, transport systems, information systems, and other physical infrastructures.
We have invented processes to stablise energy, in basic banking, in ways to trade goods and extend the shelf-life of foods. We also gain wealth by transforming the energy in ourselves into services. This capture and transforming of energy has created wealth from the earliest primitive man to today’s modern global societies.
It explains our core belief that the environment is important, and our difficulty in understanding the financial markets, where money is a traded commodity and speculation is a non-energy transforming process.
We have invented processes to stablise energy, in basic banking, in ways to trade goods and extend the shelf-life of foods. We also gain wealth by transforming the energy in ourselves into services. This capture and transforming of energy has created wealth from the earliest primitive man to today’s modern global societies.
It explains our core belief that the environment is important, and our difficulty in understanding the financial markets, where money is a traded commodity and speculation is a non-energy transforming process.
Subscribe to:
Posts (Atom)
