by Dirk
Helbing [1]
For example, “Qualified Money” would introduce reputation-dependent conversion rates to reward investments into quality. In this post, I will discuss the roots of the EURO crisis and some ideas how to overcome it.
Short history of money and future of Bitcoin
To discuss the future of money, let us first look back a little bit. By inventing a universally interchangeable good, the historical invention of money made the exchange of goods much easier. But while money was based on valuable materials such as gold in the beginning, it was later increasingly replaced by symbolic values, such as paper bills, or even entries in a digital account. Now, money is created in great amounts not only by central banks, but normal banks do it as well. If, one day, we don't trust anymore that we will get valuable goods in exchange, it is obvious that the value of money will be gone. This process is known as "hyper-inflation." In human history, this has happened many times.
Bitcoin is an attempt to avoid that such a horrible scenario can happen again.It's a peer-to-peer payment system, which does not require banks anymore.But it has other problems. BitCoins are designed such that the overall amount of this digital currency is slowly growing, and it will eventually saturate, thereby establishing something like a new "gold standard." However, we have seen in history that a gold standard is not flexible enough to enable a resilient financial system. If the volume of money grows more quickly than economic output, we will eventually have inflation. Then, the value of money, i.e. its purchasing power, will drop. Conversely, if the volume of money does not grow as quickly as productivity, we run into another problem, called "deflation." Then, money becomes more valuable over time, and people would hoard rather than spend it, as they can buy goods more cheaply in the future. Under such conditions, business cannot thrive. So, the volume of money should grow proportional to productivity, at least on average. Let me add though that the above dependencies regarding inflation and deflation are expected to hold only on the long run. Central banks and other stakeholders can manipulate financial markets, which may create delayed adjustments, biases, and abnormal market behaviors. As a consequence, it becomes increasingly difficult to interpret market signals correctly, and to respond to them in a proper way. On the long run, I think, loss of control is almost inevitable.
A new kind of money - How the idea was born
For the above reasons, Bitcoin will
not be the final solution, even though the technology behind it will be crucial
for future currencies and other services requiring secure transactions. Altogether,
however, we need to fundamentally re-invent money, as it is not adaptive enough
for our complex world. We have to ask ourselves, why the financial systems
keeps crashing since thousands of years, and what is fundamentally wrong with
the way we have set it up.
Thinking about it for a couple of
years, I came to the conclusion that, even though money is a great invention, it's
outdated. Therefore, it's time to create a better one. The argument goes as
follows. Currently, money is a scalar, i.e. the simplest mathematical quantity
one can think of. It is neither multi-dimensional nor does it have a memory. But
mathematics offers a much richer spectrum of concepts to define exchange
processes, such as vectors, i.e. multi-dimensional quantities, and network graphs.
In fact, money comes from somewhere and goes somewhere else. Who transfers
money to whom defines a network of money flows. Therefore, money should be
represented by network quantities. And money should be multi-dimensional to
allow other things to happen apart from the eternal ups and downs.
This made me think about "Qualified
Money" – multi-dimensional money with a memory. Since Roman times, people
have said: "Money doesn't stink!" In other words: it does not matter
where it comes from and how it is earned. However, what if we could give it a
scent, like a perfume? And what if this would co-determine the value of money? In
a discussion during a visit in Zurich, my colleagues Tobias Preis, Dave Rand,
and Ole Peters were fascinated by this idea. Later on, I combined it with a
reputation system and called the new concept "Qualified Money." Such money
could earn reputation and, with this, additional value! This approach has
commonalities with local currencies, but is more general and relates to the way,
modern stock markets work. However, Qualified Money opens entirely new
possibilities.
What's wrong with our financial architecture?
One of the problems of today's
financial system is the possibility of cascade effects. What started as a local
problem in the Californian real estate market became a world financial and
economic crisis, eventually causing social and political unrests. But how could
it come that far? For this, see the figure below. The world financial system
lacks engineered breaking points to stop cascades. At home, everyone of us has
electrical fuses to make sure that a local electrical overload would not cause
a larger problem, e.g. the house to burn down. In the financial system, in
contrast, the strategy is just the opposite: to ease the load on troubled
banks, some of their problems have been taken on by the states, which are now
in trouble as well, and so on. Rather than isolating infected "patients"
and curing them by a Marshall-plan-like intensive care program, we infected
many other countries that were healthy before. In this way, the overall damage
became much larger than it could have been, and it is not clear how we will
ever recover from the debt levels. If we don't get the problems solved any time
soon, cultural values such as tolerance and solidarity, or even peace might be
in danger. It's now the very fabric of our society, which is at stake. In
societies with mass unemployment, it can take two generations or more until the
good relationship between citizens and their state and a healthy social
structure recovers.
What worries even more is the fact that we don't currently have a backup financial system. For most other systems that may fail, we have contingency plans – a "plan B" or "plan C." In fact, one might argue that one reason why our current financial system performs badly is the absence of competing financial systems. Given that we believe in competition, why don't we take this seriously and build alternative systems, which could also serve as backups, as plans B or C? It's not enough to complain about having to bail out banks and about lacking alternatives. I also doubt that tougher regulations won't fix the problems. As large banks can handle the additional regulations best, while small and medium-sized banks struggle with them, these regulations may cause big banks to grow even bigger. Therefore, we should rather promote alternatives. In fact, with Bitcoin and peer-to-peer lending systems, some alternatives are eventually emerging, but we need more and better ones.
At the moment, I would say, we cannot take it for granted that the current financial system will still work in 10 or 20 years from now. Most industrial states have debts of the order of 100 to 200 percent of the gross domestic product (GDP), sometimes even a multiple of this. Controlled inflation has been considered to be a recipe to reduce these debts. The trick can work, if applied by a single country or just a few ones. However, if the USA, Europe, Japan, and further countries are all trying to reduce their debts in such a way at the same time, this may trigger an inflationary spiral that can get out of hand.
Besides, the attempts of central banks to control the level of inflation haven't worked well so far. To save banks, to encourage investments into the real economy, and to increase the level of inflation, central banks have pumped massive, almost unimaginable amounts of money into the financial markets. However, as it turns out, more than five years after the financial crisis started, companies still have difficulties to lend money for investments, many banks are still in a shaky position, and there are even worries about deflationary tendencies.
Why is this? Banks don't trust that companies would pay their loans back and, besides, they need more capitalization themselves. Most money created by the central banks does not reach the companies in need. Instead, given the low interest rates, money is mainly invested into financial markets. This drives up stock prices even though real economic growth is negligible. Rising stock prices create further incentives for virtual investments at the stock markets rather than real investments into companies. Consequently, central banks have created a gigantic bubble in the financial markets. In some sense, a virtual inflation has happened over there – the stocks have become more expensive even though most companies haven't grown. When this stock market bubble bursts, a large fraction of the money will flee into real values. This will suddenly drive enormous price inflation, as there are not enough material values that these huge amounts of money can buy. Therefore, inflation might easily get out of control. So far, this did not happen as misleading incentives have caused a temporary allocation of money in the stock markets. In the meantime, low interest rates are undermining the perspectives of life insurances and pension funds.
An
unfeasible control problem
I have argued above that the central
banks haven't been able to reach the effects they wanted. But this is not
because they wouldn’t be competent. It's because the control problem they are expected
to solve is ill-defined – it's literally unsolvable. The reason is that they
don't have enough instruments or, to put it differently, not enough control
variables. The central banks can increase the volume of money and they can
change the interest rate. That's basically it. They may also buy and sell
bonds, but many think they shouldn't. The classical instruments of central
banks are apparently not sufficient to do the job. In other words, the weapons
of central banks are blunt. New possibilities are urgently needed, and this
basically means additional ways of adaptation.
Why is this so? Let's take an
example from the world of taxes. Apart from raising money for public
engagements and investments, taxes are often used to incentivize or discourage certain
kinds of behaviors. For example, many countries have taxes on cigarettes,
alcohol, and fuel, to reduce their consumption. They may also offer tax
reductions for investments into environmental-friendly heating, better home
insulation, or buying solar panels, to promote the production of renewable
energy. It is clear that each of these goals can be achieved by suitable
taxation-based incentives. But what happens if one tries to reach many goals by
one single "control variable," the overall amount of money to be paid
for taxes? One may end up investing into solar energy production, while smoking
more cigarettes, which altogether would not change the individual tax level. So,
on average people may not be very responsive to a multitude of rewards and
sanctions. In other words, we are unlikely to reach many goals with a single
control variable such as one-dimensional money.
More control variables needed
This problem is actually well-known
from control theory. For example, complex chemical production processes cannot
be steered by a single control variable such as the temperature or
concentration of a certain chemical ingredient. In a complicated production
process, one must be able to control many different variables, such as the
pressure and the concentrations of all ingredients. It is also instructive to
compare this with ecosystems. The plant and animal life in a place will not just
be determined by a single control variable such as the amount of water, but also
by the temperature, humidity, and various kinds of nutrients such as oxygen,
nitrogen, phosphor, etc. Our bodies, too, require many kinds of vitamins and
nutrients to be healthy. So, why should our economic system be different? Why
shouldn't a healthy financial system need several kinds of money?
If we had different kinds of money,
we could probably influence how much of the money handed out by central banks
is finally used by companies for real investments. This would require at least one
additional kind of money. So, let us assume that, besides cash and goods, we
would have two kinds of electronic money: "real" electronic money
("REMO") and "virtual" electronic money ("VEM").
For example, besides real electronic EUROs, we could introduce "AEROs"
as virtual electronic money. By law, cash and real electronic money could be
invested into goods and real investments, but not into financial products.
Virtual electronic money, in contrast, could be invested into financial
products, but not into goods. The important point is now that the central bank
could hand out REMO and VEM at different interest rates. If REMO were handed
out at a lower interest rate than VEM, this would incentivize real investments.
Two kinds of electronic money
Of course, cash, REMO and VEM could
be converted into each other. However, by means of conversion fees, one could
also create incentives for one kind of money as compared to the other(s). This
would create new "degrees of freedom," as a physicists would say,
which would enable a better adaptation of the financial system to the actual needs.
For example, if REMO earns some interest rate but cash not, or if cash loses
value due to inflation, this speaks against saving large amounts of cash. It
would be better to spend cash on consumption, or to turn it into REMO or VEM.
If lending REMO is cheaper than lending VEM, it will incentivize real
investments over virtual investments into financial products. If VEM can be
converted into REMO for free, but converting REMO into VEM is costly, this
again incentivizes real investments.
So, this little extension of our
financial system will allow the central banks to more effectively stimulate
real investments into companies' production capacities. Central banks would not
have to produce anymore a bubble of cheap money, which will sooner or later
overheat the financial and real estate markets. As we have seen in the past,
this can cause dangerously large bubbles, which will sooner or later produce
large-scale global damage, when they burst.
Europe's "little" mistake
But we should dare to think one step
further. While the economy in the USA and the United Kingdom seem to be
recovering from the 2008 financial crash and the subsequent economic crisis, most
of Europe is still not doing well after several years of struggle – in fact,
some indicators are worse than after the great depression in the 1930ies. In
January 2014, Nobel prize winner Joe Stiglitz (*1943) summarized the situation in
Basel, Switzerland, as follows: before the crisis, Europe was doing very well.
It had some of the strongest economies in the world, it had some of the best
public infrastructures, best education systems, best health systems, and social
systems. However, Europe did a "little" mistake: without creating a
sufficiently sophisticated institutional framework, it introduced a new
currency, the EURO, which replaced more than a dozen other currencies.
Altogether, this created more problems than benefits, he judged.
We are not talking here about the
widespread complaints of citizens that the EURO made life more expensive – be
they justified or not. Instead, we must talk about the fact that, if we compare
all countries on a one-dimensional scale such as the gross domestic product
(GDP) per capita, there will be always
winners and losers. In this case, Germany happens to be a winner and Greece a
loser, but it could have been different as well. We must recognize that, given
the different productivity of the countries, it was just a matter of time until
economic forces were unleashed, which required adjustments. In the past, this adjustment
happened naturally by adapting the currency exchange rates. Now, in more than
15 European countries, this is not possible anymore. As above, this problem can
again be solved by adding new "degrees of freedom," i.e. new control
variables. But how to introduce these variables without giving up the EURO,
which many consider an important peace-building project in Europe?
Vitamins for the financial system
In the following, I will suggest to
introduce "Qualified Money". Qualified Money has a number of different
qualifiers, which turn money into a multi-dimensional means of exchange. The
value of Qualified Money is given not only by its amount, but also a conversion
factor that depends on various qualities. For example, if one decided that
geographic origin should be a qualifier, one would enable country-specific EUROs,
allowing adjustments of the value of money to the respective economic strength.
The same approach can be used to define regional or local currencies, if
desired. So, one could save the prestige project of the "EURO," by
making the currency more flexible. The regional variants of EUROs would be
converted into each other similarly as we are currently doing it for different
kinds of currencies at the stock markets, such as EUROs, DOLLARs, or YENs.
However, Qualified Money would not have
to be connected to local origin. The concept has potential for extension. For
example, the unemployment rate, the Millennium development goals, or any socio-economic-environmental
factors considered relevant for human well-being could be used to define
qualifiers. In our lives, it's not just money that matters. People care about
many things, and this opens up entirely new possibilities!
We could all be doing well
It is important to recognize that
both, the self-organization and management of complex dynamical systems require
sufficiently many control variables, not just one. Establishing different kinds
of money would serve this purpose. Compared to the currency system we have
today, these different kinds of money would not be easily convertible. There
would be an adjustable conversion tax or fee, to discourage conversion and to
encourage earning different kinds of money, instead. This would naturally
extend the approach we have discussed above in connection with VEM and REMO,
and it would create a multi-dimensional incentive system, rewarding us for
different kinds of efforts, including social and environmental ones.
Of course, such a conversion tax or
fee would create something like “friction” in the multi-dimensional money
system. However, we know from physics that friction can enable important
functionality. How would it be to have such a multi-dimensional money and
exchange system? Depending on how many dimensions we allow for, everyone could
be doing well, each one on the dimensions fitting his or her personal
strengths, skills, or expertise.
Today we have many ranking systems
to compensate for the lack of such a multi-dimensional money system. Besides
the Fortune 500 list of richest persons, we rank tennis players and soccer
players. Others collect medals, or scores in computer games. Scientists count
citations earned by their publications, etc. Even though some of these ranking
scales don't imply any material value, they can motivate people to make an
effort. Hence, we can turn this into a mechanism to create a multi-dimensional
reward system, as we need it to enable self-organizing socio-economic systems.
One might even consider the
possibility to allow everyone to establish a certain number of own currencies.
In a sense, this would be the logical next step after allowing banks and
BitCoin to create money (rather than just central banks). The value of these
personalized currencies would then depend on how much others trust in them and
are willing to engage in a related value exchange. I assume that, after some
time, there would be just a reasonably small number of successful currencies
that are widely used. However, they might have some interesting new properties
compared to the currencies we have today. Therefore, opening up money creation
to innovations might be really worthwhile.
Money with a memory
Let us now assume that electronic money
would be traceable. In this case, we could give electronic money a
"memory," and we could make its value dependent on its transaction
history. To put it in simple terms, money that went through the hands of Albert
Einstein or John F. Kennedy could have more value than money that was earned
with "blood diamonds." So, possible qualifiers could be, how the
money was earned, its origin or destination location, the reputation of the
products bought, or the reputation of the producer or seller. Hence, we can further
differentiate electronic money by means of additional qualifiers. This might be
imagined as treating money units like stocks or like individual currencies. In
other words, a (reputation-dependent) conversion factor would apply, when
financial transactions are made.
Benefits of money with reputation
I recognize that some people might
feel uneasy about money becoming dependent on reputation. However, in some sense,
this is already happening when we go shopping in the Internet. Depending on the
country we live in, the type of computer we are using, and perhaps further personal
qualifiers such as income, we might get different product offers than others,
at different prices. This is part of the logic of personalized recommender
systems. One might find it upsetting to pay a higher price than others, but it
could also be a lower one. When we book an airplane ticket or a hotel room, we
receive different offers, too, depending on when we book and where we book, and
whether we are regular customers or not.
In any case, there are quite some
benefits of reputation-based Qualified Money. For example, it becomes easier
for producers and stores to sell high-quality products at a higher price. Furthermore,
to get an idea how future shopping might look like, assume that there is a
database, in which information about products is stored, such as the amount of
money to be paid, ingredients, durability, level of environmental-friendly
production, level of socially friendly production, and much more. Moreover, assume
our smartphones knows our preferences, for example, that we give the price a
weight of 50%, environmental-friendliness a weight of 30%, and fair production
a weight of 20%, and that we want to avoid products with particular ingredients
we are allergic against. Then, by scanning product codes and retrieving the
related product information, our smartphone will recommend us the best fitting
products. Furthermore, if customers were willing to share their preference
settings, producers and sellers could better tailor their assortment of
products to the customer wishes. Therefore, customers would benefit as well.
They would get more products they would really like to have.
Balancing transparency and anonymity
If properly set up, Qualified Money
can create a good balance between transparency and anonymity, such that we can
have the benefits of both. Transparency can promote more responsible and
desirable behavior. It allows ethical values and higher quality to survive in a
framework of free economic competition. In fact, a considerable fraction of
people cares about ethics and fair products. Even financial investors are
getting interested in ethical investments, as they tend to be more sustainable.
At the moment we often find ourselves in a situation, where the competition
between companies is so harsh that they have to reduce production costs. This
will sooner or later decrease salary levels, production standards, product
quality and/or sustainability. In the end, we have lower salary levels or
lower-quality products. Both will eventually impact producers as well. In
contrast, reputation mechanisms could stop the undesirable downward spiral, by rewarding
higher quality products and fairer production.
The question is, whether the
transparency needed for such reputation systems will ever be reached? In fact, there
is currently a trend towards more transparency of money flows. We have recently
seen the Swiss banking secrecy melt away. Several times, whistleblowers have
sold confidential information about private accounts to public authorities. "Off-Shore
Leaks" has made international money flows more transparent as well.
Furthermore, there seems to be a "follow the money" program that
tracks individual money transactions. And presently, many countries set up
agreements for an automatic information exchange allowing public authorities to
monitor money flows and to check tax declarations.
Anonymous money exchange is under
attack for similar reasons as anonymous information exchange: in many cases, it
has promoted crime and misery. Nevertheless, anonymity has still important
roles to play. Most of us don't want anybody to know, which toys someone buys
in a sex shop. For such and many better reasons, we still need sufficient
amounts of cash besides traceable electronic money, even though it should lose
its value quickly enough to make traceable transactions sufficiently
attractive.
It should be also remembered that
anonymity is one of the most important elements of democracies. The principle
of anonymous vote is needed for independent decision-making, which is a
precondition for the "wisdom of crowds" to work. Academic peer review
as well is based on anonymity, to support open criticism without fear of revenge.
Organized crime or corruption would also be difficult to fight without
protecting the anonymity of witnesses. So, neither full transparency nor full
anonymity can work. We need a system that makes it possible to combine and
balance both principles. Introducing Qualified Money besides cash is the
solution!
[1] Dear
Reader,
thank you for your
interest in this discussion paper, which is thought to stimulate debate.
What you are seeing
here is work in progress. My plan was to elaborate and polish this material further,
before I share it with anybody else. However, I often feel that it is more
important to share my thoughts with the public now than trying to perfect the content
first while keeping my analysis and insights for myself in times requiring new
ideas.
So, please apologize
if this does not look 100% ready. Updates will follow. Your critical thoughts
and constructive feedback are very welcome. You can reach me via dhelbing (AT) ethz.ch or
@dirkhelbing at twitter.
I hope these
materials can serve as a stepping stone towards mastering the challenges ahead
of us.
I believe that our
society is heading towards a tipping point, and that this creates the
opportunity for a better future.
But it will take
many of us to work it out. Let’s do this together!
Thank you very much,
I wish you an enjoyable reading,
Dirk Helbing
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