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Reality-based Economics and the Last Big Thing

by ChrisCook Tue Dec 18th, 2012 at 07:20:36 AM EST

Also posted on the UCL ISRS Resiliblog

Andy Haldane was in the news again yesterday, this time on the subject of P2P banking which directly connects lenders and borrowers.  He does not say so explicitly, but it is of course in the interests of risk intermediaries such as banks to outsource risk to `end-user' lenders and borrowers, since banking service providers require only sufficient capital to cover operating costs.

Dis-intermediation has been increasingly happening under the radar in relation to market price risk for some time, as investment banks have sold (some might say mis-sold) market risk to `inflation hedgers' but retained credit/counter-party risk. Risk-averse investors in Exchange Traded Funds and Index Funds thereby cause the very inflation they aim to avoid, to the benefit of producers.

In order for banks to facilitate direct P2P connection of lenders and borrowers using interest-bearing debt, another framework of trust must necessarily be found. An existing trust model is that of the `Protection and Indemnity (P & I) Clubs' which have been quietly mutualising shipping and transport-related risk for 140 years, of which 135 years has been under the management of the same service provider.

However, in my view, financial and IT connectivity is evolving so fast that such an architecture would be obsolete before it could even be implemented.

Introducing T2T

Since Andy Haldane's job is to prevent the UK's financial system from falling over again, he necessarily has acquired a closer grasp of the mechanics of the banking system than either the current or future Governor, but he shares with them a fundamental, and pervasive, mis-understanding as to how the banking system works in practice.

If we look back, as I have been doing, at the historical development of the financial system and financial instruments, then the reality of the relationships, and the nature of the myths which have clouded them, becomes apparent.

Until the foundation of the Bank of England in 1694 the UK's financing and funding was essentially Treasury to Taxpayer (T2T).  From that point onwards, the national enterprise model has involved banks operating as risk intermediaries between the Treasury and the Taxpayer.

Tax Returns

For many hundreds of years UK sovereigns funded their expenditure through creating IOUs which were returnable in payment for taxes, and exchanging them with tax-payers for value received.

In other words, tax-payers were able to `Pre-pay' their taxes, receiving as a record or token that half of a `tally stick' accounting record known as the `stock'. The other part of the tally stick retained by the issuer (which in the case of taxes was the Exchequer) was known as the `counter-stock' or `foil'.

Note here that there was also another type of accounting record - the `memorandum tally' - which acted as a transaction record or receipt, and recorded title, rather than obligation.

Of course, no creditor would give £10 of value to the King in exchange for a £10 tax IOU, and stock was issued at a discount which gave rise to a profit upon the return of the stock to the issuer.

The phrase `Rate of Return' therefore refers to the rate over time at which profit arising out of an initial discount was achieved through the return of the stock to the Exchequer for cancellation.

The phrase `Tax Return' for tax-payers' annual accounting to HMRC has the same origin.

Fiscal Agency

The myth of `fiat' money creation is that the Treasury and the Bank of England have a conventional banking counter-party relationship so that a Treasury credit is reflected by a Bank of England debit and vice versa.

This is not and never has been the case. What happens is that the Bank of England creates - as `fiscal agent' of the Treasury - what are essentially Treasury IOUs, and it records these on behalf of its Principal, the Treasury, on a Memorandum Account.  In other words, a Treasury credit equates in accounting terms to a Bank of England credit.

So the reality is that tax credits created by the Bank of England as fiscal agent of the Treasury are spent or lent into circulation.

The role of private banks is a bit more insidious, since they act opaquely as Treasury fiscal sub-agents, creating `look-alikes' (some might say `counterfeits') of Treasury Credits when they spend or lend `fiat' money into existence.

Only the Central Bank can destroy such `fiat' money, whether it is created openly by the Central Bank or behind smoke and mirrors by private banks.

Orthodox or Reality-Based Economics?

The fundamental misconception which distinguishes orthodox economics from the real world is that it treats as a positive what is in fact a negative, and it bears as much relationship to reality as Physics would do if physicists assumed that anti-matter is matter.

The reality is and always has been that stock is an undated credit/equity instrument - indeed it is the original equity instrument, which pre-dates shares in the entity known as a `Joint Stock' Limited Liability Company.

It follows that the National Debt is in reality better described as a National Equity where Treasury `Gilt-Edged' Stock equates to dated interest bearing shares in UK Incorporated.

By dispelling the myths of the system, and basing Economics upon the reality, we may also blow away some of the ideological cobwebs which are integral with Orthodox Economics.

Blowing Away the Cobwebs

Firstly, the `Fractional Reserve Banking' myth, that deposits are first collected and then lent.

A moment's reflection indicates that if that were indeed the case, then there could not be any new money.  The reality is that private banks acting as credit intermediaries first create >97% of fiat money into existence and then lend or spend their `look-alikes' of tax credits by crediting the memorandum account maintained by the Bank of England.

Secondly, the `Tax and Spend' myth, that taxes are first collected and then spent.

The reality is that the Central Bank first spends fiat money into existence by creating credits as the Treasury's fiscal agent, and this is then typically `funded' through being acquired by private banks who create `look-alike' Treasury credits for the purpose.

In other words, Tax-Payers' Money never goes anywhere near a tax-payer until it's been spent by the Treasury, and taxation then acts to prevent inflation by taking fiat money out of circulation.

Prepay - the Last Big Thing ?

In my analysis the banking system died in October 2008, and is now in zombie mode, since the imbalance of wealth and purchasing power is now such that only systemic fiscal reform will work. So all Central Bank targeting, whether of GDP, unemployment, or inflation, is completely useless.

Banks have already moved on to an `adjacent possible' of a new generation of quasi-equity funds, and have thereby translated the property bubble into correlated bubbles in equities, precious metals and commodities which have perversely caused the very inflation which risk averse investors aimed to avoid.

When these bubbles collapse, which they must, through the unsustainable transfer of purchasing power to rent-seeking producers, we will then see a transition to the next adjacent possible, which is already quietly in use.  Enron, as ever the smartest kids on the block, was opaquely the `first adopter' of Prepay some 15 years ago but unfortunately it came to be used to defraud creditors and investors.

In other words, we will see a return to Prepay, but this time rather than prepaid T2T taxation we will firstly see direct Peer to Asset prepay investment in revenue streams such as property rentals and energy flows, and secondly, direct Peer to Peer credit, where `Real Bill' IOUs issued by providers of goods and services are accepted directly and are then cleared through a decentralised credit clearing system (VISA is a centralised example) within which there are no deposits.

The next few months, before Andy Haldane's new boss takes office, but not power - since the steering wheel has come off in the Bank of England's hands - promise to be interesting.

A Christmas gift for MMT! This nicely places an historical foundation under MMT.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Dec 18th, 2012 at 11:39:43 AM EST
I see why you'd call Prepay "The Last Big Thing;"  it's the final leveraging and completely circular.  If we inflate a bubble with Prepay, it's collapse won't just cause a hole, it will pull the hole in after itself.  Two questions to resolve: 1) How will it be marketed, in order to mask any Enron taint, and 2) will it be allowed, since the only purpose Prepay has for end parties is a way to cook their books?
by rifek on Tue Dec 18th, 2012 at 07:47:30 PM EST
In my view, Prepay is an optimal (which is why it is the Last Big Thing) instrument in the way that it enables the flows of value from:

(a) the capacity of people to produce goods and services; and

(b) the use value of productive assets over time;

to be monetised.

There are two key regulatory requirements however, neither of which was present in the case of Enron then or the Saudis now (who have inflated crude oil prices as a consequence of using pre-pay opaquely almost certainly with the connivance of J P Morgan).

(a) Transparency - so everyone in a market can see how many Units are in issue; and

(b) Quality Control - ie a 'Monetary Authority' who may act to review the true productive capacity which stands behind units in issue.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Dec 19th, 2012 at 08:54:15 AM EST
[ Parent ]
Those are two, very big ifs, especially since the neo-libs have done an amazing job of avoiding the blame for their antiregulatory stance being a significant cause of the present mess.
by rifek on Thu Dec 20th, 2012 at 04:42:59 PM EST
[ Parent ]
Prepay will lead to:

(a) Geographically acceptable/fungible currencies - ie prepay units of land rentals sold forward at a discount;

(b) Global acceptable/fungible currencies - based upon the value of pre-paid energy (initially natural gas).

These asset-based currencies will be exchanged against people-based value on credit terms by reference to a standard unit of measure for value (a unit of account) which will in my view be an absolute unit of energy.

Note here that disparate energy currencies are not the same thing as the energy standard unit of account by reference to which they may be exchanged. One can no more run out of units of account than one can run out of kilogrammes or metres.

These exchanges of value require a suitable 'Guarantee Society' framework of trust.

Through adopting the necessary agreements/protocols and instruments we will transition from a dollar economy to an energy economy, and to least $, £, € cost accounting  to least energy cost accounting.

The end game is for the $, £, and € to go onto an energy standard in the same way that the Euro nations fixed their currencies against an abstract (and literally worthless) €.

See my recent presentations to the Schumacher College's 'Banking on Ourselves' course.

Flight to Simplicity



"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Dec 19th, 2012 at 10:11:48 AM EST
[ Parent ]
How do we get governments and financial institutions to relinquish all this control over the currency?
by rifek on Thu Dec 20th, 2012 at 04:46:27 PM EST
[ Parent ]
Governments and financial institutions no longer have any control over the currency since Central Bank monetary measures are entirely useless.

It is completely open to anyone to accept some-one else's IOU. What has been lacking is a consensual framework within which such credit creation may take place.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Dec 20th, 2012 at 07:37:08 PM EST
[ Parent ]
Note the Minsky quote.  Only sovereign IOUs issued in the sovereign's currency can be used to pay the taxes owed to the sovereign (which ultimately is the problem with the euro).  And if an IOU can't be converted into a form that can pay other IOUs, it's going to face rapid depreciation.  Only a sovereign can put on its currency "This note is legal tender for all debts, public and private" and make it stick.  Governments control that, financial institutions are their clearing houses, and neither will give up that power without a serious fight.  And as for the former, they make the laws and dictate what you can do to them.
by rifek on Fri Dec 21st, 2012 at 01:19:19 AM EST
[ Parent ]
That's soooo Last Century, rifek.

Power seekers in public Government intermediaries are just as obsolescent as are private rent-seekers.

In the same way that risk intermediaries have an interest in dis-intermediating, since it minimises the need for risk capital, so it is that governments have an interest in doing so, because it minimises taxes.

If people come together and self organise to fill the vacuum left by the intermediaries - and that is what is happening - they may use consensual 'co-operative of co-operative' framework agreements, and currencies are among the outcomes.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Dec 21st, 2012 at 06:22:33 AM EST
[ Parent ]
hi chris,

in these two slides, can you explain how the Pool maintains enough "insurance" funds to pay Sellers for defaulting Buyers?  and how does the System ensure that too many free-riders do not participate (and presumably bring it down)?



Point n'est besoin d'espérer pour entreprendre, ni de réussir pour persévérer. - Charles le Téméraire

by marco on Sun Jan 6th, 2013 at 07:55:47 AM EST
[ Parent ]
they were slides 9 & 10 in that presentation.

do you have any document that articulates what you presented in text form?

Point n'est besoin d'espérer pour entreprendre, ni de réussir pour persévérer. - Charles le Téméraire

by marco on Sun Jan 6th, 2013 at 09:21:42 AM EST
[ Parent ]

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