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Archive for the 'Resilient Markets' Category

Bitcoin: Threat or Menace?

By Mandeep K Bhandal, on 4 April 2013


ISRS Associate Fellow, Vinay Gupta provides an assessment of bitcoin.

Bitcoin: Threat or Menace?

It’s easy to get carried away by the rhetoric around bitcoin. A “came from nowhere” new financial instrument with murky anonymous origins, associated with non-state anarchocapitalist libertarians, seems like something sprung to life out of science fiction.

Really we should not be surprised. Bitcoin is the unexpected interaction of three trends.

Firstly, there are ongoing efforts to make digital systems replicate the properties of real objects. Copyright holders have created generation after generation of digital rights management (DRM) systems to try and make files on a DVD as hard to illicitly copy as bulky, expensive 35mm cinema projector prints rather than infinitely replicable bits on a spinning disk. That other groups would try to produce hard-to-clone property rights in the digital medium should be a surprise to nobody.

Secondly, bitcoin is decentralized. Many modern computer utilities are decentralized: Skype, Spotify, Bittorrent and more are all “peer to peer” below their smooth exteriors. When you are running Skype, your computer is helping other users make calls, and nobody really cares. As sophistication increases, and user’s own computers increasingly do the work that was done in expensive data centers, it gets easier and easier to build systems which take the last jump and simply have no center at all.

Finally, dotcoms have recently been acquiring value faster than ever. Instagram went from zero to a billion dollars of value in two years, and was then sold to Facebook. Value sloshes around in these ecosystems at stampede rates with very little predictability. Was a photo sharing service with some cool image processing filters ever really worth a billion dollars? Only the market knows – a greater fool purchases your stock, and to you, in that moment, the value is completely real. Is it real for the greater fool? That depends on access to an even greater fool. But fools have never been in short supply.

In bitcoin these three trends combined: technical creation of hard property rights meets decentralization and an extremely rapid acquisition of perceived value. It should also be noted that “crypto-currencies” of this type go back at least 20 years in practice, and further in theory.

Really, the only surprise is that it is happening now, and in this particular rather strange form.

The end game for cryptocurrencies has always been the collapse of the State through tax starvation. Theorists like Tim May (formerly of Intel) predicted the collapse of the state as an inevitable consequence of widespread digital networks, and viewed the fall of the USSR as a direct result of information and communication technologies. They predicted that once cryptocurrencies became established, mass migration away from national currencies would spell and end to the current status quo. When we consider small nations like Cyprus, it’s easy to imagine a speculative future in which mass migration to a new currency standard leaves the European Central Bank largely without influence.

To assess the plausibility of those scenarios, we need only ask one simple question: “is the internet bigger than the State?” In most cases, the answer is “no.” A few very small, very fragile states might be actively at risk from digital currencies, but for the most part, State regulation of the internet is still possible, and a currency which was becoming a genuine threat to the national currency could be killed one way or another. Draconian measures might be required, but where there’s a will, there’s a way.

However, if Google-Facebook-Amazon-Apple-Microsoft-eBay-PayPal got in to the currency game, this situation could change rapidly. An internet currency backed by a consortium of that size could seriously upend many of our expectations about how the world should work. They would be capturing the last remaining part of the value chain left behind by the credit card companies.

If they got it right, they might wind up bigger than VISA.

The narrow libertarian reading of the State roots its power in finance and the coercive power of taxation. A broader understanding of the State might root its power in national identity or even simplistic notions on the monopoly on legitimate violence. Within that wider context, it’s obvious that for cryptocurrencies to have substantial impact, they are going to have to grow very broad shoulders indeed. The table is very large, the players many, and the histories long.

It’s going to take more than a digital analogue of the old Swiss anonymous banking system to cause a real upset. It may yet come, but not today.



The Community is the currency

By Mandeep K Bhandal, on 4 April 2013


ISRS Senior Research Fellow, Chris Cook discusses the need for new and ‘bottom up’ community-based economic tools. This article was also published in the business magazine, the3rdimagazine.

The Community is the currency

As the economy of Cyprus implodes, UK austerity measures begin to bite and the banking industry retreats further into itself, the need for new and ‘bottom up’ community-based economic tools has never been greater.

One such tool is the Credit Unions, where people make deposits which fund loans within a community with a ‘common bond’, which may be geographic, functional (eg the Metropolitan Police) or possibly both.

Another emerging tool is the complementary currency, of which the best known is probably the emerging range of Transition currencies such as: the Totnes Pound; Lewes Pound; Bristol Pound; Brixton Pound and so on.

While both of these tend to keep economic value local, which is unequivocally a good thing, what they essentially do is move existing economic value around; they don’t actually do a great deal to stimulate new economic activity, the need for which is growing daily more urgent.

Maybe there’s another way of doing it?

A Linlithgow Guarantee Society

The concept of a Guarantee Society is not a new one. For the last 140 years ship owners have clubbed together in a range of ‘Protection and Indemnity’ (P & I) Clubs which mutually insure risks which commercial insurers would not cover. For the last 135 years the same service provider, Thomas Miller, has served P & I Clubs by: managing risks, handling the pool of resources backing these risks; handling claims and providing other services to P & I Club members.

Since 1992 some 18 European countries have seen the formation of Guarantee Societies which enable members of an association, typically businesses, to join together to mutually guarantee bank loans by their members.

Anyone familiar with the work in the field of micro-credit of Dr Muhammad Yunus with Grameen Bank in Bangladesh will know that one of the key success factors was the way in which micro-loans are supported by the guarantees and support of small circles of friends and relatives.

The advent of pervasive direct instant connectivity and paperless accounting and administration now enables the concept of the Guarantee Society to mobilise a new approach to Community Credit.

A Linlithgow Community Credit Card

What might this look like? Well, firstly, in the future, it will probably be an element of the SIM card on everyone’s mobile phone. In the meantime it will look and operate just like any other credit card, but ‘under the bonnet’ it will be very different.

Let’s imagine a Linlithgow Credit Card, because it is the green and pleasant ‘Garden Burgh’ in Scotland where I live. Local businesses will club together, as they are doing already in a Business Improvement District (BID) initiative, as enterprise members of the Linlithgow Guarantee Society (LGS). They will then extend interest-free credit, time to pay, to local people who become individual members of LGS.

While this credit is interest-free, it will not be cost-free. A subscription will cover the agreed costs of the necessary accounting system, of which there are several cheaply available, and of the service provider. This could be perhaps a credit union or even a local bank such as our local Airdrie Savings Bank, which is the sole survivor of the Trustee Savings Banks which were privatised with the depositors’ own money.

The role of this service provider is to set and manage ‘guarantee limits’ on credit extended by enterprises, and the credit extended to individuals, and also handle problems and defaults. In other words, the service provider will do precisely what it does now but the difference is that it would no longer be exposed to the risk of defaults. Banks would queue up and compete to provide such a service.

If a bank doesn’t take the credit risk, who does?

It is the Guarantee Society members collectively who will be exposed to the risk, and they will protect themselves simply through the making of a ‘guarantee charge’ to both businesses and individuals in respect of the use of the guarantee. In other words, both businesses and customers would pay into a ‘Default Pool’ held in common by a bank as custodian for the members, rather than by a bank as proprietary owner.

Here Linlithgow benefits from being in the West Lothian region, whose council is one of four Scottish local authorities which still maintains a Municipal Bank. The very restricted purpose of the West Lothian Bank is purely to receive deposits from West Lothian Council staff and pensioners, pay them a decent rate of interest and lend money at a reasonable rate of interest to the Council.

Wherever the default pool of funds is held, a service provider ‘managing partner’, in addition to covering agreed costs, could be incentivised with an agreed bonus based upon service level and default experience.

The Co-operative Advantage

Anyone familiar with how credit cards work, which is to make a fat transaction charge to sellers, and to charge substantial interest and other charges on unpaid balances, will see that a community credit card will operate essentially as a co-operative of sellers sharing credit risk with a co-operative of buyers.

Any surplus from operation could be distributed to members as they see fit, possibly to relieve poverty or simply as a co-op dividend so that those who provide the guarantee, but do not use it, are recompensed for the risk they shoulder.

The outcome would be that such a Linlithgow Community Credit Card could out-compete conventional cards simply because it has the Co-operative Advantage of not paying returns to rentier shareholders and payments to management not reflected by performance.

The Community is the Currency

The really interesting possibilities arise from the fact that every individual is also an ‘enterprise’; it’s just that the value of the service they can provide is not recognised. So the growing number of unemployed could be extended credit by their fellow Guarantee Society members and in return could provide care for each other, and for the place in which they live or provide cultural value like music, art and drama.

As with conventional credit cards, there are no deposits necessary in such a system, which could be introduced tomorrow using conventional software. The result in Linlithgow would be a Linlithgow Pound, which spends just like a conventional pound, but does not require, as do Transition Pounds, the pound for pound backing of conventional sterling manufactured by the banking system.

So Linlithgow Pounds would be created and would circulate only within the community of members of the Linlithgow Guarantee Society.

The Linlithgow Community is the Currency.



The case for Cypriot National Equity

By Mandeep K Bhandal, on 28 March 2013


ISRS Senior Research Fellow, Chris Cook discusses how the Cyprus National Debt may be resolved into a Cyprus National Equity.

The article was posted on the Financial Times, Alphaville on March 25, 2013.

The case for Cypriot National Equity

The second attempt to resolve the unsustainable debt burden of Cyprus’s over-leveraged banks spreads the pain differently to the disastrous initial attempt, but looks likely to leave Cyprus as an economic wasteland for generations. Frances Coppola outlined brilliantly yesterday the sort of financial disaster zone which Cypriots can expect.

Cyprus, in common with many other countries, but far more urgently, requires resolution and transition: Resolution of existing debt; and transition to a sustainable and low carbon economy. Surely there must be a better way of achieving this? Well, my research leads me to conclude that there was; there is; and there will be again; if Cyprus ceases to attempt to resolve 21st century problems with 20th century solutions and instead uses an updated version of a financial instrument which pre-dates modern debt and equity finance capital.

In this post I will suggest how the Cyprus National Debt may be resolved into a Cyprus National Equity… but not equity as we know it.


The first step is for the Cyprus Treasury to create a new class of undated – by which I do not mean permanent – ‘Stock’.

This instrument consists of a non interest-bearing promissory note or unit which is returnable at any time (i.e. undated) in payment of €1.00 par value of Cyprus tax. The second step in the process is the nationalisation of the key banks, Bank of Cyprus and Laiki Bank, with shareholders receiving one €1.00 unit of Cyprus Treasury stock at par – i.e. they will receive a zero discount – in exchange for each existing €1.00 share.

The third step will be for all demand deposits, term deposits, and all classes of bonds to be exchanged for Cyprus Treasury €1.00 stock at graduated discounts reflecting the seniority, term and interest rate which applies.

The fourth step is that all existing Cyprus Treasury dated interest-bearing Stock – the Cyprus National Debt — will also be exchanged for and consolidated into €1.00 units of undated stock, again with a discount reflecting the term and interest rate.

The result will be a Cyprus National Equity: a single consolidated fund of Cyprus undated Treasury Stock returnable in payment for Cyprus taxes.

This will be supplemented by the flow of debt repayments (after operating costs) to the Cyprus Treasury from the borrowers of nationalised banks.

Rate of Return

The phrase ‘tax return’ comes from the way in which the ‘stock’ portion of a ‘loan tally’ record of prepaid tax would be returned to the Exchequer for cancellation by a tax-payer who had chosen to prepay tax. The phrase ‘rate of return’ was literally the rate at which such loan tally stock could be returned to the Exchequer.

Naturally, no creditor who prepaid tax by advancing money or money’s worth of goods and services to the sovereign would do so other than at a discount, and the rate at which the stock could be returned was literally the rate over time at which the profit derived from the discount could be realised.

By way of example, £10 of stock exchanged for £8 of value from the tax-payer and would give rise to a profit of £2, but the rate of return depended – literally – on the rate over time at which the stock could be returned to the Exchequer for cancellation. So a £10 annual tax obligation would mean the discount was realised in one year and would give rise to a £2 profit on the £8 advanced – i.e. a 25 per cent rate of return.

A £5 p.a. tax obligation would give a 12.5 per cent rate of return and so on.

Return on National Equity

The rate of return applying to this Cyprus National Equity will therefore literally be the rate over time at which the units of prepaid Cyprus taxes may be returned to the issuer at €1.00 par value, and the profit arising from any initial discount may be realised.

This is where it gets interesting.

Firstly, Cyprus taxpayers will always be in the market for stock at the best price below €1.00 so they may pay their taxes at €1.00 and make a profit. Secondly bank borrowers will also be in the market for stock, at the best price below €1.00, to pay their debt with it.

There is no possibility of a default since there is no dated debt obligation.

However, the rate of return will be determined by the levels of tax levied by Cyprus, and will be supplemented by demand for stock returnable against the flow of payments made to the nationalised banks by borrowers. Such Cyprus Treasury €1.00 stock units will not actually be euros or even (not quite) generally acceptable retail Cyprus currency, but will rather be investments priced in and exchangeable for euros at a level which reflects likely future demand from taxpayers and bank borrowers.

Through the creation of a Cyprus National Equity – not permanent equity as we know it, but an ancient form of undated equity – the Cyprus crisis may be resolved to create an interim breathing space as Cyprus funding costs are drastically reduced.

It will be seen that the debt has been resolved by a conversion or consolidation into a form of undated, rather than permanent, equity.

There’s nothing new about such a consolidation: in 1888, the UK Chancellor, George Goschen enacted “Goschen’s Conversion” which consolidated the existing disparate classes of undated ‘gilt-edged’ stock into a single class of undated ‘Consols’ which remain to this day.


In the medium and long term, however, there must be a transition to a low carbon and fiscally sustainable Cyprus economy.

Firstly, Cyprus must address resource resilience: in other words, how energy infrastructure and energy reserves, in respect of which Turkey explicitly and unequivocally staked out a claim over the weekend, may be equitably shared and optimally developed.

Secondly, Cyprus must become financially resilient, and while attention is currently away from the isolated and friendless North Cyprus it is clearly the case that some kind of economic co-operation, if not integration, is long overdue.

In that context, there was an interesting post by Nick Dunbar recently as to how the use of structured products could perhaps lead to a re-unification of Cyprus. How such resource resilience and financial resilience might be achieved simply, consensually and without the need for either power-seeking or rent-seeking intermediaries, is for another post.


What’s worth €17bn?

By Mandeep K Bhandal, on 20 March 2013


The Institute for Security and Resilience Studies (ISRS) provides a Net Assessment Bulletin (NAB) of the latest economic crises erupting through Cyprus.

What’s worth €17bn?

The latest cascade of economic crises erupting through Cyprus provides even more evidence – as if that were needed – of a severe lack of strategic grip from EU elites (be they technocratic officials, rent seeking bankers or out of touch politicians). Nevertheless, the Cyprus crises need not be wasted. A grand strategic move would be to make re-unifying Cyprus the best outcome for Cypriots, EU citizens and all our allies. Indeed, it would be worth the investment of €17Bn and certainly a better outcome than playing the financial folly blame game, when all parties are culpable in one way or another. The virtue of such a strategic move could be its honest transparency not just the important strategic advantages to be gained on several fronts.

It is worth remembering that in 2004 the Greeks threatened to veto EU expansion if the accession of Cyprus was not included as the tenth new EU member that year. The veto threat left some EU partners and allies feeling blackmailed. It need not have done so, if the Annan Plan to resolve the partition of Cyprus had won the backing of both the north and the south of the island in the referendum that same year. Inasmuch as Greek Cypriots can claim secret diplomacy undermined their confidence in the re-unification offer, the referendum result sowed discredit that has only been exacerbated by Greek and Greek Cypriot Eurozone performances since. The whole of Cyprus being an EU member but not a member of NATO adds significantly to the strategic implications of how the current crises are handled.

Today, in an effort to prevent any run on banks in Cyprus, Cypriots have woken up to another day where the banks are closed to them. The manoeuvres by the Cypriot President, Nicos Anastasiades over the last few days may have been more of an attempt to protect its off-shore financial centre business than resolve its public debt problem. Sucking more Russian money into Cyprus’ financial and energy sectors may have parochial and Byzantine appeal but ill serves Cypriots as EU citizens and the alliances Cypriots rely on for their security. Nevertheless, the Cypriot parliament was given easy populist cover for unanimously rejecting the proposal of the technocratic Troika (comprising the European Commission (EC), European Central Bank (ECB) and International Monetary Fund (IMF)). Predictable public outrage at the one-off 6.75% levy on savings of less than €100,000 will result in more than crude gestures and rhetoric involving German flags.

Politics and economics are inextricably linked. They are transnational rather than just national or international. This couples the fortunes of the few with the many in ways that are not healthy by default. Cyprus allowed its banking sector to balloon. Even if that ballooning did not involve all Cypriot banks or the informed consent of all citizens, it was their government that created a permissive environment in which too few questioned the credibility of their growing prosperity. We are left once again in a situation where the self-righteous can chant “moral hazard”, particularly if it seems that in easing the plight of Cypriots, some non-EU citizens and their illicit finances will be protected and continue their corrupting work. Yet the precedent of bailing-in the savings of insured depositors is politically toxic and contagious. It is quite at odds with how the EU obliged Eire to honour not just the letter of depositor insurance but the spirit too. The Irish have endured with good grace and done their bit to prevent contagion since 2008.

The Troika’s decision on a ‘haircut’ reaching ordinary savers demonstrates just how out of touch the political elite and technocratic officials are. Claiming Cyprus is a “special case” and other periphery countries need not fear the same fate is naïve. This policy initiative could reveal once more the fragility of the Eurozone, as depositors elsewhere in the periphery consider moving their savings into safe havens, including old-time notes under the mattress or more advanced crypto-currency bitcoins. The Troika’s political maladroitness might have been thought helpful to Merkel’s re-election prospects but lurid headlines about Russian criminals getting their hands into German taxpayers’ pockets allows populist tactics to obscure strategic wins. Putin does not shy from populism, as his rumoured statement to the Cypriot President concerning German flags underscores. However, for now any populist outburst from Putin will have strategic intent.

Cyprus as a convenient off-shore financial centre (OFC) has its advantages but Russia will be more interested in their growing energy security racket and disadvantaging NATO. Russia is seeking to shape Europe on its Byzantine terms. These continue to diverge from the shared interests and values of all EU and NATO members. Whether Putin’s strategy advantages Russians as a nation rather than their rentier state elite is doubtful. Conversely, Angela Merkel defaulting into reparation mode for a September election could mark a failure of leadership born more of bad populist tactics than strategy. This approach to Greek Cypriots is only compounded by politicians being too coy to challenge what many Germans think of the Turks next door. Turks are far more than freeloading one-time gastarbeiters; they can amplify their allies otherwise declining power, not least in a regional neighbourhood that still matters. The outlook from Moscow and Berlin does not advantage Cyprus, the EU or NATO.

Instead of leaving strategy to Putin and tactics to German populist politics, the EU could do something very worthwhile for €17Bn – re-unify Cyprus! Doing so could turn Turkish garrisons into a few more NATO bases and enable real power to be projected with energy and enterprise by the EU for the good of the whole region. Bad mouthing Russians, Greeks and Turks simultaneously is crass. A United Republic of Cyprus would create a hub for EU and NATO partners. From there options open up across the Levant, Caspian, and Caucasus that offer rewarding growth for all rather than more corruption, decline and conflict.


The Myth of Debt

By Mandeep K Bhandal, on 11 March 2013


In a recently published article in the Sunday Herald, ISRS Senior Research Fellow, Chris Cook discusses the global debt problem and the road to recovery. The below article is published with the kind permission of the Sunday Herald.

The Myth of Debt

From the latest cuts to economic forecasts to the Italian elections to the gathering debate about how George Osborne should play this year’s Budget, all discussions about the financial system now lead swiftly back to the world’s sovereign debt problem. It towers over every effort to get back to prosperity, threatening to take decades at best before it can be resolved, very possibly with an almighty crash along the way.

But maybe that is because we are looking at a 21st Century problem in a 20th Century light. My research at University College London’s Institute for Security and Resilience Studies indicates that the answers might lie in modern versions of legal structures and instruments which pre-date the modern financial system and even the Act of Union. But before I explain this ‘Back to the Future’ proposal for recovery, a warning: we’ll need to turn much of the received wisdom that underlies modern economics and politics upside down as we proceed.

Prior to the advent of double-entry book-keeping and the concept of profit and loss in the Middle Ages, accounting typically involved the use of wooden tally sticks. Notches and marks were made on a stick, with two functions. One was as a memorandum tally or receipt evidencing a sale, and the other was as a record of an obligation – a loan tally. In both cases, the tally stick would be split down the middle with the longer portion (the ‘stock’) being given to the counter-party of a transaction and the shorter portion (counter-stock or foil) kept by the originator.

For over 600 years from the early 12th Century and even before, UK sovereigns were accustomed to raising funds to fight wars and for other sovereign expenditure by obtaining money, goods and services from their subjects as an advance on their tax liabilities. The subject would receive a loan tally in exchange, which represented a pre-payment of tax due.

It could be handed back (hence ‘Tax Return’) in lieu of more conventional money at any point in the future when they came to pay their taxes. This is different from a debt, which normally comes with a date on which it must be paid back. And naturally these Medieval taxpayers did not give the sovereign £10’s worth of value in exchange for a £10 prepayment of tax but received a discount for their trouble.  The phrase ‘rate of return’ literally means the rate over time at which the stock could be returned to the issuer, enabling the initial discount to be realised.

In 1694, the Bank of England stepped in. Originally a private company, it was founded to create money backed by its gold holdings that could be exchanged for Treasury pledges over future taxes. In contrast to the old tally stick system, these pledges, known as ‘gilt-edged’ stock, or gilts, came with redemption dates and paid a fixed rate of interest.

These changed characteristics of a fixed date and rate of return made the pledges resemble debts. However, the difference is that these pledges are ownership claims created by an individual over his own income, whereas a debt claim is created by one individual over another individual’s income. The correct analogy is to think of gilt-edged stock as akin to interest-bearing shares or equity bought by investors in UK Incorporated, with a redemption date.

The position today is quite similar, except that the Bank of England is now State owned and the pound sterling is not backed by gold but by faith alone.

The fiscal myth of tax and spend shared by virtually all schools of economics is that tax is first collected and then spent. This has never been the case: the reality, as we have just seen, has always been that government spending has come first and taxation later. The reality is that taxation acts to remove money from circulation and to prevent inflation: it does not fund and never has funded public spending.

The Treasury does not, as we imagine, bank with the central bank in the same way that we maintain a bank account where our interest-bearing bank deposit asset is the bank’s interest-bearing debt liability and vice versa. The central bank creates credit/money on the Treasury’s behalf which it exchanges with the Treasury for gilts or lends to the clearing banks as necessary for them to balance their interest-bearing lending and deposits.

The clearing banks of course have their own power to create money, for the purposes of lending. They are responsible for most new money in the modern system, accounting for about 97% compared to 3% from the Bank of England.

Incidentally they too are the subject of a well peddled myth, which is that deposits are first collected by banks and then spent or lent into circulation on the basis of requiring a certain reserve level of deposits to be maintained. In fact, there is no constraint on UK credit/money creation of reserves: the constraint on modern money creation by private banks is the capital required to cover losses on loans.  Private banks first lend or spend what are essentially ‘lookalikes’ of central bank money, and then fund their dated interest-bearing loans (assets) with dated interest-bearing deposits (liabilities).

Putting most money creation into the hands of organisations whose raison d’etre is to make money from lending (and more recently, from speculation) is behind much of what has gone wrong with the financial system. As with all historic bubbles, the profit motive drove excessive credit creation. Bank lending departments were abetted by everyone from bank lobbyists persuading the authorities to allow dangerously low capital ratios to trading departments devising increasingly complex instruments for shifting loans off bank balance sheets to make more and more lending possible.

From out of these observations, I reach two conclusions. First, the clearing banks cannot be trusted to freely create the credit which is modern money.  If money is to be created by a middleman or intermediary then it should be the Central Bank or the Treasury: the question is, how and by whom such State credit issuance and allocation should be professionally managed and accountably supervised.

For instance in Hong Kong, there is no central bank. The Hong Kong Monetary Authority supervises the issuance of virtual currency and physical bank notes by three commercial banks including HSBC. The Hong Kong dollar is kept pegged to the US dollar between upper and lower rates which are defended by a currency board mechanism, putting strict limits on the amount of money that the commercial banks can create.

The idea of direct Treasury creation of money should not seem alien, by the way. During the First World War, UK Treasury notes known as Bradburys were temporarily issued as money to surmount a shortage of credit. In the US to this day, there remain a small amount of US Treasury Notes (greenbacks) in circulation which are worth exactly the same as the Federal Reserve Bank dollar notes which replaced them.

My second conclusion is that we must revisit the concept of the National Debt itself and recognise it for the National Equity it is in reality. We have only saddled ourselves with this debt delusion because we have forgotten what the true relationship actually is between public spending and taxation.

All existing UK gilt-edged stock could be consolidated as happened before with Goschen’s Conversion in 1888 which created the single class of undated Consolidated Stock (‘Consols’) which remain to this day.  We could again create a single class of undated stock and the absence of dated ‘debt’ obligations would drastically reduce the UK’s funding costs to the rate of return paid in respect of this ‘National Equity’.

In fact, one could argue that the creation of £375 billion of quantitative easing (QE) reserves – upon which the Bank of England pays interest at 0.5% pa – has partially achieved such a Consolidation by the back door.  These reserves of fiat money created and used by the Bank of England to buy  and hold gilts are assets which are functionally equivalent to gilts, since both are created as claims over future tax income, just like the broken tally sticks from days long forgotten.

Such a centralised re-architecture by the UK government of the national balance sheet is admittedly difficult to foresee at present. But once you dispel the myth of the national debt, it creates a space for discussion of more practical solutions now emerging as a result of technological innovation. With the prospect of a Scottish Treasury emerging in the near future, this is worth serious consideration.


Panel: Open Capital

In Mathematics there is +1, -1 and 0; in Physics, positive, negative and neutral. But in Economics we see only conflicting absolutes of equity and debt; freehold and leasehold; public and private. The long forgotten prepay instrument which enabled UK sovereigns to fund themselves through tax prepayments opens up new neutral asset classes which I refer to as ‘Open Capital’.

Prepay instruments enable not only direct ‘Peer to Peer’ credit, but also direct ‘Peer to Asset’ investment in productive assets without Treasury or banking middlemen.

I’ll illustrate this by outlining a couple of prototypes under development. One involves a housing authority that is building new flats in a project financed by a bank on the basis that their construction loan will be refinanced by the local council once the block is complete. This way the bank gets repaid quickly and the council avoids taking the construction risk.

This model will get the flats built, but means that the money is tied up in the project for years while the housing authority repays the council. The concept of Open Capital ‘rental prepay’, is that once the flats are let, investors will buy (say) 40 or 50 years of rental units at a discount. For the sake of argument, it could be 22 million £1.00 units of index-linked rentals sold at a price of £15m to investors.

Long-term funding for the project becomes equity not debt, albeit not equity as we know it. The refinancing releases what is essentially a revolving pool of public credit to be reinvested in other projects. The Open Capital model is particularly well suited to affordable housing because  the absence of compound interest and debt repayment drastically cuts funding costs and means a more reasonable rental may be charged.  Since an affordable rental is by definition more likely to be paid; the risk of non-payment is lower; and this greater certainty justifies a lower rate of return.

My second example of Peer to Asset investment concerns energy saving schemes. Suppose  investors are concerned about inflation and believe that natural gas will hold or increase its value relative to sterling.  investors may buy units in a fund at the market price of gas in £/therm each of which equates to ownership of a standard number of therms of gas.

This fund would then invest in energy-saving projects and households or communities would take on a ‘gas loan’ obligation to buy back therm units from the fund at the gas market price. Suppose one was a community combined heat and power generator, where instead of heat going up the chimney of a power station, we are going to use it to heat people’s homes. Now suppose this halved the number of therms of gas that each household used per month, from 120 to 60. They would pay the supplier for 60 therms and would buy back the 60 saved therms from the fund thereby reducing their gas loan by 60 therms.

Instead of receiving a sterling loan, the generator is funded by a gas loan based on future consumption, though an electricity loan is equally viable The investor makes money if the price of the power goes up, and loses if it goes down.

Unlike the UK Government’s Green Deal, which is lending money for household energy saving projects, this idea lacks two disadvantages that some believe will make that scheme unworkable. It does not involve compound interest and there is less risk of the savings being undermined by people simply turning up the heating, because unless they save gas, they end up with higher bills during the repayment period.



Measuring the resilience of Micro Nuclear Energy

By Mandeep K Bhandal, on 20 February 2013


ISRS Senior Researcher, Jas Mahrra comments on the need to explore the resilience of Micro Nuclear Energy.

Measuring the resilience of Micro Nuclear Energy

On the 15 February the FT commented on the state of the nuclear industry (Price gap threatened nuclear aims and Nuclear flexible fission). It pointed to the debate around Britain’s nuclear options as being in a state of flux as the battle for pricing and subsidies continues. There is increasing enthusiasm across the world to continue a nuclear option but on a much smaller scale. These micro generation nuclear plants are seen as the answer to the escalating investment decisions of building the traditional big nuclear power plants and their corresponding decommissioning costs.

Nuclear energy has been the archetypal energy generation and distribution mode for the 20th Century in that it was big centralised and worked through wide area distribution. This underpinned and defined health and safety, protective security (physical, personnel, information etc) and how Industrial Control Systems (ICS) linked this mode with all others through the grid.

Whatever the options are for either a big nuclear plant programme verses smaller scale nuclear plants the resilience of micro generation plants need to be explored and there is a need to understand both the benefits and the measure of resilience. It is worth noting that the resilience of networks, whether generation is centralised or decentralised has not been properly explored. Micro generation has been thought the preserve of renewables (wind, solar etc) and has had to address distribution and storage issues but has not been seen as involving big health and safety or protective security issues. The advent of micro generation with local and wide area distribution creates the opportunity to define resilience on new and more appropriate terms. These characteristics challenge the defining assumptions that underpin security and resilience within the nuclear sector. Such transformation means that templating legacy approaches would evidently be inadequate. Micro-nuclear generation can reframe all these assumptions about what is needed for the future.

In our forthcoming publication, entitled Resource Resilience, ISRS examine the complex and interacting energy system through an assessment of the geo-strategic, economic and environmental implications of competing resource use. We posit that a major re-think of the complexity and risk management tools are needed to better navigate through the energy crisis and enable a more resilient model. In a networked world, crises continually test for resilience. Nuclear will prove no exception to this.

Brittle Energy

By Mandeep K Bhandal, on 7 February 2013


ISRS Research Manager, Mandeep Bhandal provides a brief assessment on the irresilience in the energy system and how ISRS’ forthcoming publication, ‘Resource Resilience’ will address the complexities.


Shale Oil

By 2030, the global population will reach 8.3 billion people. Within this population increase, it is the growth of the middle classes that is dramatic – implying a greater consumption. Scarcity of global resources to meet global demand is perhaps the most pressing challenge we as citizens, businesses and our governments face. Yet, there is plenty of reason to be optimistic. The International Energy Agency (IEA), an intergovernmental organisation and OPEC’s counterpart affirms growing global production of key fossil fuels in the coming decades. Much of the increased production is to be found from unconventional oil and gas, in which the US has seized a strategic lead over the last few years.

Assessing resilience & irresilience

However, the US’ strategic lead has consequences. Today, the Executive Director of the IEA, Maria van der Hoeven, comments in the FT regarding the potential of the shale boom turning to bust, should the US fail to address the bottlenecks in its energy policies and regulations. This greatly underscores that the energy system is brittle. It is irresilient. It is easily disrupted, fragile and prone to catastrophic failures. Although uncertainty cannot be removed, we need to build a more resilient energy system. At the Institute for Security and Resilience Studies (ISRS), we define resilience as the enduring power of a body or bodies for transformation, renewal and recovery with the flux of interactions and flow of events. Resilience is our ability to act decisively and learn in a world of change. Irresilience (the inverse of resilience) must not be overlooked though but is poorly assessed. What the physicist Per Bak called “self-organised criticality” too often builds up undetected irresilience in our systems. Irresilience makes our systems prone to catastrophic cascading failures.

Brittle Energy

Recent experience evidences such irresilience in energy systems. Whilst Libya produced only 2% of global oil, the importance of “sweet” crude to regional consumers is understated by that percentage. The refinery capacity fed by Libya’s sweet oil can only process low-sulphur crude oil. Unrest in Libya not only sent the price of oil up but also disproportionately disrupted supplies of oil to Europe, which consumed 85% of what Libya produced. The heavy dependence of Italy, France and Germany on Libyan sweet oil was revealed. Dependence was not limited to crude supply. Even with Saudi Arabia pumping more oil to replace the lost production capacity, Europe did not have the additional capacity to refine the more sulphurous and dense crude. Instead, the oil was shipped to newer refineries in Asia who were able to process the oil and once refined passed to European consumers.

The success of US shale oil production is poised to reveal a similar brittleness. Although vast quantities of shale oil can now flow from mid-continental US, a few major supply barriers are now evident. Shale oil is sweet oil. US refinery capacity is for heavier more sulphurous oil. It is also concentrated on the coast for imports. Moreover, the legislative legacy of the 1970s energy crises means that exporting shale oil needs US presidential ascent under the Export Administration Act of 1979. To build on the successful production of US shale oil will require improved transportation infrastructure, refinery capacity for sweeter oil and changed legislation. If the US is to maintain a strategic advantage and benefit from the shale boom, it needs to welcome options for overcoming legacy energy bottlenecks. As Maria van der Hoeven suggests, failure to do so is already making the value of lighter oil relative to heavier oil collapse. This is a perhaps a lead indicator for wider irresilience in a system.

In our forthcoming publication, entitled Resource Resilience, ISRS examine the complex and interacting energy system through an assessment of the geo-strategic, economic and environmental implications of competing resource use. We posit that a major re-think of the complexity and risk management tools are needed to better navigate through the energy crisis and enable a more resilient model. In a networked world, crises continually test for resilience. Leaders need to show vision and stimulate innovation in tackling irresilience. The US is not alone in learning how to strengthen the energy system’s resilience.  Partnerships are indeed needed if we are not to become victims of success and failure in our increasingly interdependent world-economy.

Submission by Chris Cook to the Land Reform Review Group

By Mandeep K Bhandal, on 16 January 2013

ISRS Senior Research Fellow, Chris Cook, on behalf of Nordic Enterprise Trust, was invited to submit evidence to assist the work of the Land Reform Review Group (LRRG). The Group has been set up by the Scottish Government to develop innovative and radical proposals that will contribute to Scotland’s future success.

Please see below and here for a transcript of the submission:

Back to the Future – 21st Century Land Tenure and Investment



21st Century problems cannot be solved with 20th century solutions


In the course of my research as a Senior Research Fellow at University College London’s Institute for Security and Resilience Studies (ISRS), and my practical implementation of this research with the Nordic Enterprise Trust, I have come to the conclusion that the solutions to 21st Century problems are, ironically, to be found – ‘Back to the Future’ style – in updating legal frameworks and financial instruments which date back hundreds if not thousands of years.

Many indigenous peoples, such as American Indians and Australian Aborigines, find it impossible to understand how anyone can own land. Whereas most religious traditions – including Christianity, Islam, and Judaism – were all founded upon a belief that absolute ownership, particularly of land, is God’s alone, and that a tribute should be paid accordingly, such as a tithe.

In Mathematics there is +1, -1 and 0; in Physics , there is positive, negative and neutral; but the property rights which underpin modern political economy are based upon conflicting absolute property rights: Freehold vs Leasehold; Equity vs Debt; Public=State vs Private=Plc.

Intriguingly, the neutral/indeterminate state does exist in Scottish criminal law as the Not Proven verdict, which supplements the absolutes of Guilty and Not Guilty. However, there is no satisfactory and sustainable civil legal framework in Scotland or anywhere else for the Commons. This absence has led over many centuries, all over the world, and particularly in Scotland, to expropriation and enclosure of the Commons in one way or another and eventually to the concentration of land in relatively few hands.

In the absence of a word which describes a neutral framework for the property relationship in which no stakeholder is dominant I have adopted a neologism –  Nondominium. Such a collaborative and consensual legal and financial framework for sustainable development and management of resources is capable of revolutionising Scotland’s economy and society.

The enabling investment instrument for Nondominium is a form of investment which pre-dates modern finance capital, and in fact has existed for as long as mankind itself: Prepay.  In this submission I shall describe firstly, the neutral Nondominium framework for land tenure and secondly, the Prepay investment instrument, and then address the application of these tools to the Land Reform Review.


2/ Nondominium

(a) The Property Relationship

As Jeremy Bentham pointed out, Property is not an object or thing, but a relationship: the bundle of rights and obligations which connect the subject individual to an object, such as land (real property) or increasingly, knowledge (intellectual property).

While there are many types of rights and obligations, this proposal identifies four key classes of stakeholder rights:

ñ  Use – exclusive or otherwise

ñ  Usufruct – the fruits of use

ñ  Management

ñ  Custody – stewardship.

Existing legal frameworks for the relationships between these stakeholders are riddled with conflicts and complexities.  Apart from the basic forms of tenure, such as freehold and leasehold, there are further rights and obligations such as easements and burdens, mortgages and statutory restrictions such as those relating to planning.

Beyond these, is the use of an overlay of judge made ‘common law’ in respect of land to address shortfalls and iniquities arising from statute. There is also the use of corporate vehicles as a framework for property rights in land, which give rise to contractual rights of use, usufruct and management, and which is a subject to which I will return below.

(b) What is Nondominium?

 Nondominium is an agreement which not only brings together these stakeholders jointly/collectively to hold land in common but also enables them severally/individually to share the rights and obligations as they may consensually agree.

In simple terms, the user of the land pays a rental in money or in kind (‘money’s worth’ such as produce) and a proportion of this flow of value is allocated to a Manager stakeholder group which provides services such as introducing occupiers and investors; dispute resolution; valuation; maintenance or supervision of maintenance.

It will be seen that the Manager’s interests are aligned with those of any Investors who participate in the Nondominium agreement by investing in the value which flows from use of the land.  No stakeholder has a dominant or positive right to impose themselves on any other.  But stakeholders do have certain veto rights within the agreement to say what may not be done by others.

The outcome of the use of what is essentially a ‘Co-operative of Co-operatives’ is that the Occupier, Investor, Manager, and even the Custodian may all change, but the land is never sold again, remaining in perpetuity within the Nondominium.

(c) Comparatives


Existing multi-stakeholder forms of tenure are all flawed in one way or another.

Community Land Trusts own land on behalf of the community and lease the land to occupiers,  and typically loans are secured against leases to develop the land – although an extremely complex and so far unsuccessful attempt has been made using trust law to create a type of unit investment.

Ebenezer Howard’s Garden City movement was implemented through corporate ownership which was intended to keep the homes affordable in perpetuity, but increased land values led owners eventually to collectively agree to privatise their properties in order to collect windfall gains.

A form of co-operative individual Co-ownership was implemented in Scotland using Industrial and Provident Societies as a vehicle for the land ownership, but again this fell to privatisation through the introduction of ‘right to buy’ coupled with freely available bank credit.

Co-operative housing still exists, whereby contractual rights of occupation arise through membership of a corporate vehicle such as a Friendly Society or another, but such Co-ops rely on levels of altruism among members which are no longer widely in evidence.


There are several ways of investing in land and buildings.

One is to invest directly in the shares of property companies, some of which buy, develop and sell property, typically using debt financing to enhance returns.  Other property companies buy and hold property and are popular with long term investors seeking reliable income.

Other legal forms such as trusts and limited partnerships are used as vehicles for property investment.  More recently, we have seen the introduction of Real Estate Investment Trusts (REITs) which distribute to investors almost all the rental income received and which are said to be ‘tax transparent’ because the REIT pays no tax, and the income passes directly through to the investor.  There are problems with all of these vehicles, such as a conflict of interest with the manager, and the difficulty in buying and selling Units, because the underlying properties can take a long time to sell.

(d) Why ‘Nondominium’ ?

There is an extremely successful form of co-ownership tenure known as ‘Condominium’ which is a combination of collective ownership and private use and management now in widespread use throughout the US, with variations in other countries.  Developers of Condominiums finance the development, and occupiers fund purchase of completed apartments and houses, through bank mortgage loans, which were a major contributor to the US property bubble.

But the Condominium is interesting for another reason, which is that it was in the US a form of agreement introduced – ‘bottom up’ – by a lawyer and which was subsequently codified State by State as its use spread rapidly.  Whereas the word ‘Condominium’ implies shared dominant rights, the proposed agreement brings within it the rights to the usufruct in a way that no stakeholder has dominant rights, and hence the neologism ‘Nondominium’ seemed appropriate.

(e) Company Limited by Guarantee (CLG)

A CLG is one of the most flexible corporate forms there is. In the UK, it is envisaged that the Nondominium agreement will form the constitution of a ‘multi-stakeholder co-operative’ CLG.

There are extremely topical precedents for this in the way that the Mount Stuart and Applecross Estates were both vested by their owners in perpetuity in CLG vehicles. However, the use of the CLG as a vehicle has been criticised for the absence of participation by community or tenants in the CLG, whom the former owners who founded these Trusts chose to exclude from participation.

But the use of the CLG restricts these Trusts in terms of their financial capacity to invest in the estates and this often gives an unsatisfactory outcome for tenants who rent land or houses from a CLG Trust.

The innovation which enables investors in land to participate in a CLG Nondominium agreement is an instrument which in fact pre-dates modern finance – Prepay.

3/ Prepay

(a) Origins

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, and they received as a record or token of that pre-payment the 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’.

Clearly, no creditor would give £10 of value to the sovereign 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 Exchequer.  So tax-payers would pay forward, or ‘pre-pay’, their tax obligation, at a discount.

The phrase ‘Tax Return’ for tax-payers’ annual accounting to HMRC originates from this annual settling of accounts. Even more significant is the origin of the phrase ‘Rate of Return’ which simply describes the rate over time at which the profit arising out of an initial discount was achieved through the return of the stock to the Exchequer for cancellation.

So by way of example, if £10 of tax was prepaid with £8 of money or money’s worth, the profit of £2 would be achieved in a year if £10 tax was payable in a year, and this would give rise to a 25% annual rate of return (£2 divided by the £8 investment). If the tax rate was £5 pa then the profit would be made in two years and the annual rate of return would be 12.5% and so on. It will be seen that there is no compound interest, although there is a return in respect of the use of the money or money’s worth provided by the creditor.

(b) Rental Prepay

If rentals are prepaid at a discount, the result is a simple new (but in fact, ancient) instrument for direct investment in land.  A Rental ‘Prepay Unit’ or rental credit issued by the Custodian with a ‘par value’ of £1.00 will be accepted by the issuer in payment for £1.00’s worth of rent.

An investor is not restricted through having to find another financial investor in order to realise a profit, but may do so by returning the Unit against land use himself. He may also sell to property occupiers either collectively, through periodic auctions conducted by the Manager before rental due dates, or by private treaty at any other time. The point being that Occupiers will always seek out and buy Units at the cheapest available price below £1.00 and then pay the balance of the rental in £ sterling.

(c) Outcomes


The absence of compound interest, and the fact that no debt repayment need be made of debt in respect of the land element, means that the rental level may be set at a lower level.

The increased affordability means that the rental is more likely to be paid, and moreover, Occupiers who choose to maintain the property themselves or even invest in improvements, will be allocated rental credits, subject to valuation and supervision by the Manager.


For the Investor there is no possibility of default, because there is no debt obligation. The risk to the Investor is that the Rate of Return will be less than anticipated, or even zero, because the flow of rentals against which Units may be returned falls short of expectations.

By definition, an affordable rental is more likely to be paid, and therefore the risk that rentals will be less than expected is reduced, which justifies a lower rate of return.  At a time when conventional investments pay derisory or even negative ‘real’ (after inflation) returns Rental Units will be attractive to long term investors such as pension funds.

The outcome is similar to a Real Estate Investment Trust (REIT), but with the feature that Units are returnable against property use.  In this context the Holiday Property Bond (HPB) enables investors to acquire an entitlement of ‘Points’ which give rights to occupy HPB property.


In all other forms of legal and financial structure, with the limited exception of co-operatives, the interests of a Manager (where relevant) are not aligned with those of other stakeholders, and nowhere is this more evident than in Scotland, where the conduct and service levels of Factors has long been a running sore.

In Nondominium, a Manager shares proportionally in the gross rental flow, and therefore has an incentive to ensure high standards of quality and energy efficiency, since this minimises the cost of occupation and maximises returns.

However, a Manager may nevertheless be incompetent or otherwise fail to fulfil the expected duties, and the Nondominium agreement will incorporate provisions to enable that situation to be addressed.

4/ Land Reform Review

(a) Enable more people in rural and urban Scotland to have a stake in the ownership, governance, management and use of land, which will lead to a greater diversity of land ownership, and ownership types, in Scotland;

(b) Assist with the acquisition and management of land (and also land assets) by communities, to make stronger, more resilient and independent communities which have an even greater stake in their development;

(c) Generate, support, promote and deliver new relationships between land, people, economy and environment in Scotland.

The use of these tools opens up a plethora of urban and rural; public, private and third sector policy options, all with potentially wide ranging effects which combine to completely transform existing forms of tenure of and investment in land, both in Scotland and elsewhere

The consensual framework agreement is infinitely flexible, and will be used in a wide range of applications, depending upon existing use, tenure, and the extent of financial encumbrance.

Perhaps the most important outcome is that the use of these two complementary tools enables the resolution of unsustainable debt through exchanging debt for Prepaid Rental Units. As previously stated these undated credits were the original form of equity which preceded the absolute ownership form of equity comprised in shares of a ‘Joint Stock ‘Company as this entity evolved.

Such a ‘debt/equity swap’ of debt exchanged for rental credits, provides a better outcome for existing lenders than any refinancing with new debt can ever do. It also offers new hope for existing property owners with negative equity or insufficient equity to move and for a younger generation with little or no hope of a home they may call their own. For the older generations Prepay offers a form of equity release which is superior in outcome to any other.

So this ability to create rental credits opens up a new currency for social policy.  A generation which is ‘long’ of land and ‘short’ of care both for themselves and their home could essentially exchange rental credits with a generation which is long of care and short of land.

The Nondominium – which is not so much an ‘organisation’ as a framework agreement for self organisation to a common purpose – enables community assets to be transferred simply and effectively. Public bodies who wish to transfer assets to a community may retain a measure of veto control in the public interest as a ‘custodian’ member.  In terms of achieving ‘best value’ an agreed proportion of the flow of rental credits could also be retained by the public body, and allocated to a suitable use, such as to youth enterprise.

Development of land within a Nondominium makes redundant the existing form of profit-maximising development transactions where the developer’s only interest is cost minimisation, and energy efficiency and build quality are secondary.  This“4 B’s” (Buy, Borrow, Build & B…er Off) model is replaced by a co-operative agreement to share in mutually created surplus value, where high standards of build quality and energy efficiency are implemented because they reduce the cost of occupation over time and maximise the rental value.

The principal stumbling blocks are regulatory, and taxation issues, but these are by no means insurmountable.  Detailed, prescriptive financial services regulation is largely transcended by the fact that a ‘Nondominium’ is essentially a private ‘club’, but with open access due to the fact that anyone who agrees to the rules may join. It therefore does not involve the Public, and a combination of transparency and quality control by Manager stakeholders provides a form of self-regulation.

Taxation is an interesting issue, but there is the potential for a shift to a much more efficient and equitable fiscal approach than applies today.

To a great extent, since the Nondominium agreement is consensual, there is no reason why it needs legislation at all, and work is proceeding in respect of several prototypes.

The role of Government would be to disseminate best practice; to develop new policy options; to lead adoption of the model in respect of public land; and above all to facilitate the ‘bottom up’ evolution of a new wave of community-based value from land held in common.

The principal resistance to simple, consensual solutions tends to emanate from those with a vested interest in complexity and conflict, and some resistance may be expected from the professions and from consultants.  But even here, emerging areas such as collaborative law, and accounting for a ‘triple bottom line’ demonstrate that the professions can and will change with the times.

5/ Open Capital Foundation

The proposal is to bring together interested stakeholders in policy development in the public; private and academic sectors within a suitable framework – itself a ‘Nondominium’ agreement – to develop, implement and conduct ‘action-based research’ through a programme of local property prototypes across a range of applications.

With this in mind, an unincorporated association with the working title of the ‘Open Capital Foundation’ has been founded for the explicit purpose of the development of the concepts of Nondominium and Prepay.

Reality-based Economics and the Last Big Thing

By Mandeep K 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.

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 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.

Chris Cook

ETF’s – Virtues or Vices for Investors?

By Mandeep K Bhandal, on 10 September 2012

ISRS Senior Research Fellow, Chris Cook,  discusses the  virtues and vices of Exchange Traded Funds in the FT on the 10 September 2012.

Dear Sir

I was interested to read John Gapper’s article today re the virtues of ETF’s for investors.

Now, the virtues of ETFs for their originators is quite evident. A stampede of risk averse ‘passive’ investors has, particularly post QE, been convinced by investment banks of the virtues of ‘inflation hedging’. Since market risk is taken by the investor, and not by the banks, excellent returns on minimal capital requirements may be made by banks through strategies such as High Frequency Trading and Delta One proprietary trading incorporating asymmetric information.

Unfortunately, the virtues of ETFs for the originators comes at a price both for the underlying markets and for ETF investors.

Firstly, the presence of generally ‘long only’ passive and risk averse investors in markets –  whose motivation is to avoid loss rather than to make speculative transaction profit – has largely destroyed the price formation mechanism and has thereby financialised those markets where they have become predominant.

The result has been correlated bubbles in equities, energy and commodities and, to use a term coined by the FT’s Izabella Kaminska, a ‘Dark Inventory’ of encumbered shares and commodities. We therefore see a two tier physical market where a privileged few profit from asymmetric knowledge of the encumbered assets.

Secondly, and as a result, we have seen bemused value investors departing equity markets which have lost almost all connection with the underlying reality of assets and dividends, and market participants in commodity markets who are at a loss to understand how market prices are connected to the reality of production and consumption.

In summary, ETFs have killed our present generation of markets and constitute the next great regulatory accident waiting to happen when, not if, the current correlated bubbles collapse and risk averse ‘muppets’ realise that they have been mis-sold market risk on a cosmic scale.

I think that we shall soon find that the unseen vices of ETFs far outweigh any apparent virtues.