The author's suggestions have some interest but as policy they are both unworkable and unnecessary. Just defining what operations deserve zero interest loans and what do not may seem simple in broad brush terms, but the actual definitions would require volumes of legislation. Administration would be a nightmare. And that's before we get into the tax implications. One of the major lessons of the past few decades, and it is a bitter one for social engineers, is that concessions and subsidies have to be very carefully designed, of they will be grossly misused.
Then there is the problem that the suggestions amount to changes in a financial system that held up pretty well in a face of financial melt down everywhere else. the real question is whether the Americans will bite the bullet and reform their financial system. We live in hope.

Interesting read as a starting point.
Worthy of refinement and consideration. Several other related issues and alternatives come to mind.
The undeniable objective fact is that the current system needs taming.
Philosophically it needs to become the tool of man not it's master.

Curmudgeon,

Loans backed by existing assets are at least 1/10th the cost of equity backed by future assets. This means that existing businesses do not invest in new assets if they can possibly help it. It means that the rule of thumb for a new technology to compete on investment grounds is that it has to be about an order of magnitude better in performance to an old technology before it can get investment finance.

If anyone is subsidised it is the holders of existing assets in comparison to those with ideas for future assets.

It is my belief that no legislation is required as it operates using existing mechanisms. If there is please point me to it.

The general area for zero interest loans is specified - not the detailed investment. That is determined by the market place in investments. This is one of the reasons why it is done this way so that citizens choose which particular investments to make not the government.

There are no tax implications. You pay taxes on earnings and on capital gains.

The system has been designed to be "exactly" the same as the current system and if by some chance there is a law that says there should be no zero interest loans then we can overcome that by charging 0.00001 percent.

The government currently guarantees ALL bank deposits so there is no issue around that.

It will work and it is being done already on a small scale with some of the NAB products.

Of course the system has to be very good at "keeping the books" but that turns out to be the easy part with modern information and communications technology.

Kevin, we have had this discussion so many times on OLO, under your Fickle Pickle nom-de-plume.

First of all, you make highly questionable assumptions.

>>It is called a financial crisis because it started as a problem with the financial system and has spread to the "real" economy.<<

The financial system is part of the real economy. With or without inverted commas.

>>Money has two basic functions. The first is as a measure of value for the exchange of goods and services. The second is as a store of value.<<

Wrong.

Money is not a store of value. Stored money has no value at all. It is inert.

It is only when money moves, that its value is discovered.

An example.

The 1970's "oil crises" moved the price of crude oil from $3 a barrel on 15th October 1973, to $80 in 1979. This provided many Middle Eastern countries with windfall profits of many billions.

If they had simply used this money to store value, they would not have built all those schools, roads, hospitals.

More dramatically, the German Mark failed dismally to "store value" in 1923. One day a billion marks would buy a loaf of bread. Store the money for a day, and it's half a loaf.

Money's one and only function is as a measure of value for the exchange of goods and services.

Which renders your fear of "fiat" money irrelevant.

"'Fiat' or printed money does not represent anything and is used to facilitate trade rather than act as a store of value."

It does actually represent something, but only symbolically (i.e. governed by the symbol it bears - $10, $50 etc.)

But you are right, it is hopeless as a store of value.

Exactly the same as gold coins, or cowrie shells, or banknotes, or leather squares, or wampum or bits and bytes in a bank account.

All of the above only have value when used in trade.

You are right, too much money on loan is painful to an economy, as we are now discovering.

But your proposed solution is, as ever, unworkable.

Pericles,

I think we both agree on what money is so I will not address your concerns about the misuse of terms.

I truly want to know why you think the solution is unworkable. I took on board ideas from our last discussion so that this scheme fits within the existing framework. The only technical difference that I can see to the way the existing system works is that government has to agree to allow the banks not to show zero interest loans on their balance sheet. In other words the government guarantee the deposits so that the loans do not have to appear. However, the government already guarantees all bank deposits so that should be possible.

There is a lot of work to be done to implement this sort of system but it isn't difficult.

I am looking for structural issues that need to be addressed or for better ways of describing the system. If you can point out any such areas or things that do not make sense then please let me know.

I am looking for any community or government groups or private groups that want to see if their community infrastructure ideas can be helped with zero interest loans. If anyone has any ideas then contact me through olo and I may be able to make some suggestions.

I'm not sure that we do, Fickle Pickle.

>>Pericles, I think we both agree on what money is...<<

And that is where my problem with your theories lies.

As I stated in my earlier post, money only acquires a finite value when it moves. The system of lending that has developed over the years identifies this value through i) interest rates and ii) time. There is also the dimension of location - a dollar has a different value in different countries, or different locations within the same country.

In project finance, the owner of the capital has a number of choices. He can invest directly in the project, in which the risk is direct and immediate. He can lend the money on terms that will be beneficial to him, either accepting an interest rate/time combination, or a share of the increased value. Or he can invest indirectly through listed stocks.

The process adopted is dependent entirely upon individual circumstances. In other words, there is no mandated "right" or "wrong" way to invest in a project, merely a combination of risk assessment and return on investment.

There is room, no doubt, for zero-interest transactions.

But that does not translate, from being individually a worthwhile and beneficial transaction, into an entire system of lending and borrowing.

Because it does not scale.

It works in the micro-finance area mainly because i) the individual amounts are small, ii) the risk to the lender can be spread over a very wide range of projects and – most importantly - iii) the incentives on the recipients to succeed extends way beyond the simple need to “repay”

But in major projects it is virtually indistinguishable from capital investment.

Finance is provided, and any increase in value is dependent upon the success of the project. The bigger the project, the greater that risk.

It is highly unlikely that “loans” - with such an uncertain future, not underpinned by a measurable return - will displace venture capital in this scenario.

And as a system, it will not on its own solve anything.

Hope this helps.

Loath as I am to become involved in this cozy discussion, sorry Fickle P but your posts make highly questionable statements.
Example: Loans backed by existing assets are at least 1/10th the cost of equity backed by future assets.
This basically makes no sense. Banks have their own rules on lending which have been hammered out over eons so they are well aware of the costs of lending against secured as opposed to unsecured assets (future assets would count as unsecured). In any case, they are constrained by the BASEL II accords.
If you are talking about zero interest loans then tax most certainly does enter into it. Actually zero interest loans use to be quite common - a business would frequently lend to money to its owneer or a director on very easy terms. Also use to happen between companies here and their parent company overseas as a way to repatriate profits. Also use to happen the other way around where the loan was disquised equity. You want to open a big can of worms. Forget it.
Then there is the problem of their being no real reason for doing this in the Aus economy. Investment in R&D for example, would not change at all because of any of these suggestsion. R&D spending reflects the structure of the economy.. but that's another big can or worms..

Kevin's version of the money supply is not entirely correct.

Money is essentially an asset (store of wealth) that is universally recognised and easily exchanged, and as such acts as the lubricant in the gears of commerce.

Banks do not create money, but the banking system system does.

Banks cannot lend out more money than they have deposited, and in fact are required by law to retain a certian percentage (k%) in liquid assets.

How money is created in simplistic terms is that with an intial deposit of say $100 dollars, the bank can then lend out say $95 (k=5) to Mr X who then purchases something from Mr Y who then deposits it in another bank, who lends out $90.25 etc.

This effectively creates 100/k times the amount of loans. On this basis banking law in most countries regulates k as one of the means of controlling the supply of money, as too much money chasing too few assets reduces the value of money and causes inflation and a loss of confidence in the currency. On the other side of the coin, too little money causes interest rates to increase (the cost of borrowing) and puts the skids on commerce.

Given the above, the rest of the article bears little resemblence to reality.

In fact, the banks giving interest free loans is pure fantasy.

Pericles,

I am not saying that all investment and all loans are going to be zero interest loans. I distinguish between loans that are backed by existing assets and loans that are backed by future assets. Most loans even for most new assets will still use the current system. The proposal is a way for some new assets to be funded in a more efficient manner and where risk is shared throughout the community. The system scales because individuals, as they do today, will group the money from the zero interest loans and hire people to do the investing. These are relatively easy systems to implement with modern technologies.

Today ALL loans must be backed by real assets. The interest rates on loans is determined by the quality of the assets backing the loan. This is a very good system for mobilising funds from existing assets and I have no quarrel with it.

What I am trying to change is the cost of funds for the construction of some new assets. Today loans are not given on the basis of the risk associated with the new asset but on the risk associated with existing assets. To get people to finance new assets that are only backed by new assets you normally get investment via equity. In real life today - for those of us who do it - the cost to the current "owner" of the future asset is a minimum 10 times the cost of getting a loan against an existing asset (which is why we mortgage our houses rather than get equity). The reason for the great disparity is NOT the risk of the new asset but that there are few people and institutions permitted to invest in equity in new assets. (Investing in the share market is investing in old assets). However new assets ARE riskier and I am suggesting a mechanism where the risk of failure of some of the new assets is shared by the whole community.

Curmudgeon, I will stop being cosy. You misunderstand and then inevitably misrepresent what I am saying.

I am beginning to understand a little more of your reasoning, Fickle Pickle, but it is still somewhat muddled.

Possibly, you are underestimating the multi-dimensional nature of the problems you are trying to tackle.

>>The interest rates on loans is determined by the quality of the assets backing the loan.<<

Time and quantity also have a major impact. It is also instructive that "quality" was the major variable in the collapse of the US mortgage market. No amount of flexibility in the interest rate could compensate for the fact that many individuals had over-borrowed against over-valued assets.

>>Today loans are not given on the basis of the risk associated with the new asset but on the risk associated with existing assets.<<

Logically, the risk of an unknowable (in value terms) future asset is far higher.

I find it difficult to understand how the risk-value of money can be zero, when the project carries a higher-than-normal risk itself. It is not only counter-intuitive, it is completely illogical.

Investors, even (especially?) if they are governments, need to discern a value received, in exchange for the value applied.

Your proposed process also appears to come with its own overheads.

>>individuals... will group the money from the zero interest loans and hire people to do the investing.<<

This seems to indicate that as well as the estimated project costs, simply acquiring the investment costs money, sourced from the interest-free pool.

If you then add the management tasks associated with keeping an eye on the project's success (in order, ultimately, to derive value from your investment), there seems at first glance to be an inordinate amount of wastage in the system.

Ultimately, any commercial enterprise relies upon end-users who surrender some of their own earnings in exchange for value. The ultimate test of your project has nothing to do with interest rates of the lack of them, but on the viability of the investment itself.

If the project itself is viable, the means of investment in it - be it equity, convertible loan, maxing-out the credit card or micro-finance at no interest - is irrelevant.

Pericles,

The only difference between the current system and my proposal is that there is a new loan product with the following characteristics.

There is a limit on the total amount of zero interest loans issued
There is no interest on the loans
The loans are repaid from earnings on investments
The loans must be invested creating a new productive asset for a particular purpose

The critical point is the latter. Will the investments over their lifetime produce more value than it costs to create the assets.

This is the same point you make in your last sentence and with which I completely agree.

From the total system point of view it does not matter whether the loans are repaid or not or how much interest is charged. Interest and loans determine ownership not value.

For renewable energy we know that on existing prices most forms of renewable energy generation including solar thermal, geothermal, wind and solar voltaics will return more value than is invested. We do not invest because of interest charges on the capital and because we have to pay back the money before they start to generate income.

The same is true for most investments in ways to save energy including insulation, double glazing, heat pumps rather than direct heating of air.

I know how to build the loans system so that it will achieve its purpose and not be compromised through non compliance. I know that the cost of building and operating the system will be much less than the current cost of distributing loans. I know this because we have built, constructed and are selling a technically similar system you can see at http://www.greenid.com.au

Have a look at the first few chapters of our upcoming book to see the background to the ideas. Zero interest loans will be Chapter 6 and were invented in response to previous discussions we have had.

http://cscoxk.wordpress.com/2008/06/08/a-solution-to-the-tragedy-of-the-commons-chapter-1/

I'm still not sure that I follow your logic, Fickle Pickle.

What, for example, is the common ground between interest-free loans and an online identity system?

>>I know how to build the loans system so that it will achieve its purpose and not be compromised through non compliance... because we have built, constructed and are selling a technically similar system<<

In any event, building a system is not the key issue.

You mention that your zero-interest system will "not be compromised through non compliance"

How does it handle the inability of a project to repay the investment?

I looked for assistance in deciphering your code by reading a little of your "Rewards" effort. Unfortunately, it contained too many contradictions for it to be of any use.

"Rewards could be funded by a small increase in the price of all water. Anyone who meets the goals would then have the extra cost of water reimbursed through the Rewards. Those who use more than their allocation or who don’t support the goal will end up paying slightly more for their water,"

How is this different from a simple "user pays" system? Apart from the imposition of a limit, that is.

And let's be honest. Fundamentally, it is simply another form of taxation. Of which you earlier disapprove:

>>One of the most common economic means of regulating a public good is through the imposition of taxes or levies. Examples include emission and effluent charges and user fees for waste disposal. However, such approaches tend to be viewed negatively and are open to criticisms as mere money-raising exercises."

I'm not sure how to resolve the confusion, since it doesn't seem to have any connection either, with interest-free loans.

What am I missing here?

Pericles I tried to explain in 350 words but failed miserably.

Here is an explanation that is much longer. Hope it helps. If it doesn't please come back with more questions.

http://cscoxk.wordpress.com/2009/08/27/reply-to-pericles/

That's certainly one way of circumventing the word limit, Fickle Pickle. But unfortunately only adds to the confusion.

I queried your assertion:

>>I know how to build the loans system... because we have built, constructed and are selling a technically similar system<<

You responded

>>what is the common ground between an article on penguins and an article on fractional reserve banking. The answer is they were both prepared using Word.<<

So the relationship between your online identity management system and your loans system is that they are both computer programs?

That confuses medium with content. Presumably you are equally confident building airline reservation systems?

But this worries me most.

>>The bank does not lose because under the scheme the bank does not have to make up the money<<

You are suggesting that the government underwrites every loan made under this scheme. I'm not sure that I would vote for a government that displayed such fiscal recklessness.

The intention of the "bank guarantee system is not to pour money down the drain.

http://www.tresscox.com.au/resources/resource.asp?id=385

The existing guarantee applies to wholesale funding.

>>The government does not lose because all that has happened, as far as they are concerned, is the money supply has increased<<

And this is a good thing... how?

I thought that your idea was to avoid printing money?

>>Rewards is different from “user pays” because people who use more of the common good pay more but give the extra money to those who consume less.<<

That is "user pays". People who use more, pay more. What happens to the "extra money" is irrelevant.

Either there is something very basic missing from your explanation, or I am looking in entirely the wrong place.

Pericles,

Yes we can build an airline reservation system and we can do it for a fraction of the cost it would been 5 years ago. My estimate is 2 million dollars for the first functioning system. It will not have all the bells and whistles but it will do the minimal functions. That is another thing about modern systems - you do the minimum necessary to get a system to do something useful and you let it evolve through use.

People do not realise the advances we have made in how we can construct information systems

We use a technology that some people now call "cloud computing". Our organisation owns no servers, we do not own any system software, we manage no computers. This immediately reduced our costs by half compared to our previous method of supplying our systems.

The scheme I am proposing is for the government to guarantee the money deposits NOT the loans - and they are already doing this. It is called the bank guarantee. The risk on the loans is taken by the borrower and the borrower alone.

Where did I say that I wanted to stop printing money? This is what the idea is all about. We print money but we make sure we create a productive asset with the money we create. The key to the whole idea is that we have devised a way that ensures that productive assets for a particular section of the economy will be built for the least cost. Where the money comes from does not matter as long as the money has zero interest, and if it has to be repaid the repayments come from earnings.

I would prefer for the money not to be repaid but that is too much for anyone to accept just now and it does not involve the banks. We have to involve the banks because they dominate the financial landscape and I think zero interest, no risk to the bank loans, is acceptable to them and to the government.

I don't believe you, Fickle Pickle.

>>Yes we can build an airline reservation system and we can do it for a fraction of the cost it would been 5 years ago. My estimate is 2 million dollars for the first functioning system<<

It would need to have extremely limited function at that price. Have you any idea of the scope of Amadeus, or Galileo, or SABRE?

And there's no need to try to snow me on the topic. I am fully aware of the technology, having run - and founded - software development companies in the past, and my present business being heavily technology-dependent to this day.

I'm sorry, but your ideas become increasingly obscure with each new post. Something of a feat, really.

I'm just going to have to resign myself to remaining in the ranks of the ignorant, when it comes to your financial theories.