I know there will be many different topics debated, but here are some topics I would personally like to discuss at the next BCBSF3.
Yesterday I read through a fascinating paper called Opacity and the Optimality of Debt for Liquidity Provision. The main point is that welfare of participants is maximized when using debt instruments to trade, rather than, say equity or real assets. The reason is that participants will be less worried about a debt than by a piece of equity, so they will seek less information, which in turn will maximize the issuance of debt, and maximize welfare.
Of course, while all of this is fine, a serious financial crisis can happen when everyone starts doubting at once about the debt that no-one seemed to question at all.
What’s fascinating is that according to the authors: welfare is maximized when participants are equally ignorant of the actual quality of the debt and trade simply according to its face value:
In this economy government policies that increase transparency would reduce welfare. This would seem to be counter to the intuition built from the idea of efficient markets.
They do not stop there. They actually claim that the complexity of securitization, CDOs, etc. is good because it increases costs about figuring out the exact value, which in turns maximizes welfare because it facilitates trade as long as everyone is equally unwilling to do any homework (if I understand correctly):
Clearly, if complexity raises the cost of producing information, raises ?, this can be welfare improving. Suppose that agent A could choose a level of complexity for the security designed at t=1. This corresponds to choosing some ? less than a given maximum. For large w, agent A would always choose to issue the most complex security, the one with the maximum ? because this maximizes the amount of debt that will be accepted by agent B without triggering information production.
More, they even justify one of the roles of the central bank as maintaining the opacity and secrecy.
The lender-of-last- resort’s role is to exchange information-insensitive debt for information-sensitive debt, possibly at a subsidized price to prevent information production, or, to make the private debt, which has become information-sensitive, information-insensitive. This prevents the crisis from being worse…
“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”
We are so obsessed with our bank account balance being positive that we forget it is a very crude measure of our value in a society. Three persons with a net worth of $0 could have this balance for very different reasons:
- one person may have borrowed $1M many years ago and have just finished paying it back;
- one person may have just opened an account with no deposited money, nor borrowed money.
- one person may have borrowed 100 times $1,000 and paid each time back.
Same balance, but very different levels of value and risk contributed.
On how to improve the account balance, there is a lot we can learn from exchanges not based on bank money, such as time banks, bartering networks or gift circles.
The San Francisco Time Bank for instance shows the balance, but also the hours received and given:
The sharing Web site Neighborhood goods accounts for the money you saved your friends by allowing to borrow your goods (and, I believe, until recently the money your friends saved you).
I watched Capitalism: a love story this Saturday night.
I didn’t think it was one of his best. Bowling for Columbine was my favorite.
I think Michael Moore failed on several accounts:
- He vilified capitalism without defining it.
- In particular, he didn’t distinguish capitalism and corporatocracy.
- Most importantly, he didn’t dig deeper in the corporatocracy’s enabler: money.
When is Michael Moore going to stop beating around the bush and make a movie about money?
When I see the Foursquare-style badges sprouting up in different places (most recently on Huffington Post), I can’t help but think of a section of Montesquieu’s satirical Persian Letters which is a collection of fake letters sent by two persian noblemen who are traveling through France. The section speaks about how the kind of France uses title of honour to finance his wars.
The king of France is the most powerful of European potentates. He has no mines of gold like his neighbour, the King of Spain; but he is much wealthier than that prince; because his riches are drawn from a more inexhaustible source, the vanity of his subjects. He has undertaken and carried on great wars, without any other supplies than those derived from the sale of titles of honour; and it is by a prodigy of human pride that his troops are paid, his towns fortified, and his fleets equipped.
Then again, the king is a great magician, for his dominion extends to the minds of his subjects; he makes them think what he wishes. If he has only a million crowns in his exchequer, and has need of two millions, he has only to persuade them that one crown is worth two, and they believe it. If he has a costly war on hand, and is short of money, he simply suggests to his subjects that a piece of paper is coin of the realm, and they are straightway convinced of it. He has even succeeded in persuading them that his touch is a sovereign cure for all sorts of diseases, so great is the power and influence he has over their minds.
Humor aside, there is this interesting connection between badges and actual money: sometimes titles/badges are a better way to have access to scarce resources, sometime they are the only way. More importantly, both are issued by the sovereign of the community and distributed by its agents.
I’m curious as to the actual benefits the badge holders will enjoy on the Huffington Post community. Will these badges unlock scarce resources ? At this point, their FAQ does not answer this question. I sent them an email and looking for their answer.
Also, I’m wondering how an actual Huff’ Post currency and balance could be computed, and work as an internal virtual currency. Sharing articles, commenting, writing articles, viewing ads and buying products advertised with US$ or donating US$ money would earn you Huff’ Post currency. On the other hand, reading articles would cost you Huff’ Post currency. Perhaps some advertised products would be available at a discount payable in Huff Post currency, which would cost Huff Post currency as well.
So if you are a big reader, you’d have a big negative balance and to not be viewed as a free rider by your social network, you could choose between participating more, buying more products advertised by the newspaper or giving money. This would only require all users to be registered.
Our current paradigm with money is one of a centrally-managed, privately-issued, state-guaranteed, accepted unit of value that we pass around in exchange for goods/services. If you look at this as an information system, this is a very primitive one inherited from the times when money was a commodity.
Given that credit money is merely information, many monetary reformists have questioned whether our money should be centrally-managed, privately-issued, etc. but most monetary reformists have assumed the use of a shared unit of value, if only at a community level. Shared units of value unfortunately always come with very difficult definition, adoption, and ongoing management issues. For instance, there must be rules as to how they are issued and how they move from one person to the next.
Tokens you pass around are like point-to-point communications model such as email, where messages are sent from one person to the next, forwarded, etc. We know the limitations of such a communication model. What’s valuable is what people decide to send you. A much more powerful communications model is the publish-subscribe model. This is the model of the Web/blogs/twitter/wikis: I don’t send to someone in particular, but to a shared space, where those interested to follow me get notified or know where to find the updates. What’s valuable is what you decide to receive.
In a world where huge amount of data flow every minute, what we need are not shared units of value in which we can express ourselves in an arithmetic way. What we need are the personal version of enterprise business intelligence tools that help us interpret our world in the way we want so that we know where to direct our energy.
Our personal intelligence tools, and how they render the world we live in, will drive an increasing portion of our actions, including giving away services or goods. Others will not necessarily owe us a favor or debt for these gifts, but will similarly act and give to enjoy the feedback of their actions. In the next 5-10 years, we can expect some interesting developments at the frontier of activity streams, information visualization and games. Expect to see people sharing their own renderings, which others will combine with others’, etc. This will be particularly interesting as the Social Web morphs into the Web of Things.
Power will move from influencing the distribution of money to influencing which personal intelligence tools we use and how we configure them.
When asked “Do you still think it would be a good idea to have a computer run monetary policy?” he answered:
“Yes. Of course it depends very much on how the computer is programmed. I am not saying that any computer program would do. In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year. There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.
“In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions. One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge. We have seen that in the history of our own Federal Reserve System. Surely a computer would have produced far better results during the 1930s and during both world wars.
“That raises a question about the desirability of our present monetary system. It is one in which a group of unelected people have enormous power, power which can lead to a great depression or which can lead to a great inflation. Is it wise to have that power in those hands?
“An alternative would be to eliminate the Federal Reserve System; to reduce the monetary activities of the federal government to the provision of high-powered money, that is, currency and bank reserves, and to constitutionalize, as it were, what is to be done with high-powered money. My preference is simply to hold it constant and let financial developments produce the growth in the quantity of money in the form of bank deposits, a process that has been going on for many decades. But that is, of course, politically impossible.”
Of course the problem of how the issuance of money should be managed is directly related to the fact that we assume a system where there is a single currency issued and accepted.
In my view, the Fed was established simply because private financial institutions have a better track record than governments at ensuring widespread acceptability of the money they issue by preserving its purchasing power and providing convenient means of payments. The single currency on the other hand facilitates tax collection, and channeling large capital amounts towards measurably profitable ventures.
The problems in such systems are several:
- bankers must be paid for their diligence service in the form of interest on loans, which requires endless monetary debt expansion to pay for the interest on the previously issued debt.
- there is a limit to debt expansion since debt is a claim on wealth and wealth is a physical concept, not a mathematical concept like debt.
- as a result the system is systematically prone to booms and busts. Regulations will do little except comfort the masses that “this time is different” until the next bubble “we couldn’t foresee” blows up.
- money issued privately by banks is in fact ultimately backed by the government, which means they have to be bailed out when peak debt is reached.
How do we design a complementary system where:
- money issuance is interest free, because it does not require the diligence of bankers,
- systemic risk from local default to deliver is not protected by banker’s over-leveraged capital or by the taxpayers, but by the system itself, but not by loss of purchasing power of the monetary unit.
- money is issued in proportion to known deliverable wealth, not desired profitability.
My ideas in a coming post.
I just finished reading Wealth, Virtual Wealth and Debt (1926) by Nobel prize-winning chemist Frederick Soddy. I really enjoy reading these old books… On one hand it is depressing to see the high hopes that existed in the 1920s after what was known until 1939 as the Great War. Thinkers like Soddy seemed very optimistic that the same revolution that had happened in science was about to impact the world of economics, and with it monetary policy and positively impact the world’s poverty. As we all know, history took a very different path then.
On the other hand, reading this book fills you with optimism since one may argue that the context was not ripe for change back then. It may be now. The big contextual change since the 30s is that there is a larger awareness worldwide on the fact that earth will run out of the life-friendly deposits and environment it has offered gratis so far. We may not have reached the tipping point yet. A couple more major crisis, food and/or environmentally related, may be needed for that unfortunately. Crisis is ??????, “decisive moment”.
If I had to summarize the book in a few bullet points:
- wealth is not the same as money. Wealth is what enables and sustains life, it is the product of available energy. Whereas money only values what is scarce. Air, water, land is wealth, but economists won’t measure it until it becomes rare enough that it will have a price.
- wealth is limited by fundamental laws of physics. As long as we are bound to the earth, no wealth generating process is free of any waste. There is always waste, heat, loss (including for building solar panels).
- money is wealth that does not exist, it is merely information, something that represents the wealth we gave out, without anything in return. The quantity of wealth that community participants are willing to give away against acknowledgement of community debt is the community’s wealth, since it allows the community to cooperate. The unit we use to measure this “virtual wealth” is money and obviously it’s not because the quantity of money increase, that the virtual wealth does too.
- As far as solutions are concerned, Soddy essentially recommends issuance of money to be done at zero cost to the community, i.e. by the government, not by banks, and regulated via taxes according to a price index. He recommends that deposits at banks be fully backed with customers paying for account maintenance. He believes that it is possible to convert from a system where money is created by bank and government accumulate debts to a system where government have no debt, issue the money and banks only lend the money that their customers are asking them to lend.
And now a few quotes:
Originally wealth meant wealth – the state of well being, just as health means the state of being hale.
The century that has come and gone has seen a steady alteration in the significance of the word wealth from its original meaning, wealth, as the requisites that enable and empower life, to debt, the right of the creditor to demand wealth and the duty of the debtor to supply it. (p97)
Credit means surely that the creditor gives up to the borrower the use of the property lent. It is true that in granting bank credit the bank gives up nothing whatever, but the community does, and the borrower receives it.
Wealth has proved a quantity to difficult and too involved for analysis by the modern economist. The earlier economists did, according to their lights, attempt to deal with it; but the modern school have more and more taken it and its origin for granted and confined themselves to the study of debt, or, as we shall see, with chrematistics rather than economics. Debts are subject to the laws of mathematics rather than physics. Unlike wealth, which is the subject to the laws of thermodynamics, debts do not rot with old age and are not consumed in the process of living.
Power over men is the essence of debt. Power over Nature is the essence of wealth. The not owing and not possessing wealth owed to one individual by another or by the community gives that individual power over the other or the community until the debt is paid. When paid, the not-owner becomes owner. The wealth he now possesses, but the power over men he loses.
Wealth is the product of useful or available energy. Economics deal not with, but entirely with the flow of useful and available energy and its transformations into useless forms, and physical wealth as a product of the control and direction of this flow.
Money is not wealth even to the individual, but the evidence that the owner of the money has not received the wealth to which he is entitled, and that he can demand it at his own convenience. So that in a community, of necessity, the aggregate money, irrespective of its amount, represents the aggregate value of the wealth which the community prefers to be owed on these terms rather than to own. This negative quantity of wealth I term the Virtual Wealth of the community because the community is obliged, by its monetary system and the necessity of having one, to act as through it possessed this much more wealth than it actually does possess.
This Virtual Wealth is thus a peculiar part of national credit, and is sharply to be distinguished from the rest, which, indeed is the only part of the national credit usually recognized, and which is in no way different from that of an individual. […] The National Debt must continue to be paid for until it is repaid. Whereas the Virtual Wealth of the community, although it is National Debt in one sense, is permanent, necessary, beneficial, normally non-repayable and non-interest-bearing debt.
The nation must act, and continue indefinitely to act, as if it possessed more wealth than it does possess, by the aggregate purchasing power of its money, but the important thing is that this Virtual Wealth does not exist. It is an imaginary negative quantity – a deficit or debt of wealth, subject neither to the laws of conservation nor thermodynamics.
It is not the amount of money people have that is of any real importance, but the amount of wealth they are in a position to obtain any time in the future on demand, and therefore go without in the present, that is of importance.
It is the virtual wealth which measures the value or purchasing power of money, and not money which measures the value of wealth.
The virtual wealth has little to do with the quantity of money. The habits of a community are essentially conservative, so that it can only change within comparatively small limits. Whereas the quantity of money, on the other hand, is absolutely and entirely arbitrary and can be theoretically be made as small as or as great as the nation pleases without any limit whatsoever.
Money is debt that need not be repaid at all, and indeed can only be repaid by the community itself obtaining possession of the money and destroying it. These are the only kind of debt that are wholly beneficial to the community. They need not bear any interest whatever.
Money = authorized token of the indebtedness of the whole community to the individual possessing the token.
Money is a debt repayable in wealth. Whereas most debts are repayable in money.
Janet Tavakoli is someone I discovered over the last two years and whose writings I follow eagerly. She provides deeper insight than the typical “stock market is down b/c investors are taking profits” from the Bloomberg and Wall Street Journal. I don’t believe she gets the credit she deserves and I hope she will get a government position when it is finally realized that those who have been part of the problem can’t be part of the solution.
The above interview dates from April 2009, but I really recommend it.
Her perspective on money is:
Money as a way to provide security and freedom. Freedom to do the things I enjoy and to provide opportunities to the people in my life that are important. There is nothing evil in money. It is the role of our government to ensure its value and that it is accepted everywhere for goods/services.
Here are a few quotes I noted from the interview:
When you create a lot of bad loans, and pass them off as if they are not bad, there is obviously fraud. It was not a mathematical error, it was not a black swan.
It’s a scandal that banks are raising fees on credit cardholders while we, the taxpayer are loaning money to them at extremely low rates.
We are being taxed without effective representation. People should borrow prudently, inform themselves, get on their local congressmen/senators.