By Mandeep Bhandal, on 17 December 2012
In an interview with the Independent on 17 December, 2012, Andy Haldane, director of financial stability at the Bank of England takes a positive view of peer-to-peer lending (P2P). In response, ISRS Senior Research Fellow, Chris Cook says that P2P is only the beginning.
Andy Haldane is in the news again today, 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 which135 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.
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.
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.
The myth of ‘fiat’ money creation is that the Treasury and the Bank of England have a conventional banking counterparty 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.