Posted by: cjenscook | 05/05/2009

Filling the Vacuum

What brought home the reality of emissions trading and carbon credits to me was a futures and options conference I attended a few years ago. The ethics and morality-free zone of a panel of top energy traders was the sole occasion in the year when these experts used to get away from their desks and discuss trading strategy and tactics, and did so with all the freedom of people who routinely earn (or at least, get) in the high seven figures.

Keeping the Donkey Healthy
When asked what they thought were the chances of emissions trading to achieve its aims the consensus of the panel of traders was “slim to zero”, and when the question was put to the floor, there was general agreement with that assessment.

An analogy from the floor hit the spot, to general amusement:

“If you want to keep a donkey healthy you don’t regulate what comes out of it: you regulate what goes in”.

What emissions trading and carbon credits are all about is to confer value by political and administrative “fiat” upon something intrinsically worthless – ie CO2. It should come as no surprise therefore that the most enthusiastic proponents of the Kyoto climate change strategy are pretty much the same people whose business it is to create interest-bearing IOU’s and attribute value to them by similar political and administrative fiat.

We are now seeing cosmic amounts of fictitious and value-less credit disappearing into the vacuum at the heart of our financial system whence it came. Likewise the collapse of the productive economy is also leading to the collapse of the value of the billions of carbon credits issued to power generators and others, and constituting a mighty windfall.

An increasing number of industry commentators, and the more clued-up politicians who understand these things, agree that a carbon tax is far more likely to succeed than emissions trading or carbon credits. Of course, this does not play well with those to whom taxes generally, and taxes affecting business in particular, are anathema. For as long as we are continuing a spiral into Depression increased taxes are extremely unlikely politically and the only conventional political option is again deficit-based, this time upon the fiscal deficit between government expenditure and income from taxation.

If the conventional solutions don’t work – and quite clearly they do not – then what might an unconventional approach look like? I believe that the solution to the carbon market problem will also be the key element of the solution for the global Credit Crash. We must fill the monetary vacuum by re-basing our money upon value (or ‘money’s worth’), rather than claims over value issued by middlemen and based upon a small amount of regulatory capital.

The Vacuum
The origins of the vacuum lie at least 600 years ago with the Lombard goldsmiths in Italy. When they took in gold for safe-keeping on their ‘bancs’ they cannily observed that the receipts they gave were rarely redeemed and that the gold remained in their custody. This was because the receipts/IOUs were much more convenient as money than the gold they represented. Even more cannily, the goldsmiths began to issue more receipts than they had gold, and to charge interest to borrowers for the privilege. The credit they thereby created galvanised the economy and the results of this new, initially private, form of deficit finance are splendidly visible all over Italy to this day.

In 1719 the remarkable Scot John Law was the first to nationalise the goldsmiths’ private enterprise sleight of hand through the incorporation of the French state owned Banque Royale. Unfortunately the vast amount of credit this proto-Central Bank was able to manufacture in excess of its gold holdings was the basis for blowing up the ‘Mississippi Bubble’ in Mississippi Company shares.

Since then Central Banks have routinely issued deficit-based money in similar fashion, but in a more disciplined way. The last vestiges of gold backing of Central Bank money disappeared in 1971 and the money we use today is now backed only by governments’ power to tax. Our entire economy is therefore based upon twin Public and Private deficits: fiscal deficits, requiring governments to borrow and/or create money Zimbabwe style; and the monetary deficits of private bank credit creation which have recently been responsible for the Mother of All Bubbles in property and Private Equity.

Carbon Currency
I have been providing the Iranian government with strategic oil and financial market advice since 2001, and in the last two years their acute need for financing has meant that the simple but radical partnership-based proposals I have developed have struck a chord at the highest level.

My proposal to Iran – and to their fellow “Gas OPEC” founder nations, Qatar and Russia with whom they own in excess of two thirds of global gas reserves – is simply to issue as globally valid currency Units redeemable in natural gas. These Units could then be sold to countries such as China who are not only energy users in a big way, and who would be interested in securing the price of their supply, but are also looking for a store of value or ‘reserve currency’ as an alternative to the dollar.

Similar “unitisation” of other carbon-based fuels – especially gasoline and heating oil/diesel – will allow those nations such as Iran afflicted by the oil curse to cut back the staggering waste of energy which is the consequence when – for instance – gasoline is priced at 20 pence per gallon. Gasoline and fuel prices could be raised to the full international level – priced in dollars initially – but bloody revolution would be averted not by cash subsidies, but rather by issuing the population with Units redeemable in gasoline etc. While some would continue to waste fuel, it would not take long before most cut back their use and spent some or all of their Units domestically or internationally on something else instead. ie the result is an energy-based currency.

To monetise carbon-based fuels in this way is all well and good, but what do we use when the last barrel of crude oil is sitting in a museum? More to the point, how do we finance the necessary transition to renewable energy in preparation for that day, especially if banks remain crippled?

Carbon Pools
The interesting thing about renewable energy is that once an initial investment has been made then the energy produced is free. The production of renewable energy assets such as wind turbines and tidal lagoons may be thought of as a “Pool” of millions of Mega Watt Hours of energy. National Carbon Pool funds would be used for domestic investment, and when linked internationally, would invest in cross-border infrastructure such as a European SuperGrid.

These Carbon Pools would be primed with an initial amount, and then fed by a carbon levy made on all carbon-based fuels. The resulting fund would then make interest-free investments firstly in renewable energy projects (Mega Watts) and secondly in the cheapest energy of all – energy savings (Nega Watts) – for instance by piping waste heat to the vicinity of conventional power stations in the form of hot water.

These energy loans would then be repayable to the Carbon Pool either in Mega Watt Hours of production of renewable energy or from savings made by property occupiers and collected as a “Hot Water Rate”.

The flow of Units created in the formation and operation of the Pool could then be distributed equally to all as an Energy Dividend. Units could be redeemed against consumption; used to repay an energy loan; or simply exchanged for something else of value.

Money for Nothing
Firstly, the Carbon Pool mechanism is fair, because those who have more than average consumption of carbon fuels will be compensating those with less than average use of this Commons.

Secondly, the economics of energy is turned on its head because when energy – which has intrinsic value – is unitised and sold, then the cost of investment in renewable energy and in energy savings is zero, because it costs nothing to redeem the Units.

But most importantly of all, by making the energy value of carbon suitably valuable and investing the resulting surplus in renewable energy and energy savings for the benefit of all, rather than a charmed few, we may actually arrive at a policy with a realistic chance of leading to the necessary transition.

Energy is only one type of value which is capable of filling the monetary vacuum, and on an international basis. The value of land use is even more important, but that, as they say, is another story.



  1. Great post!

    The perspective of the traders about cap and trade is interesting. It simply rings true.

    The idea of monetising energy is not one that I have heard before.

    Difficult to see politicians making the hard decisions to take this step despite the clear logic.

    • Thanks, Jason.

      I agree that politicians would be unlikely to take the lead on this in the face of entrenched oppostion from intermediaries who feel threatened by it, but in fact there is nothing to stop the necessary consensual partnership-based mechanisms being introduced whether or not the politicians or executive get behind it.

      It will be introduced, and will spread virally, I believe, firstly because it works, and secondly because it can.

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