The Problem
The emerging economies of the newly emerging North and South Sudan nations are inextricably linked to the oil resource which originates in South Sudan and transits to market via North Sudan.

This resource flow has rapidly led to what appears likely to be a fairly intractable dispute.

Both countries need:

- Equitable and sustainable agreement for the sharing of the oil resource;

- Equitable and sustainable agreement between them; financiers and funders; and service providers.

The Solution
This proposal outlines two innovations:

Nondominium – a framework agreement within which the two Sudans may engage with each other; with financiers and funders; with customers; and with service providers;

Units – undated credits which are accepted when presented by customers in payment for oil.

Nondominium – a Sudan Foundation
The proposal is that the two Sudans should form a Sudan Foundation legal entity, and commit to that entity, as custodian or steward, whatever rights in respect of of crude oil production, storage; transit and use they may agree.

Each Sudan would have agreed governance rights of veto under the Sudan Foundation agreement. This negative or passive veto right of stewardship is very different from conventional Western property rights of absolute ownership and temporary use, or the complex and problematic alternative of Trusts under Western Common Law.

The new term – Nondominium – reflects the fact that neither North nor South Sudan may impose its will on the other.

The Sudan Foundation would be a subscriber to a Sudan Partnership framework agreement between the nations; investors of money or money’s worth; and a consortium of service providers.

Sudan Partnership
The Sudan Partnership would not own anything; employ anyone or contract with anyone. It is not an organisation, but is rather an associative framework agreement within which the Sudans consensually agree in respect of the sustainable development of any resources which they may agree to incorporate.

The Sudan Partnership agreement is a framework agreement within which associative sub-agreements – ‘enterprise agreements’ – are concluded between stakeholders in respect of crude oil production; processing; transit; storage; logistics; administration and so on.

The Sudan Partnership creates and incorporates a ‘Pool’ of Sudanese oil, both in the ground and in transit, which is available for the financing and funding mechanism of Unitisation

Unitisation
A Unit is simply an undated credit or IOU issued – under the management of a service provider – by the Sudan Foundation on behalf of those stakeholders with a right to flows of production under the Sudan Partnership agreement.

Funding may be obtained by stakeholders through selling Units at a discount to investors and/or customers.

Example – Oil Loan
North Sudan sells to a Middle East fund – from its agreed %age entitlement – 10 million Units each redeemable in payment for one barrel of oil.

A price of $90 per barrel is agreed when the market price of this oil for ‘spot’ delivery is $100 per barrel.

North Sudan has fixed the price of 10 million barrels of existing stocks and future production and has an interest free loan of $900 million for as long as the Units remain in issue. If the price rises, North Sudan foregoes the gain; if the price falls, North Sudan has locked in a surplus.

The Middle East fund owns a valuable economic right, and may sell Units profitably if the price of crude oil rises or at a loss if the crude oil price falls.

If there are no financial buyers in the market if it wishes to sell, then a fund holding conventional oil investment instruments may be unable to sell other than at a massive loss. But Units may always be sold to customers if the Unit price is below the ‘spot’ market price of oil. So a trader with a need for a 600,000 barrel cargo may buy 600,000 Units from the Middle East fund if he perceives that the spot price of oil may rise by the time he takes physical delivery under a supply contract.

Outcomes
Firstly, through Nondominium and the Sudan Partnership, a resource sharing mechanism between the Sudans which is independent of the dollar price of oil.

Secondly, a simple but radical Sudan Partnership framework to engage with the private sector to develop and operate oil infrastructure so that the interests of the public and private sectors are truly aligned.

Finally, an optimal – and, serendipitously, entirely sharia’h compliant – financing and funding mechanism through Unitisation.

By the time the (privately incorporated) Bank of England came along to privatise the money supply in the late 17th century there were at least £17m worth of tallies in issue at a time when the total cost of the operation of the Kingdom was perhaps £2m to £3m per annum.

From 1660 onwards, the UK began to issue interest-bearing Stock wholesale which met a demand for long term risk free annuity investments. This Stock paid interest periodically to the holder and became very popular with long term investors, representing the lowest risk and most solid income stream available. Meanwhile the physical tally stick accounting system gradually fell into disuse as the accounting system became a more secure double-entry book-keeping system.

Several classes of Stock were issued and in 1752 these were consolidated into what became known as Consolidated Stock or Consols. Further issues were made and in 1888 these were all brought together by (Chancellor) Goschen’s Conversion as the 2.5% Consols which remain in existence to this day.

A Return to Stock
Under professional management of credit managers/service providers, and the accountable supervision of the Bank of England as monetary authority, local Treasury branches could issue, in virtual form, undated Stock which would be redeemable in payment against taxes.

Stock would be issued at a discount – eg a Unit of £1.00 of Stock sold for 90p – and the rate of return depends on the period over which the Stock is returned to the Treasury in payment of taxes. The very word return alludes to this long forgotten practice of returning Stock to the issuer.

Stock revolutionises long term investment by transforming the risk. There is no longer a risk that debt and interest will not be paid. The stockholder may redeem Units against taxation, or may sell Units to other taxpayers/investors. Even if pure investors will not buy Stock, taxpayers will always buy Stock when the price is below £1.00.

The rate of return depends literally upon the date of return of the Stock to the Treasury or the date of sale: the former depends on the rate and basis of taxation, while the latter depends on liquidity – the ability to sell stock.

Liquidity is transformed: instead of a market in debt fragmented by different rates of interest; repayment dates; and trading platforms, there will be a single wholesale market in Stock, probably through periodic auctions on the Treasury web-site. The retail market in Stock takes place throughout the nation: Units of Stock in bearer form – Treasury Notes – may simply circulate alongside Bank notes as they still do in the US.

Stock also revolutionises Government funding, since massively reduced funding costs enable the issuance of new Stock to create new productive assets – which was precisely the reason why the wiser sovereigns issued Stock in the first place.

Qualitative Easing
The outcome of such 21st Century Stock issuance would be to transform the quality rather than the quantity of UK public credit – a debt/equity swap on a national scale.

Such Qualitative Easing will give a short/medium term breathing space for the transition of the UK economy to a sustainable long term fiscal basis.

But that is another story……..

Stock
For several hundred years, sovereigns financed and funded themselves and their nations by issuing IOUs, often in the form of split wooden tally sticks. The creditor was given the ‘Stock’ as a receipt and as a credit token redeemable in payment of taxes, while the Sovereign retained the counter-stock or foil.

From 1660 onwards, the UK began to issue interest-bearing redeemable Stock. These credit instruments paid interest periodically to the holder and became very popular with long term investors, representing the lowest risk and most solid income stream available.

Several classes of such Stock were issued and in 1752 these were consolidated into what became known as Consolidated Stock or Consols. Further issues were made and in 1888 these were all brought together by Chancellor Goschen’s Conversion as the redeemable 2.5% Consols which remain in existence to this day, since unless long term ‘risk free’ rates fall below 2.5% the Treasury will not redeem them.

The point is that even though Consols are said to be part of the National Debt there is – unlike with virtually all other Treasury Gilt-Edged Stock (‘gilts’) – no dated debt obligation to repay them, although the government has the right, as though these were 2.5% redeemable preference shares in UK Plc.

Which is, of course pretty much exactly what they would be if the UK were a ‘Joint Stock Company’ where the collective Stock had been divided up into £1.00 shares.

Euro Stock
My proposal for a temporary resolution of the € crisis – pending a transition to a sustainable basis for the € of which more anon – is for the ECB to announce that it will issue a few trillion € in Stock.

Technically, the proceeds of this ECB Stock are used to buy Stock issued by EU Treasuries which in turn enables them to buy back their unsustainable debt. The outcome is simply that the ECB would exchange Stock for EU debt at the market price of the debt.

The ECB would apply a coupon of (say) 2.0% pa and this would have several outcomes:

(a) EU nations’ funding costs would be slashed, which in turn would mean that this modest return would be more likely to be paid; more secure; and lower risk, justifying the lower return;

(b) The intractable issue of the massive overhang of € short term sovereign debt refinancing would become irrelevant;

(c) There would be a single pool of liquidity at periodic Stock Exchange auctions on the ECB web-site, instead of a pool of debt fragmented by rate of interest; issuer, date and trading platform;

(d) Sovereign credit default swaps – which are distinctly problematic anyway – would be dispatched to the dustbin of history where they belong

Qualitative Easing
So, in true Bulldog Drummond style, when that master of derring do was completely and irretrievably in the s…t………

……“with a leap and a bound he was free”.

An issue of ECB Stock would enable what is essentially a debt/equity swap which affects the quality rather than the quantity of credit. This Qualitative Easing gives a short/medium term breathing space for the transition to a sustainable long term basis for the €.

But that is another story……..

In order to understand what has been going on in the oil markets it is necessary to understand how the market works, and the changes that have taken place in recent years.

The oil market has come to be dominated by intermediaries ie middlemen who put their capital at risk in search of a profit in dollars, which is the global price reference currency for oil trading. Unlike the ‘end user’ producers and consumers, intermediaries have a vested interested in moving prices – for them, market price stability is death, whereas for end users price stability is necessary in order for them to budget and to invest.

A Marriage is Arranged
What changed in the early 90s was the entry of a new type of fund which enabled investors to take and hold medium and long term positions in the oil market. The first of these was the Goldman Sachs Commodity Index (GSCI) fund.

The stroke of marketing brilliance which accompanied the GSCI was to call this investment a ‘hedge against inflation’ and to market it to risk averse investors. ie to investors wishing to preserve their wealth against a decline in value of the dollar relative to commodities.

The GSCI took a long term position across organised markets of which the largest was in crude oil and it did so through by buying, and rolling over from month to month, crude oil futures contracts. The smartest kids on the block soon came to appreciate exactly how much this gave them tactical/micro and strategic/macro advantages.

The tactical advantage was that their discretion over exactly when and how this position was to be rolled over gave them an edge over the other players. The strategic advantage arose out of their realisation that the GSCI was taking a long term position in the market which was precisely opposite to that of oil producers who wish to protect themselves by ‘hedging’ against a fall in crude oil prices through selling crude oil futures contracts, and rolling over that hedge from month to month.

In the jargon, GSCI was structurally short while a producer like BP was structurally long.

So in the mid nineties, BP and Goldman Sachs got married. For 12 happy years they were joined at the head, by the same chairman, Peter Sutherland, while BP’s Lord Brown sat on the Goldman Sachs board for much of this highly successful period. During this Happy Time (the phrase used by U-boat captains when sinking huge numbers of ships before convoys were implemented) both BP and Goldman Sachs made massive profits – no-one will ever know exactly how much – from this relationship.

BP was essentially monetising their stocks, and even reserves, of crude oil and this gave both Goldman Sachs and BP a monumental trading advantage over other players through what is essentially ownership of stocks which is invisible to the market.

This has been termed Dark Inventory

Bubble 1.0
The GSCI fund grew relatively slowly over the years, but eventually other market players caught on, and in 2005 Shell entered into a relationship with an issuer of this new breed of Exchange Traded Funds (ETFs) called ETF Securities. This perfectly transparent relationship enabled investors to invest directly in Shell’s stocks, which provided cheap funding for Shell, and enabled investors to avoid being pillaged in the futures market casino as they rolled positions over month to month.

Other funds sponsored by banks preferred to form Dark Inventory, and set up trading operations in order to manage the process, and this enabled them to make easy profits through what is euphemistically called ‘information asymmetry’.

Accompanied by increasing tightness of supply in the physical crude oil market the price gradually rose from 2005 as money moved into the market and Dark Inventory built. This rise was ramped by hype from market players, who interpreted virtually any news as being positive for the crude oil price.

The classic example was the way that restrictions on supply of crude oil products – which increased their market price – were used, through faulty economic logic, to justify a rise in the price of crude oil prices. The truth is of course that restrictions on products reduces the demand for crude oil to refine, and logically it should have led to the fall in crude oil prices which would have occurred without the presence of purely financial buyers in the market who swallowed the faulty economics.

As a market observer who agrees with my analysis points out, the crisis in refining is indicative of the fact that something is artificially supporting input costs… and it’s not end demand. In any other industry, people would conclude that the situation is not sustainable.

This macro strategy became a victim of its own success, since it turned out that there was in fact a limit to how much inventory was available to be darkened, and crude oil prices rose to levels at which the demand for products became affected. At this point, several market players who took a view that market prices must fall made big bets by selling futures contracts. Unfortunately for them, they were unaware of the Dark Inventory and they were ‘squeezed’ by those who knew where the treasure was buried, which caused a spike’ in the oil price to $147/barrel.

The market then collapsed, and when frightened investors pulled money out of the funds in late 2008, the market price fell as low as $30 per barrel.

Hubris – Bubble 2.0
Bubble 1.0 had been hugely profitable for producers generally, of course, and the collapse in prices caused them all enormous financial problems.

But then the 2008 credit crash came to the rescue. The Federal Reserve Bank’s monetary policies of zero dollar interest rates and massive printing of dollars drove a massive wave of inflation hedging demand into all organised commodity markets and particularly crude oil. The fund industry urgently needed to find much greater pools of crude oil stocks and reserves to create the necessary scale of Dark Inventory.

My thesis is that a geo-political deal was struck between the US and Saudi Arabia, no doubt facilitated by the smartest brains that money can rent. A maximum price level (a cap) was set to prevent politically unacceptable US gasoline prices, and a minimum (collar) price was set to provide the Saudis with a politically acceptable budget. This strategy worked, as the price rose and became pegged to the dollar; OPEC meetings became incredibly boring; and the Saudis essentially acted as a global oil bank, who were printing oil, rather than dollars.

But this strategy was always an unstable equilibrium, like a Roll on Roll off ferry steaming along through calm seas, but with the bow doors open, and water swilling about on the car decks. In March 2011 two big waves hit – one literally. Firstly, there was a supply shock as large amounts of best quality Libyan crude oil supply was cut off, and secondly, there was a demand shock as Japan shut down nuclear power and replaced it with increased demand for carbon fuels.

These shocks saw genuinely speculative money pour into the oil market which drove the US gasoline price to politically dangerous levels, and led to expedients such as the release of strategic stocks by the IEA.

Then the Federal Reserve Bank turned off the money tap, as it ended its quantitative easing programme, and I agree with those who say that Bernanke is reluctant to implement another QE3 round because he fears negative rates, and debt deflation above all else.

Nemesis
What this meant for the oil market was that new Dark Inventory stopped being created. Meanwhile, as producers continue to sell their own production and inventory at inflated prices, they take windfall dollar profits out of the markets. So the funds which actually own this Dark Inventory now have massive unrealised losses which they can avoid only if physical demand picks up; QE3 and financial demand restarts; or they can find a greater fool to buy their Units.

This means that the new buyers necessary to keep the market price inflated in future have withdrawn This led to future prices sagging below current prices, a state of affairs known as a Backwardation. Moreover, recent market turmoil has seen a stampede back to the dollar. In September, $9 billion was withdrawn from commodity markets by index funds. The collapse of commodity prices in late 2008 was associated with just such an outflow of commodity market fund money.

A collapse in oil market price is actually under way, and in the Bizarro world of Dark Inventory, market participants working on conventional market assumptions mistake apparent demand for real demand.

So if a market participant buys Brent/BFOE forward contracts, physical market traders may be blithely unaware that the buyer is ending a lease agreement and repurchasing oil they have already sold. Traders are suckered by illusory market demand into a forward sale, and then find themselves ‘squeezed’ and having to buy back their contracts at a loss, which ‘pops’ the price briefly upwards, which is precisely what happened in 2008.

Investment banks are like submarines: they are a beautiful piece of engineering, but they sink ships. They have had two successive Happy Times, and it’s time to end the war. If the oil market collapses, as I confidently predict, it will have far-reaching effects, not least a regulatory disaster as the risk averse investors in these ‘inflation hedging’ funds claim that they were never informed of the true risks they were running and the extent to which they were being pillaged by the casino.

They did not realise that they had inadvertently caused the every inflation they sought to avoid: an example of Soros’s reflexivity in action.

This oil price collapse is a necessary step on the path to a next generation of networked and resilient oil market where middlemen transition to a role as ‘capital lite’ market service providers.

The Oil Market is Dead: Long Live the Oil Market!

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

There are two principal 20th century legal approaches to joint international development of resources: International Law (Convention) and Common Law (Equity). There have been proposals for co-ownership between nations but while Condominium – as it is known – is not unusual such Condominium agreements have typically only been reached in respect of relatively low value bilateral territorial disputes.

A good example of the Common Law approach is in the North Sea, where rights to production from oil and gas fields are now dealt with through the use of a common law Master Deed agreement. While this is imperfect, it is a great improvement on the complete legal nightmare which preceded it.

In Scotland there is, in addition to the existing polar opposite verdicts of Guilty and Not Guilty, a third null or indeterminate verdict of Not Proven. In the context of civil law, French jurisprudence distinguishes between contrats de mandat, which are essentially one way agreements mandated by statute or judges, and contrats de société, which are associative, consensual agreements.

The former class together comprise the Rule of Law which Western nations have insisted on imposing wherever their writ runs. But the Rule of Law has never sat well with nations, particularly East of Suez, where absolute rights and obligations are not the norm, and where consensual agreements are customary. It is said that Napoleon’s experience in Egypt and interest in Islam may have informed the French Napoleonic Code. Similarly, the joke is that there are as many Sumo wrestlers in the US as there are attorneys in Japan, and anyone who has done business in Japan will know that because trust is assumed, agreements are typically simple and brief.

Consensual agreement opens up a route to resolving even the most intractable disputes, and by way of example perhaps the most valuable, and hence most disputed, territory is the Caspian Sea. The relatively simple – but still intractable – bilateral dispute between Iran and Russia has, since the end of the USSR, been multiplied by the conflicting claims of what are now five littoral Caspian nations: Azerbaijan, Iran; Kazakhstan; Russia and Turkmenistan. Their claims relate not just to rights on the Caspian Sea surface, but to rights in the sea, and above all to the rights to what lies under it.

If a 21st century approach to territorial disputes can resolve this Mare’s Nest, then it can probably resolve anything.

A Caspian Partnership
The proposal is that the littoral Caspian nations should form a Caspian Foundation legal entity, and commit to that entity all existing rights in respect of the use, and the fruits of use (usufruct) of the Caspian Sea, and everything on it, in it, or under it. The Caspian Foundation would act as custodian or steward and the Caspian nations would have agreed governance rights of veto.

The Caspian Foundation agreement reflects an agreement between the littoral nations jointly or collectively.

The negative or passive veto right of stewardship is very different from conventional property rights of absolute ownership and temporary use under Condominium. Moreover, it does not confer the active power of control held under common law by a Trustee on behalf of beneficiaries, and the legal complexities and management conflicts which go with that status.

The new term – Nondominium - reflects the fact that no country or combination of countries has the power of dominant control over the relevant territory and resources.

The Caspian Foundation would be a subscriber to a Caspian Partnership framework agreement between the nations; investors of money or money’s worth; and a consortium of service providers.

This Caspian Partnership would not be yet another international organisation, with everything that goes with that. It would not own anything; employ anyone or contract with anyone: it would simply be an associative framework agreement within which Caspian nations self-organise to the common purpose of the sustainable development of the Caspian Sea. Within such a framework agreement a great deal is possible, although expectations may diverge to an extent that even consensual agreement is impossible.

The Caspian Partnership agreement would comprise a Master framework agreement within which a myriad of associative agreements between the Caspian littoral nations individually or severally would be registered and evolve organically.

In particular, it is possible to envisage a new ‘Pool’ of Caspian oil and gas production which would open up the 21st century direct financing and funding options of Unitisation (ie simply the issue and sale by producers of credits redeemable in payment for gas) which is the key market instrument underpinning the ISRS Resilient Markets initiative.

A Caspian Pool of natural gas production also opens up the possibility of a Caspian ‘balancing point’ spot gas price in just the same way as there is already a virtual national balancing point at which the UK spot natural gas price is set.

Nondominium
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.

It is apt to describe this proposal’s essentially Gandhian approach to the property relationship as Nondominium and such a collaborative and consensual legal and financial framework for sustainable development and management of international resources is capable of revolutionising international economic relations.

I’m old enough to remember the earlier UK trial of all-year-round British Summer Time between 1968 to 1971, and have been following with interest the doomed succession of Private Member’s Bills aimed at re-instating or extending ‘Daylight Saving Time’ . This is perhaps a more accurate name than British Summer Time, particularly in Scotland, where summer begins, if at all, later than in the rest of the UK.

Rebecca Harris MP’s current effort has at least made it past Second Reading

Daylight Saving Bill passes Second Reading

I’m not going to rehearse all the pros and cons here, but perhaps the most entrenched objection is an understandable antipathy to dark Winter mornings, which grows stronger the further North one goes in the UK.

My proposal is pretty much independent of these arguments and is based upon my preference for symmetry, and the fact that the current operative dates of British Summer Time are extremely asymmetric.

Solstice and Symmetry
The shortest day of the year – the Winter Solstice – is either December 21st , or 22nd, and this is of course the day when sunrise is latest and the mornings darkest.

Now, our clocks currently go forward from Greenwich Mean Time (GMT) to British Summer Time (BST) on the last Sunday in March, which may fall on or between 25th to 31st March; while the clocks go back on the last Sunday in October, which may fall on or between 25th and 31st of October. The former date is (including Leap Years) anything from 94 to 101 days after the solstice, while the latter is anything from 51 to 59 days before.

My suggestion is a simple one, and based upon the premise that the calendar difference from the solstice which is appropriate for alleviating the onset of Winter darkness should also be appropriate for marking its end.

I propose that we should bring forward the beginning of British Summer Time to the second Sunday in February, which falls on any date on or between 7th and 13th of February, and therefore between 47 and 54 days after the solstice.

I find the thought that the clocks could go forward in a just over a couple of weeks from now a cheering one.

Maybe any MPs who agree with me could convince the government not to reject Ms Harris’s Bill in its entirety but enact a little Symmetry instead?

This has been propagated by lurid and ill-informed articles in the Press – most notably ‘Daily Mail’ images of tankers full of oil moored off the UK coast. This greedy speculator myth has been taken up by politicians who have driven almost entirely useless action by US regulators in particular.

While the blame for high prices correlated across commodity markets is being firmly ascribed to greedy speculators intent on making transaction profits I do not believe that they are to blame.

QE and the Zero Bound
The US government has reduced interest rates to zero, and for good reason as the credit markets collapsed. They have also been assiduously pouring in money in order to save the US financial system through Quantitative Easing (QE) and other monetary strategies.

QE is the creation of credit (eg dollars) by Central Banks, and in the US this means the Federal Reserve Bank. This was necessary to replace the money draining out of the financial system as legions of US borrowers were unable to perform in respect of the unsustainable loans they had taken on, and had QE not happened there would have been massive defaults, and a Depression.

But a side-effect has been a huge pool of dollars roaming the global financial economy looking for a safe home, and this has reduced short term dollar interest rates on US government debt to zero.

Anything but Dollars
Investors see the Fed flooding the US financial economy with freshly created dollars and they conclude that this will mean that asset prices, and retail prices generally will rise. So if dollar interest rates are at zero what is an investor to do?

The answer is that investors are flocking to buy anything but dollars whether or not it carries an income. They firstly flocked to the traditional haven of gold, which soared in price to over $1430 per ounce, but frankly this is a matter of indifference to the man in the street because he can’t eat gold, heat his house with it, fuel his car with it, or type e-mails on it.

But in recent years, facilitated by the financial services industry, new asset classes of Exchange Traded Funds (ETFs) and related ETCs and ETPs have sprung up which enable investors to invest in any commodity which is traded on an organised market. Tens of billions of dollars are therefore being invested in commodity markets through such funds or through other more exotic products.

The outcome has been that most markets: precious and base metals; energy markets except natural gas (which is an oversupplied and fragmented market); and of course many agricultural commodities; are being simultaneously financially inflated.

These markets have therefore become ‘correlated’, and move up and down at pretty much the same time. They are doing so because demand in these hugely diverse physical markets is moving in lock-step. But demand is not the same thing as consumption, and the difference lies in the ability to stockpile commodities, which is more easily achieved in some commodities than others. Metals are easy to store indefinitely, relatively inexpensively; crude oil and products less so; food commodities are bulky and perishable; while electricity is virtually impossible to store.
While China in particular is a buyer of most commodities, this is not necessarily for current consumption, but rather for future consumption, and like financial buyers they prefer spending their dollars on such hard assets to buying US T-Bills bearing zero per cent. The difference between buyers like China and purely financial buyers is that China at least has a use for the commodities.

While the purpose of physical markets is to enable ‘end user’ physical producers and consumers to transact at an agreed market price, it will be seen that in most markets that is no longer the case, since participation by risk-averse financial investors who are ‘hedging inflation’ has driven the physical price to levels at which demand dries up, because consumers can no longer afford to pay.

Cui Bono?
Who gains from high prices? The answer is obvious: producers gain from high prices, and if there is one thing that the history of commodity markets tells us it is that producers can and will attempt to maintain prices at high levels wherever possible. They do so publicly by creating cartels to support prices by stockpiling and otherwise – such as in the tin, cocoa, coffee markets in the past – or by privately manipulating prices, such as Yasuo Hamanaka’s escapades on behalf of Sumitomo over 10 years in the copper market.

While there are indeed speculators in these markets, for them it is a less than a zero sum game. Their motive is Greed, and in their search for transaction profit they may either buy first and sell later, or vice versa. While they certainly add to short term volatility, they have no medium and long term effect on market prices because they neither produce nor consume the physical commodity.

It is in fact producers, who are currently – in the finest tradition of market capitalism – dipping their bread in the economic gravy through selling at the highest possible price to risk averse financial purchasers whose motive is not Greed, but Fear.

The outcome is therefore a massive wealth transfer from consumers to producers as a result of the inflated prices in the physical market. But that’s just the way it goes when it’s the producers’ turn. When markets are over-supplied and investors are absent, then producers engage in a ‘race to the bottom’; the lowest cost producer is the last man standing; and it’s the consumers’ turn at the gravy.

The only constituency who always wins in our casino market capitalism are the casino operators: ie the exchanges, banks and brokers. Producers; consumers; speculators and traders all pay a ‘cut’ to the casino, but the problem is that on this roulette wheel there are at least half a dozen zeroes…..

Re-inventing the Markets
The current generation of markets has become entirely financialised and dysfunctional, and is no longer fit for purpose. If and when interest rates rise; or investors become less fearful; or the price of commodities chokes off demand, as it did in 2008, then we shall again see commodity prices collapse to the ‘lower bound’ of over-supply. In other words, the market will transition from a ‘sellers’ market’ to a ‘buyers’ market’.

As long as dollar interest rates are at zero the demand will recover, and the market price will once again, as it has already, march up to the Top of the Hill, like the Grand Old Duke of York’s Men.

The only long term solution is to completely re-architect markets. Firstly, cutting out middlemen – which is a process already under way. Secondly, a new settlement between producer and consumer nations – a Bretton Woods II. This is not feasible unless and until commodity markets collapse from their current financially pumped-up unstable equilibrium – probably later this year. The currently triumphant and increasingly macho producers will then temporarily lose the whip hand, and at this point a sustainable market architecture may at last be achieved.

The reality of modern banking is that credit institutions – as banks and building societies are now formally known – create credit based upon a ‘cushion’ of financial capital specified by the Bank of International Settlements in Basel. This credit is instantaneously deposited in a recipient bank account, either of the bank itself, or another bank in the system which maintains the recipient’s account.

Banks must procure the deposits they need to balance their accounts from a shrinking (since wealth has become increasingly concentrated in the last 30 years) retail deposit base, and increasingly from wholesale deposits in the interbank market. When this wholesale market seized up in the Credit Crunch the central bank stepped in as ‘lender of last resort’.

Even among those relatively few who do understand some of the workings of modern banking – whether supporters or critics – there is a belief that all of the credit created by private banks constitutes interest-bearing loans to borrowers. In fact banks not only create credit when they lend but also when they spend by crediting the accounts of suppliers; staff; management and even shareholders in respect of dividends.

Most importantly in the context of the Public/Private discussion which follows, banks may also create credit when they acquire income producing assets – in particular when they acquire the debt (gilts) which the Treasury issues to ‘fund’ its public expenditure.

The outcome is that most of our money comes into existence when banks create credit by lending or spending, and simultaneously creating a ‘demand deposit’ or Bank IOU held by the recipient borrower or supplier.

So the answer to the monetary ‘Chicken and Egg’ question is that the Credit chicken precedes the Deposit Egg – and not, as most schools of Economics assume, vice versa.

Fractional Reserve Banking is a myth and numerous other economic myths associated with this assumption die with it.

So much for the monetary chicken and egg question – what about the fiscal one? Does taxation give rise to spending, or is it the other way around?

Tax-payers Money
The conventional ruling ideology – and the enormous cloud of rhetoric based upon it – is that ‘taxpayers money’ is collected and spent. Note here that by definition the Public Sector cannot ‘invest’ since investment is to all intents and purposes defined as being made by legal persons – individual and corporate – which in combination make the Private Sector ‘Private’.

The reality is very different.

The Treasury spends money by instructing the Bank of England to create and spend Public credit on its behalf, which is then instantaneously deposited in the accounts of recipients. Rather than leaving it at that, the Treasury chooses to ‘fund’ that public expenditure by issuing and selling debt – ‘gilts’ – which is purchased by banks who create credit (as explained above) for the purpose.

The outcome is that credit which was – as it is with notes and coin, and QE credit – non interest-bearing Public Credit is now replaced by interest-bearing Public Debt.

The payments made by the Bank of England on behalf of the Treasury gives rise to income received by millions of public servants. The outcome is that public servants become ‘tax-payers’ without the money which paid them having been anywhere near the Private Sector.

In other words the conventional wisdom and rhetoric concerning Taxpayer’s Money is baseless.

The Myth of Productivity
Taxation of public servants relates to work carried out by productive civil servants who are providing services which the population have democratically decided through their representatives are necessary.

A nurse does not become magically ‘productive’ when he/she moves from the NHS to a private hospital. A tax demand from HMRC and an invoice from a private supplier are functionally equivalent, the only difference being that public services do not require an additional payment to shareholders.

While I agree that public services could be carried out more efficiently, public servants are certainly by any standards productive: just not productive of profit for shareholders. Orwell would have been proud of the way that apologists for shareholders have hijacked and perverted the language of ‘productivity’.

While an enormous amount of economic activity takes place outside the Public sector, this relies upon a flow of credit created by Private banks, and upon investment by shareholders, both of which are in short supply.

Moreover, in recent years, for ideological reasons, an increasing amount of public expenditure on services is now carried out by private enterprises, and almost all spending on creating Public productive assets is carried out and expensively funded by the private sector. This means that increasingly the private sector has being financed day to day by the Public credit. This in due course also gives rise to tax payments by them to the Treasury, completing the circle.

A considerable part of the payment to private sector suppliers – ie the profit in excess of costs – is extracted by unproductive shareholders, while a massive amount is extracted by equally unproductive landlords as rent for the use of UK land. Both of these unproductive constituencies benefit from privileged property rights which give rise to unearned income and gains, which go largely untaxed.

Coalition Cuts
To cut public expenditure on productive assets and productive public and private sector employees under current circumstances is like applying leeches or cutting off the limbs of a patient bleeding to death internally. Cuts should instead be applied to the unproductive sectors.

Existing imbalances in income in the UK, while less than in the US, would be completely incomprehensible in more equitable societies such as Japan and the Nordic nations where top management receives a relatively low multiple of that earned by the lowest paid staff.

There are great savings to be made by cutting UK public and private sector managerialism which has seen outrageous nest-feathering both by management and by the parasitic professional consultocracy with which it is integral.

But the greatest savings to be made are in funding costs.

The simple fact is that Treasury spending does not need to be funded by the issue of gilts. The proof of this is QE, where Public credit is being created and used to buy previously issued gilts. All this achieves is to replace one – interest-bearing asset (gilts) with another non interest-bearing asset (demand deposits of virtual cash/IOUs). It does nothing at all to ensure that credit reaches the productive real economy.

There is an Alternative
The alternative is for hundreds of billions of Public Credit to be created and issued over the next few years as required for the creation of affordable housing; renewable energy and energy savings projects; a new generation of infrastructure; and above all to give our population – particularly the excluded younger generations – the knowledge, skills and capabilities required to create these assets.

The creation of such Public Credit would be managed by professional service providers with a stake in the outcome, under the accountable and transparent supervision of a Monetary Authority. We would then see the transition of Banks from creators of Private credit to managers of Public credit creation.

Once productive assets are created, then they may be re-financed – ie long term funded by investors such as pension funds – by credit based directly upon the use value of the assets themselves. This investment would then enable the Public credit which financed them to be retired and recycled, removing any possibility of inflation.

Likewise, the newly productive public and private sector individuals responsible for the creation of these assets would be paying tax, which would again retire and recycle the Public Credit which financed it.

So the basis of the economy could be the creation of credit based upon the earnings of productive individuals, on the one hand, and the use value of productive assets, on the other.

Good News and Bad News
The Bad News is that there is not a Cat in Hell’s chance that such an alternative system would ever be implemented within the existing paradigm of financial markets.

The Good News is that the pervasive spread of direct instantaneous connections is already leading to the implementation of complementary structures and solutions.
I am confident -based upon observation of the phenomenal rate of implementation in the developing world – that these solutions will make existing financial intermediaries largely redundant in the next few years..

“…and now what do we do?”

Dozens of advisers and academics have been descending on Reykjavik to advise the mayor on solutions ranging from the Gold Standard to a Reykjavik Bank. But as Dr Narsi Ghorban put it:

“21st century problems cannot be solved by 20th century solutions”

Best Finance
In 25 years of market development and regulation – six of them as a director of a global energy exchange – I gained many years’ practical experience in developing market structures and products.

It was Napster which first woke me up to the effects of the direct instantaneous connections of the Internet. I looked on astonished as a 19 year old – by inventing online music file-sharing – single handedly made obsolete the entire business model of the global music industry.

This realisation was reinforced by a visit to a major oil broker where I was intrigued to find that negotiations in the global market in cargoes of crude oil had migrated from telephones – where traders could manage only a couple of parallel conversations – to Yahoo ‘instant messaging’ chat-rooms where they could manage dozens.

The oil traders had done this because (a) it worked; and (b) they could: the fact that it was also (c) free, did not actually occur to people who routinely spent a thousand dollars on a night out, but it did occur to me.

Since 2005 I’ve been working in Scotland with the Nordic Enterprise Trust (NET) and with a little seed funding from the Norwegian government we have developed some simple but radical new partnership-based legal and financial structures as a framework for direct transactions. In the same way that the music industry has seen a move to direct ‘Peer to Peer’ connections, I got to thinking about how the financial system might look if the current middlemen like banks and insurance companies were transformed to a role as service providers.

Even a couple of years ago, before the Credit Crunch, such a transition was unthinkable. But now that banks everywhere fear to risk what little capital they have left, then the more far-sighted banks may well be interested in a complementary approach to new business.

The partnership-based structures we observe are emerging globally, from the UK to Japan, and from the US to India, and doing so because, quite simply, they work.

My case is that Peer to Peer Finance – which consists of Peer to Peer Credit and Peer to Peer Investment – is, in all probability, Best Finance.

Best Credit
Everyone is used to banks providing the credit (time to pay) which is necessary for the circulation of goods and services and the creation of productive assets, to the extent that we cannot conceive any other way of doing it. But the fact is that enterprises routinely extend ‘trade’ credit to each other (‘B2B’), and to their customers (‘B2C’) . The reality is that if X gives Y an IOU in exchange for goods, and Z is then prepared to accept X’s IOU in payment from Y, then the result is a monetary system.

So the source of credit is not the bank, but ourselves, through our ability to create value such as goods and services. The role of the bank – as a credit middleman – is actually to provide a framework of trust by coming between buyer and seller, and providing a guarantee backed by the pool of capital provided by shareholders. NET’s simple but radical approach is for a framework of trust to be provided by buyers and sellers collectively as a Guarantee Society: this is not an organisation – it does not own anything; do anything; or employ anyone – it is simply an agreement.

Our proposal to the Best Party is that they facilitate Reykjavik businesses and citizens in coming together and agreeing – through a simple and consensual ‘umbrella’ Reykjavik Guarantee Society agreement, that they will mutually guarantee the credit which is to be granted directly from businesses to each other, and from businesses to citizens directly.

Best Credit will be interest-free, but not cost-free, and requires no deposits. How does that work?

Firstly, there will be a service charge to cover the costs of providing the communications platform, accounting system, and management services. Secondly, both sellers and buyers will pay an amount into a ‘Reykjavik Pool’ in case of defaults. One innovation is that with the agreement of the seller, buyers may settle credit not just in ISK but in any form of ‘money’s worth’ acceptable to the seller, such as fish, or maybe in due course energy units or even land rental units.

The result is a Peer to Peer credit system which operates on a ‘not for loss’ – or cost recovery – basis, and where banks cease to be middlemen bent on extracting profits, and transition to a role as service providers sharing surplus.

Best Investment
Everyone is used to the Twin Peaks of Investment: Equity and Debt. Equity is property ownership generally but most people think of it as shares in a Limited Liability Company. When we distinguish between Public and Private we actually mean owned by the State, and owned by a Limited Company, respectively.

Debt, on the other hand is credit created by banks, loaned at interest to borrowers, and secured by claims over productive assets such as land. The outcome of Equity and Debt is to create two conflicting legal claims over the same productive assets.

Now, in Scotland there are not just the two verdicts of Guilty and Not Guilty, but a strange third verdict of ‘Not Proven’. In the same indeterminate twilight zone are also to be found new partnership-based legal forms which bring together Public and Private within municipal partnerships. The City of Glasgow now has five of these, which borrow conventionally from banks (or used to).

NET’s innovation is the simple but radical Capital Partnership which brings investors inside the partnership on the basis of sharing production or use value. This has very interesting outcomes.

By way of example, Reykjavik could set up a Reykjavik Property Partnership agreement, and invite distressed home owners and their equally distressed banks to make their properties and debts subject to the agreement. An affordable rent is then set, and indexed to rental values, and a pool of Reykjavik rentals is thereby created.

The Alchemy is simply to divide this rental pool into proportional Units – say billionths – and issue these to the banks in exchange for their debt, and to co-owner occupiers in return for any equity. Now the picture is completely changed for both banks and home owners. The banks have an asset far more valuable than any distressed debt can ever be. The occupiers, on the other hand, pay an affordable ‘capital rental’, and if they pay more than that due they acquire more units. Even better, if they maintain the property themselves they will be credited with ‘Sweat Equity’ units.

A second possibility is to create – within an Energy Partnership framework agreement – Units redeemable in payment for energy. Using such a unitisation model, Reykjavik Energy – which is already a partnership – could rapidly be refinanced interest-free with credits denominated in energy, rather in a conventional debt-based currency. If they are adopted – and anyone familiar with Pay as You Go mobile phones; Air Miles; or loyalty schemes operated by shops will understand Energy Units – they would rapidly be used beyond Reykjavik.

Best Practice
We believe that the Peer to Peer Finance models for credit and investment may in fact be Best Policies, which currently lack a Party to implement them. Jon Gnarr leads the Best Party, which currently lacks Policies to implement. Maybe we should talk?

I have been promoting the concept of a National Equity, and a legal and financial infrastructure enabling it, for several years now. But merely floating the idea on LabourList elicited a mixture of incomprehension and derision.

In fact, as I pointed out, a National Equity has to all intents and purposes existed since the mid 18th century in the form of the UK Treasury’s undated, but redeemable Consolidated Loan, and the more recent undated, redeemable War Loan, both of which are interest-bearing government debt or ‘gilts’

In addition to this apparently anachronistic undated debt, the UK’s notes and coin, which are undated instruments of ‘sovereign credit’, are to all intents and purposes also a non-interest-bearing form of equity, and we have Mr Darling to thank for the fact that this stock of cash has now been boosted by £200bn of sovereign credit in the form of the much maligned and widely misunderstood ‘Quantitative Easing‘. The fact that the Bank of England chooses to pay 0.5% in respect of the bank reserve balances which were pumped up by QE has essentially created a form of UK Plc redeemable equity costing the public 0.5% a year. Cheap at the price.

I believe that it is possible for the public and private sectors to combine to create new forms of equity instruments within the framework of corporate partnerships, rather than archaic company and trust law vehicles. Such Public Equity is capable of revolutionising the long term financing of UK productive assets – such as affordable housing, renewable energy, new transport infrastructure, and the re-skilling of our workforce. As I have pointed out, such massive government investment can and should be funded by QE provided it is managed professionally under the supervision of a monetary authority.

It may not be conventional – but I agree with the FT that it is about time the UK issued some National Equity – just not the toxic form of equity comprised in a Plc.

Cross posted on Labour List