by Migeru
Thu Oct 30th, 2008 at 08:14:05 AM EST
The situation surrounding International Letters of Credit doesn't seem to be getting any better more than two weeks after I first posted about it on the front page (This is where it gets real on October 13)
In my opinion the solution is going to have to be to create an international trade credit guarantee society. The WTO could organize this. It could be capitalised (maybe to the tune of $1 trillion) with a loan from the World Bank denominated in the IMF's "Special Drawing Rights" currency. Users of the guarantee (either traders or their countries) would pay an insurance fee for the use of the guarantee, which would be used by the guarantee society to pay the loan back. Come to think of it, instead of a loan this could be one of Chris Cook's 'capital rental' arrangements where, as long as the guarantee society uses the money from the WB (or from member states themselves) it pays a fraction of the 'insurance fee' revenues back to the capital contributors.
Below the fold I relate this situation to Chris' earlier writings on 'peer-to-peer finance'.
Chris Cook has been heralding for a long time the dawn of a new era of 'peer to peer finance'. In a recent comment thread he outlined it thus:
The solution, and the logical consequence of the Internet is IMHO for:
- Peer to Peer credit - ie a Guarantee Society approach where bilateral unsecured credit is supported by a mutual guarantee;
- Peer to Peer Investment - a Unitisation approach where Units issued by an Asset Trust or Capital Partnership would be redeemable in productive use value (eg Kilowatt Hours or Square Metre Years), and would replace secured credit.
In both cases, Banks are disintermediated and must morph to a service provider role in order to continue to be relevant.
Now, Peer to Peer credit as described is as old as banking itself. Meet the
Letter of Credit (courtesy of Naked Capitalism blog)
For those new to this topic, international trade depends to a large degree on letters of credit. While they can help finance shipments, an even more fundamental role is that they assure the shipper that he will be paid for the cargo sent. Without banks using letters of credit as the means to send payment to exporters, parties that are new to each other or conduct business with each other infrequently could never trade with each other (one type, a documentary letter of credit, requires that forms, often a very long and elaborate set of them, verifying that the goods have been inspected and certified, that customs, have been cleared and all relevant charges and duties paid, be presented and vetted before payment is released).
(my emphasis)
In other words, a letter of credit is a bank-provided guarantee of a bilateral, 'peer to peer' credit transaction between two third parties. The bank providing the guarantee rarely has to actually put any money of its own in anyone's account - it just stands by ready to do so in the case that there is a problem with the shipment.
Trouble is, it appears that banks are now unwilling to accept each other's letters of credit or even unwilling to issue them, and so trade is grinding to a halt. See for example
"Our banker, State Bank of India, issued a letter of credit (LC) to the exporter's bank in South America, but the bank refused to negotiate the LC and pay the exporter. We will now have to negotiate with another banker to get the consignment totalling 1.5 million tonne of de-gummed soybean oil," said a company source.
Which makes me question banks' ability to "morph to a service provider role in order to continue to be relevant" as they are
already unable to fulfill their
current service provider role in
existing peer-to-peer credit.
