Saturday, August 22, 2015

The Piketty Pessimist

Have a read through:
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.

Monday, July 27, 2015

On the Greek Crisis

A quick note - if the Greek Government introduced a Tax on The Use of Money, many of the current problems might be solved.

The tax would solve the problem of unpaid and uncollected tax revenue, at little extra cost.
The flow of financial information would alleviate the concerns of the lending banks.
The transparency of tax revenue would help plot the long term loan repayment schedules.

It is more than likely that the EU banks would view Greece as a much more secure investment and extend the loans.

Introducing the Taxing of the Use of Money

On the weekend I was asked about how a government could introduce a tax on the use of money.
The view was that it would be politically impossible, and a bureaucratic nightmare.

If you think of it only as a revenue source - yes.

But think of the information flow back to the government. The tax is based on all transactions.
So once in place, no matter how small the revenue, it is possible to extrapolate back to the streams of money flows in various regions and industries.

So the first step is to legislate the tax at a very very tiny percentage - just sufficient to get the data flowing and for the banks to implement the collection and transfer to the government tax accounts.

Then once the tax is in place, Treasury can start to calculate the revenue flows from incremental percentage increases. And public education programs can be started to explain which taxes are being abandoned in exchange for what percentage increase, until the point where all other taxes and imposts have been removed.

The time scale and rate of change is a matter of bi-partisan and public support. But the increase in timely financial and economic information should make it attractive to all parties.

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.

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 ( ) 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

Sunday, May 24, 2015

The Invention of Debt and Inflation

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.

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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.

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.
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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.
Mild Inflation can have positive effects:
  • 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.
Historically high rates of inflation and hyperinflation have been due to excessive currency printing ( 1920s Germany), or floods of currency-like commodities (1500s Spain), or periods of failure of confidence in the government guaranteeing a note or bond based currency (1990s Yugoslavia ).

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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.

* 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.