Note: the use of the name Praxis here, is a project-name that refers to the demurrage-based digital currency that will be used within arcologies.
Preamble
The world revolves around debt. It lies at the very heart of our currency. Every single dollar created since 1973, the year the gold standard was dropped, has come into existence through the issuance of debt, either when a central bank creates money from nothing, when it buys debt obligations from governments or commercial banks, or when a commercial bank loans out a depositor’s money without deducting it from the depositor’s account balance.
It’s very important to understand that money is nothing more than points – a way keeping score in a grand game. The game dominates and controls our lives. Most people are so embroiled in it that they have come to believe that its rules and winning strategies are fundamental to economics or even to human nature itself. Most believe that there are no other viable games to be played. It’s either capitalism as we know it today, or communism or anarchy.
The most fundamental rules of our economic system are built into the nature of money itself. Money is not neutral. The way it is created and the way it is inseparably bound to interest and banking, dictate the deepest foundations of our economic system. It’s ultimately why small appliances break after only a couple of years, why we overfish our oceans, why we extend copyright out to hundreds of years, why patent-trolling is a profitable enterprise, and why we underfund our schools.
But like any game, it’s possible to change the rules. By designing a new form of money, we can choose rules that dictate strategies of gameplay that lead to happier, healthier societies. Many harmful, but financially successful strategies in the old game would no longer turn a profit – and previously uneconomic but socially beneficial strategies could be turned into winning plays. This is what Praxis would attempt to do.
Praxis is not that radical a departure from modern economics. It would still allow for the mix of private and public economic activity that we have today. However, as a result of its altered rules-of-the-game, many of the ills of today’s world would be rendered uneconomic, and many positive, world-building activities that are financially marginalized today, would be encouraged and rewarded through positive financial returns.
Finance in Praxis
One excellent example of how Praxis would create a better game is the way the finance would work under Praxis. Praxis would eliminate the need to charge interest on loans, and it would allow the economy to be self-financing without having to borrow from the banks.
Finance today revolves around borrowing far more money than you have (the principle) in order to buy the things you need (capital investments, housing, transportation etc…), then paying back that principle over long periods, with interest.
We pay an enormous price for borrowing with interest. For example, imagine a husband and wife together make an average of 120,000 inflation-adjusted dollars per year. Over the course of their 35 year working lives they will have earned $4,200,000, or $2,730,000 after tax (assuming total taxation at 35%). Say they buy a house from a retiree for $500,000 at 3% interest, and say inflation runs at an average of 1.5%. That would make the inflation adjusted interest equivalent to 1.5%. At 1.5% interest, if it takes the couple 25 years to pay off the loan, the loan will have cost them nearly $600,000 in interest. That’s almost 22% of their entire lifetime’s after-tax income!
The thing our couple is paying interest on is not the house, but the principal they owe the bank, but what if it were possible to buy the house without ever needing to exchange that principle in the first place? It seems impossible until you realize that nobody ever actually wants principle, and very few people ever hold onto it for more than a day. It’s cashflow that’s king. For example, the retiree who sold the house is not going to stuff his mattress with half a million dollars worth of bank-notes. He’s going to exchange the principle for an investment vehicle that generate a monthly cashflow that he can live off.
Even a complex operation such as building airplanes is all about cashflow. Airlines don’t have billions with which to buy fleets of aircraft, so they borrow the principle from banks and pay for it with monthly cashflow. Airplane builders need cashflow to pay for labor and purchase parts. If parts prices exceed cashflow, then principle is borrowed, and paid for with cashflow. The parts manufacturer needs monthly cashflow to pay its employees, and to buy aluminum. The aluminum producer needs cashflow to pay its employees, and make loan payments on the dump trucks and diggers it’s on the hook to the banks for.
At every link in the complex web of transactions that bind our economic lives together, the banks are there, exacting their considerable toll. We only think we need them because we’ve been trained believe that every purchase must be paid in full, at the time of purchase – and only the banks have that kind of money. Ultimately though, the true value of money comes not from the vault of a bank, but from the hard work people are willing to do to earn it. In effect, the banks are lending us our own hard work, and charging us interest for the privilege!
By eliminating the need to exchange principle, Praxis would allow us to break loose from the need to pay interest on loans. The easiest way to explain how this could work is with a concrete example. So let’s return to the couple buying the house, but this time, let’s assume the economy now uses a mature form of Praxis-style money.
This time, after the couple and the retiree agree that the house is worth $500,000, they begin to negotiate the terms of payment. The couple offer to pay the retiree $2000/month for the next 20 years. For sake of simplicity, let’s pretend that will total up to $500,000. The retiree agrees to the terms and asks them to present him with an insured cashflow instrument.
Explanatory Example
1. The couple use their phone or computer to access their Praxis wallets, and create a cashflow instrument at $2000/month with a term of 20 years.
2. The couple asks an insurance company to insure the cashflow. If for any reason the couple is unable to continue making payments, the insurance company will be required to make the payments instead.
The insurance company asks the Praxis system for permission to review the couple’s credit history. Praxis in turn asks the couple for permission to disclose their credit histories to the insurer, which they allow. Upon confirming the credit-worthiness of the couple, the insurer binds itself to ensure their cashflow. The instrument now looks like this:
There would also be a separate, much smaller, uninsured cashflow instrument from the couple to the insurer, to cover the insurance expenses, but for sake of simplicity, I’ll leave that out of the picture.
3. Now that the couple has an insured cashflow instrument, they present it to the retiree. The retiree inspects the terms of the instrument, the rate, the duration, and the insurer, and is satisfied with them all. He therefore accepts the instrument, thus making himself the recipient, and in return transfers title of the house to the couple.
The house has now been sold. The couple is still on the hook for paying off the $500,000 over 20 years, but they don’t have to pay any interest on the principle, because the principle never existed. Their total financial burden is thus less than half of what it would be under the conventional financial system.
In exchange for the house, the retiree now owns this cashflow instrument. Because it’s ensured by a reputable insurer, the instrument is as good as money, and as we’ll see, he’ll use it as such.
Derivative Cashflow Instruments
The retiree now needs a new place to live. Since he’s downsizing, a $250K apartment will do fine. Upon finding one and agreeing on the terms of purchase, he pulls out his phone to access his cashflow instrument. From it he spins off a derivative instrument: $1000/month for 20 years, and presents it to the seller of the apartment:
Since the new instrument is nothing more than a redirection of a portion of the original cashflow instrument to a second recipient, it will appear to be insured by the same insurer. However, the source of the cashflow from the Apartment Seller’s point of view will appear to be the Retiree. Since the terms of the instrument are agreeable to the Apartment Seller, she accepts the new instrument and the sale is completed. The retiree now has a nice apartment and $1000/month to live on. If later he decides to purchase a car, he can in the same manner carve off another portion of his original cashflow instrument and redirect it to his car dealer.
Credit Event
Immagine 10 years go by without incident. Half of the value of the original cashflow instrument has now been paid, and half remains. Then for whatever reason, the couple is no longer able to continue making their payments. A credit event occurs and the Praxis system automatically begins pulling the cashflow payments from the insurer’s wallet.
The insurer, aware that it is now on the hook for the cashflow, contacts the couple and determines that no further payments are forthcoming. It is therefore forced for foreclose on the house. Let’s say it finds a buyer willing to pay for it with a cashflow instrument of 2000/month for 20 years. The insurer makes the sale and the picture now looks like this:
But the insurer is not finished. The unfortunate couple is still entitled to half the proceeds of the sale, since the house sold for $500,000, and the insurer is only on the hook for $250,000. But at the moment, and for the next 10 years, all of the cashflow from the sale of the house is needed to cover payments from the Insurer to the Retiree, there isn’t anything left over to give to the couple.
The insurer solves this problem by accessing a cashflow swaps market and doing business with a swaps market-maker. For a reasonable price, the insurer swaps its 2000/M for 20Y cashflow with an insured 4000/M for 10Y cashflow. Note that both cashflows have the same value. Now the insurer has enough cashflow to meet its obligations, so it re-arranges the cashflows as follows. For the sake of simplicity I’ll leave the Apartment Owner out of the picture:
At this point, the insurer has completed its work and has netted its cashflows to zero. The original couple have an instrument worth their share of the house equity, and the cashflow to the retiree was never interrupted.
Note that the insurer is only out of pocket for the cashflow payments that had to be payed before the house could be foreclosed upon and sold, and for the administration costs of reshuffling the cashflows. Assuming the house sold in less than 2 months, the insurer would not be out that much money. Therefore with a competitive market, the cost of insuring cashflows would be very affordable.
Conclusion
This example shows that with a healthy insurance and cashflow swaps market, a modern economy can finance itself without the need to make interest payments on loans. The savings to both companies, individuals and even governments, would be enormous.