Alternative currencies to the rescue?

We’re trying to evaluate the current and future practical use value of alternative currencies here. It’s a pragmatic approach focused on existing options. (There has been a scientific economic approach already where Eric, Sepp and Alberto talked about highly generic value flow systems.)

This report is a bit unusual, as it’s not centered around any project I’m involved in. Instead, the origin and basis is a discussion about alternative currencies that some of us Edgeryders started over here. Many thanks to James, Lucyanna and Betta for their contributions!

I will now go on to introduce you to three widespread flavors of alternative currency, then talk about some personal experiences with them, and finally I will need your opinion on something …

Barter currencies

How does it work? While there had been barter systems before, it was Michael Linton who developed the variant used most commonly today - called LETS (local exchange trading system). This is a local user group where new users have to apply to the not-for-profit organization managing the system, and then get a barter account in a central, mostly web based accounting system. The account starts with zero, cannot be filled by converting legal tender, and there is no interest rate. Account total and turnover total are public. Transactions are voluntary and prices in barter currency units can be negotiated at will. There's a directory of all offers within the group from which users can select.

Economics. Mostly, it is said that LETSs are localized in order to keep value circulating in the local economy (by necessity, as the local currency units are worthless out of this system, or alternatively, some systems allow conversion but have high transaction fees for that). So in effect, you will rather buy that bag of vegetables from a local farmer for LETS points rather than imported from around the world, even if the price in LETS points is somewhat higher because the local farmer might not bee too competitive on the globalized food market. On system level, this amounts to a support for / revival of the local economy. The second acclaimed aspect of LETSs is that they make currency more abundant - great for those who are short in legal tender. That’s because, in economic terms, LETS is a system of mutual credit. Just that debt is not owed to a bank instittion but to the community of users. And the community is willing to give you credit because it trusts you to pay it back with future offers and services in the LETS system. This even works for unemployed people, who otherwise would not even dare to ask a bank for credit. (Fun fact, missed it myself for 28 years: There’s not much difference between a bank and a LETS user, because banks create the money they hand out as credit. It does not exist before. Not kidding!)

Usually, a LETS has limits in place for both assets and debt, meant to prevent both hoarding and defaults and to keep the currency flowing around. Still, as with every credit scheme, trust is a limiting factor, and in this case trust is only within a well-defined group. That’s why most LETS systems are quite small and localized; however there are attempts to connect LETSs together like clearinghouses or CES (an “exchange of exchanges”), Ripple or Circular Multilateral Barter. It should be noted that “local” character means rather “confined to a community”, which can be either really a local community or a social community, for example a web based one. If there’s trust and cohesion in a community, barter currencies can work.

Is it successful? Valuations of success depend, but in practical terms many such barter community systems start enthusiastically but then finally the economic activity comes to a halt. Seems related to lacking sufficient critical mass (enough people) to make this work in the longer term. There are approaches to make a “global LETS” possible (see above), but none of them is established so far as a comfortable one-stop solution so that trading with users of other LETSs is quite a difficult interaction so far (and thus, rarely done).

However: barter currencies tend to spring up in cases of economic trouble, and tend to be way more successful in these times (maybe not beyond, but it’s a great self-help mechanism anyway). The most interesting developments in this area are going on in Greece at the moment (see the BBC documentary embedded below, also appearing in this good overview article on, which is a platform run by our fellow Edgyryder Neal Gorenflo). Greece recently even passed regulation that allows and supports these “alternative economic systems”.

How do I start one? Starting such a local currency is more a matter of finding critical mass, socially, because the technology is all there for free; see an overview of software for alternative currencies on my site, also including more links about background concepts.

Time banking

How does it work? Pretty much the same as LETS, just that the unit of exchange is one hour of work with an egalitarian "all time is equal" principle. (There are other variants that value time by qualification or mutual agreement, but these ae really no different from LETS.) There are also "time saving banks" where people can save up time, by helping others, to later be redeemed for old age care for example.

Economics / practical use. Using work time as the basis of value is based on the “labor theory of value” - quite a fringe concept these days, as the competing “subjective theory of value” has been broadly adopted. However that’s not too much of a problem: currency is a social construct, so it can be designed to deviate from whatever we intuitively / most commonly use to determine value. If a group adopts this new concept, the currency works. Also, I think there are good reasons to argue that the labor theory of value should be adopted again as being more fair: in an untouched world, everything of value to humans is either free or created by investing time. Another note: 1:1 exchange of time has, to my knowledge, a taxation advantage at least in some jurisdictions: it’s considered as “not directed towards gain”, so does not constitute taxable economic activity. While producing own goods and trading them in a LETS system large-scale without operating a company might get you into trouble with tax authorities.

How do I start one? Again, it’s about building a sufficiently large group for this to work. But in contrast to barter currencies / LETS, this seems to work also with much smaller setups. Personally, I have two such schemes going on where there are only two of us in each one. For the technical side, again see my overview of software for alternative currencies.


Of course there's also Bitcoin. It's attractive on its own terms, yet is neither barter currency nor time bank, rather like digital cash.

How does it work? This will be a bit weird for those who never heard of it. Ok then … the best first contact with Bitcoin is probably the video embedded below, which happens to be the nice little clip on After watching, you know that Bitcoin is free software, works globally, has no transaction costs, and does not need any central authority (which is needed even in LETS systems and time banks). So there’s no third party that you need to trust, as to not interfere with your business (like PayPal does, notoriously) and to not run away with your money.

Technically, this is enabled by a quite ingenious cryptographic scheme: pseudonymous accounts are kept for all Bitcoin owners, and the account balances and transactions are all public and stored on each Bitcoin-enabled computer, in the so-called “blockchain”. Access to transfering funds from one account to another is possible by cryptographic keys stored on your own computer, and a transaction becomes effective by being approved by the network of Bitcoin software clients: they calculate a new “block” for the blockchain, which adds yours and others’ transactions to this shared accoiunting ledger.

This block calculation takes a lot of computing effort from all the thousands of networked computers combined - currently it’s estimated at 137 PetaFLOP/s; compare that with the world’s fastest supercomputer, able to do 11 PetaFLOP/s. The result is just a mathematic “proof of work” that prevents attackers from creating a forged transaction history. And the one computer who found the solution to the proof-of-work problem is rewarded with 50 newly generated Bitcoins. That’s how Bitcoins come into existence, so called “mining”.

Finally, the new block is published and check by each of the Bitcoin network’s computers, including your own if you have the Bitcoin software client running. They check and approve a new block if no double-spending of already spent coins occurs in it, by comparing with the previous transaction history. (And that’s how your encryption key to your Bitcoins loses its validity after you transferred them.) Compromised “evil” clients may accept a block with double-spending, but they are simply ignored by the well-behaving ones. So the behavior of the whole system (defining the correct transaction history) is implemented only in individual decisions of all participants - nice example of emergence, and beauty of P2P.

Economics / practical use. Bitcoin does not have any of the advantages of LETS over money: Bitcoin and Euro etc. are readily exchangeable, and Bitcoin is not created from P2P credit. Both limit its supply, meaning it is just as hard to earn Bitcoin than it is to earn “real” money. Even “worse”, there’s a feature in Bitcoin that cuts of their creation (“mining”) after ~20 million are in existence, meaning there is no way to do Bitcoin inflation by money volume expansion. The design of Bitcoin is tuned to become a “great store of value”.

So unlike LETS, Bitcoin as a system does nothing to overcome money scarcity. But its global instant, no-fee, irreversible and quasi-anonymous transactions have earned it some uses as a better Internet payment system already. And after all, if there is a community that decides to keep their money local, it could also use Bitcoin instead of a LETS system, and profit from getting rid of all system maintenance (not tried yet, this is an own idea).

There’s also a kind of “Bitcoin economy” already, with some hundred small shops trading in Bitcoin and startups offering Bitcoin services; see the list of real things and services to buy with Bitcoin. Also, Bitcoin integrates with major webshop applications, for example there is a Bitcoin module for Magento.

How do I start? To start using Bitcoin, you basically need to install it on your computer and learn how it works:

  1. Download the Bitcoin client software from, install it. Wait for some hours to download the so-called blockchain (some hundred megabytes).
  2. Get some Bitcoins. Usual way is to buy some on a Bitcoin exchange, but you could also sell something on, say, (Bitcoin auction / shopping portal).
  3. To buy something, you'll have to use the Bitcoin client to send some of your bitcoins to the receiver's bitcoin address, which looks like for example "143PV9zhJUwCiTDD8i7FE16JbfiJvX9zQo". The transaction is more or less instant and basically cost-free, and shows up in the other party's Bitcoin client.
  4. To receive Bitcoins, hand out one of your Bitcoin addresses shown in your Bitcoin client software.
  5. ((Important: before you get involved in Bitcoin with larger sums of money, ask or learn about securing your Bitcoin wallet. Theft has happened and equates to accessing an unencrypted wallet.dat file on your computer. And, theft is irreversible!))

Bounty: your first Bitcoin. I am into Bitcoin for a year now and like to introduce people to it … so may I give you a little incentive? I will send 1 Bitcoin (ca. 4 EUR currently) to the first person from Edgeryders who is new to Bitcoin and manages to post their Bitcoin receiving address in the comments.

Personal Experiences

My problem with local currencies so far is that they are local (because I’m frequently changing places, so involvement on the local level is not sustainable for me). However I did some experiments to find my place in all this:

  • Internationally: fail. Opened an account at the Global Groups Exchange group at CES. This is their only time-based international group, so it seemed quite appropriate. Yet it's not busy there: the social critical mass is missing to make it a success. Also they don't have an egalitarian "all time is worth equal" principle there, means you can charge more than 60 minutes per hour if you like; I'm not too much of a fan of that idea.
  • Among friends: fail. Once I had installed Cyclos on an own server (which is an impressive and free time banking and LETS software by the way). Had planned to use it among friends as a compensation system for time spent in neighborly help, to maintain fairness here. However those friends  friends were not too enthusiastic about it, and anyway, just a groups of friends would not provide the necessary group size for the system to take off.
  • In our startup: win. We have a time based compensation system going in the startup company that I'm involved in. Every one of the founders records their working hours, enters it into a (self-developed) web based software, and the system always attributes a share of the company's total gain according to the total work hours. So, all time is valued equally, including re-valueing past work times as the company's financial results change. It's my best experience with practical time banking yet, works really smooth and we never had to talk about or even quarrelled about money in our startup.
  • Bitcoin: interesting. As another part of alternative currencies, I'm involved in Bitcoin - but not mining or speculation, which are the main activities in the Bitcoin economy so far. So for now, I'm experimenting with it a bit, like buying things on for Bitcoins, and also I plan to accept Bitcoins in a webshop that I'm running.

Note to Policymakers

As shown above, Local Exchange Trading Systems and timebanks are value transfer systems that overcome personal liquidity issues entailed in the bank-centered system of legal tender. They offer economic development options amidst all the current economic collapse and high unemployment, potentially also triggerig a revival of the formal economy. So it is proposed here to enact EU-wide regulation that gives non-profit status to local currency initiatives, not taxing any transaction happening there. (This exemption can be limited to individual self-supply transactions; there is no need to allow big business, as local currencies are intended as a means of self-help in tough times.)

Such policy has already been exemplified in Greece in September 2011. Quoting the NY Times:

“Last week, [Greek] Parliament passed a law sponsored by the Labor Ministry to encourage the creation of “alternative forms of entrepreneurship and local development,” including networks based on an exchange of goods and services. The law for the first time fills in a regulatory gray area, giving such groups nonprofit status.” [source]

Call for Opinions: Timebanking on Edgeryders?

This nice idea was raised by lucyanna in the original discussion:

“It would be great for this community to actually test a time-banking system, this will help us all understand in a practical way how alternative currencies work.”[source]

Personally I’d welcome an Edgeryders time-bank - because I’d fill more into the “haves” and “needs” profile sections if I knew that mutual compensation is ensured.

Now, fellow Edgeryders, we need your opinions: Do you think this is feasible, do we have the “social critical mass” together for it? Do you think this experiment would provide valuable insights and / or relevant practical use value by means of mutual help? Would you want to participate? Alberto is open for such an experiment on Edgeryders in principle, but I’m not an expert to know if we as a community are in a position to make this a success. So please tell us what you think!

(What I could contribute is the tech part. I found a comfortable and free software that just fits: mutual_credit Drupal module. Drupal is the software behind the Edgeryders site, and this is a program tailored for Drupal to provide time banking and / or a barter point system.)


Ok, this is hot stuff

Matthias, I am on the road and can’t look up all the references right now. But this is a very high level contribution, and I am giving you 250 extra reputation.

Now, a heartfelt piece of advice: ping currency-minded Edgeryders (those that you mentioned, plus at least hexayurt - you want to ask him to recommend someone else as well, maybe Smari is interested - and jacky).

I propose that you join forces to design a currency experiment that we could try and run - perhaps at the Strasbourg conference. If you can come up with something you like, we’ll propose it to the community. If not, it will be  good discussion. How’s that?


Very interesting post

Thank you for all the useful information.

I think time-banking is in theory the one option that obliges everyone to play fair. I might be wrong, though. Can time-banking go wrong ? (fraud, abuse, unfair gains ?). I am not an economist, this is the reason why I might feel enthusiast about things I only half understand. Still, I love the idea of encouraging people to give away for free or in exchange for their time.


Can time-banking go wrong? Frankly, I don’t really know. An opinion, anyway:

I haven’t heard about cases of fraud so far, and the overall risk is relatively low in case of a system where time balance is (restricted to) be close enough to zero. Means for example, I could either have at most 500 hours credit or debts, but not more, so could at least lose 500 in case of system default.

Because default seems like a possible option, as time-banking is a credit scheme - so if some contributors with time debts refuse to pay back in future work and leave the system, the loss has to be managed somehow. Right now, this seems rare because time banks are local systems and people can develop trust, and are generally made up of honest time-banking enthusiasts anyway. Personally, I’d be wary however to save all time for old-age care in one time bank, for example (such schemes exist, but that would be too risky for my taste).

Maybe somebody else can comment who is involved into a specific local time-banking community.


Thank you. So time-banking is pretty safe. That’s how I thought it is. I think time-banking also promotes socialization and human interaction, while electronic currencies do not. Am I wrong to assume this ?

Right to assume so, lucyanna. Timebanking always includes providing a service to each other and needs a cohesive, trustable (so relatively small) community to work. Both good for socializing.

“Electronic cash” currencies like Bitcoin however provide ease of global transfer and trading with lower trust requirements worldwide (you only need to trust for this one transaction to go right, not for somebody to pay back all time debts to the community eventually). Moreover, esp. Bitcoin provides a great community by itself around the technology, in case one is into that; there are some hundred little Bitcoin related startups (I guess) and a lot of creative minds in there. But it’s a tech community about Bitcoin, not about the services possible by paying in Bitcoin.

Bitcoin is interesting, but…

Bitcoin is fun to watch, and at some level, all any currency needs in order to be able to work is to be untraceable, be in reasonably constant supply, and tradeable for goods people want. In Bitcoin’s case, a significant amount of its demand is due to the ability to use it to trade for illegal items (such as stolen credit card numbers.) This probably doesn’t augur well.

I’m also a little sceptical that it’s as anonymous as claimed though, given the distributed way bitcoins are generated.  The real test is when people begin lending schemes with it, since much as we dislike it some level of debt is vital for social organisation. But as i said, it’s fun to watch. Bear in mind if you use it that the most important rule of any exchange is “Caveat Emptor” - Let the buyer beware.

As you say, timebanking is also not without its own problems, since it doesn’t really pay attention to the most important service provided by market based monetary systems which is allowing relative demand and scarcity to be automatically computed on a distributed basis through the price level.

Silk road

The main exemple of what Jacky says is “Silk road”, the underground website where you can by any drug imaginable. Usable and completely anonymous website. User pays in Bitcoin and everything’s done. The website also explains how to get your drug “chez toi”.

And also anonymity is the way to send email if you don’t want to reveil yourself. And say what? You can blackmail someone


you can also send info that your government don’t want to spread out! Lobbies are full of secrets and I’m not talking about Coke’s receipt.

Anonymity is the only mean that the weak has against the rich.

The mind of a Bitcoiner

In another thread, lucyanna asked if using Bitcoin is rewarding to me personally - given that it has none of the advantages in money supply that barter currencies / time banking has.

I would say, yes, Bitcoin is rewarding to me because it feels as being “our own money”. The people’s money. Let me explain:

  • It's not central banking money. In the case of the Euro, the ECB has the ultimate say, and a "user" of the currency doesn't have any influence on what the ECB does to it (LTRO, LTRO2, Target2 credits, Emergency Liquidity Measures). All that may be with good intentions to keep the economy up and running, but it dilutes the currency to the point where people I know don't keep their earnings in Euro around ... . Bitcoin excludes this by an upfront design contract right in the software: there will never be more than ~ 20 million Bitcoins around, there's no way to bring money supply inflation to Bitcoin (except >50% of users agree on the change).
  • It's not corporate e-currency. There are all kinds of issues with the most widespread e-currency today (PayPal). We use it in an online shop, but dislike it. PayPal takes 1.9% for receiving money [source]. Given a trade margin of, say, 25% of final price, this amounts to 7.6% of the raw gain, just for the transfer! In the Bitcoin world, transfers are free (fees can speed up the transaction a bit, but are rarely ever used). Even worse, PayPals reversible "soft money" transactions put the seller at risk of loss because of all kinds of exploitable buyer protection policies. And that also slows down the transaction process (up to a week for larger sums!). In the Bitcoin world, transactions happen instantly worldwide, and are "validated" after one hour (6 new blocks). We will definitely start accepting Bitcoins in our webshop ...
In all, Bitcoin has many followers among libertarian and anarchist folks; they like it because it's a currency without interference and control by the state or any other central entity.

Lost again :frowning:

Ok, I’m definitely lost again here.

it’s a currency without interference and control by the state or any other central entity.

In my understanding, the reason why the State is historically better at currencies than other social actors, is precisely that it interferes quite a lot: typically, by guaranteeing that it will accept its own currency (for example, as payment for taxes). If we all the state is willing to do that, then I can always accept money from you in return for something you want from me: worst case scenario I can’t use the money for anything else, but I can use it for paying taxes and acquiring government services. That makes it safe to trade something for central bank money. Such safety is transitive: everybody knows that everybody knows that we can always use central bank currency to pay taxes, so we can all relax and accept payment  in currency.

And that’s why - as I see it - bitcoins as they are credible small change. I might accept payment in bitcoins if I am selling my bicycle, provided there are enough vendors out there that will take them. But I probably would not accept to sell my apartment against payment in bitcoins.

(oh man, here we go again) :slight_smile:

To accept is not to control

Ok, I’m definitely lost again here.

Don’t give up! :wink: Alternative economics is way simpler than everything you already understood about the mess we’re seeing in real-world economics and finance …

Actually, Bitcoiners would welcome if the state accepted their coins for tax and service payments, thereby creating the critical mass for widespread adoption. Because that’s what complementary currencies are always struggling with, so you’re right about the apartment example for now.

However, even if the state accepts Bitcoins, that would still not allow state interference and state control. Hard cryptography is in the way. Plain and amazingly impossible. (Except in a limited sense by dictating white market prices and exchange rates.) And by “interference” I rather referred to how PayPal etc. messes with individual business relationships. Accepting a currency is not really interference …

In economics, I surveyed frequent talking about the “independence of central banks from the state”, such that central banks are just to warrant currency stability and nothing else. That makes a lot of sense to me, as for example in Germany we have a sad history of how central bank credit was used to prepare for WWII. However, people are in power of the central banks, and politics regularly succeed in pressuring them to “help”. See the LTRO and LTRO2 injections of the ECB - I’m not an expert on all this, but I doubt that it’s the central bank’s task to keep an ailing economy up, putting the currency to risks of instability.

That’s why some people proposed to replace the seemingly “untrustable” central bank with a cryptographic P2P scheme. (Bitcoin is the first workable implementation, but the idea was around before.)

You might say, but then Bitcoin cannot ever help in economic recovery by means of “quantitative easing”. Probably right. but we’d still not be damned to full-length depressions: I’d suggest that Bitcoin is more the “value store” and “global transaction” currency while mutual-credit arrangements like local currencies are more those to enable economic activity and help through recessions. Different currencies for different tasks, and why not have them in parallel?

Do people who propose reform, even understand how it works?

Well - it’s an open question whether quantitative easing in the sense that most people mean (injecting more money into the system) it is really the answer - the US money supply has been expanding since 2007 (not because of the Fed, but just because that’s what banking systems do) and it hasn’t helped them much. It’s also not actually the case that that QE is expanding our money supply (people with bank deposits), it’s actually expanding the bank’s money supply, essentially the amount of money in the clearing system, and although there is a link between the two, increasing the bank’s money doesn’t necessarily increase the general money supply.

On the other hand the monetary statistics are very clear that the money supplies of Spain, Greece, and the UK are currently contracting. This is a major problem, because it causes monetary deflation (prices drop for purely mechanical reasons, not because more is being produced which is the good kind of deflation). Monetary deflation is an issue because prices of most things can adjust to the money supply over time, but one thing critically can’t - and that’s debt.

Besides the not inconsiderable technical issues with Bitcoin, the real issue isn’t the monetary unit in and of itself. It’s the debt networks that are created from it. I do get very nervous when people start throwing around all these alternative curency ideas, because the potential for them to go badly wrong is very high - 19th century American Banking is a fun study for that kind of thing.

A fascinating paper that i think everybody should read is the semi-notorious “Cigarette Paper” by R. A. Radford:

Which describes the monetary systems used in POW camps during world war 2, and the inevitable inflationary incidents caused by Red Cross parcels.

Opportunity to learn is always great to have, so let’s see what I can take from here. I’ve read the “Cigarette Paper” by now and it’s really good … didn’t know it before. Very illustrative :slight_smile:

That paper had several examples of deflationary effects due to scarcity of “cash” cigarettes - bringing economic activity down and forcing people to take up barter again etc… Taking this to Bitcoin, impending deflation is indeed Bitcoin’s most critical issue. Because with a hard limit of ~21 million coins in existence, their value would greatly appreciate if the economy indeed grows to much larger volumes of trade.

Now I’m not Satoshi; or if, I wouldn’t tell it here :smiley: (Satoshi is the mysterious anonymous  hacker who developed Bitcoin). But he or she seems to have had an analogy to gold in mind. It would’ve been simple to design a steadily inflating currency with the same crypto scheme, but Satoshi did not; others may do so in the future. On the other hand, some claim that it’s unfair that Satoshi and the few early adopters during the first 1-2 years could generate 2-3 million Bitcoins at ridiculous computing difficulties, possibly making them rich. These are unspent so far, and are indeed a serious risk for price fluctuation should they come to the market. Just like any huge volume that hits the exchange market at once (like during the 2011 MtGox hack).

So indeed there are several peculiar issues with the Bitcoin mini-economy, like there were in the cigarette economies. Uncontrolled does not mean unburdened. Fiat money without central banking is an experiment after all, and I think (hope) that nobody takes it so serious over the next few years that Bitcoin’s potential technical failure would break their neck, economically.

Apart from that, you mentioned that the debt networks created around a new currency unit are the real area of concern. That’s an interesting point, and I haven’t seen anybody in the Bitcoin community raise it so far. Indeed, if people start doing fractional reserve banking etc. on top of Bitcoin, in a totally unregulated manner, I can envision the fraud and losses … . There has been a foretaste of that already in the MyBitcoin incident, an e-wallet service where many suspect that the owner did run away with the coins stored there.

However on the other hand, is it realistic to assume that the untrustability of all the coming, unregulated Bitcoin banking services will mean that no inter-bank wire payment system will appear and instead all value will be transferred as “real” Bitcoins via the blockchain? That would essentially mean a slowly progressing but stable economy where debt cannot increase over the amount of Bitcoins in circulation. I’d hope for that.

But I see the problem you raised: people will re-invent fractional reserve banking etc., and it will be unregulated and chaotic at first, then they will call for the state to regulate it, and in the end it’s just a re-enactment of how gold standard dollars developed into today’s fiat currencies … . Hmm, good point, will have to think about it. Maye the only difference to prevent this development is that Bitcoins as the “real thing” can be as easily transferred as wiring money today, and can be easily stored securely at home by encryption; thus avoiding the need to store them in a bank and to use (alledgedly) gold-backed “bank notes” for transferring them. We’ll see.

((Regarding my notion of QE: just wanted to express that such measures of currency control, whether helpful or only hoped to be helpful, are simply absent in the Bitcoin world.))

Constant money supply’s

The trouble is, we don’t know what a constant money supply world would be like - because we’ve never experienced one - at least not for the last 400 years or so. The other problem is that you can’t just do away with debt, it does serve a necessary economic purpose - but there needs to be some kind of control on how much of it there is - which used to be interest rates, until the Economists took over.

There’s just a lot (imho of course) that we don’t understand about how these systems work - and part of the trouble there is that they’re very slow systems, and you have to measure their success or failure over decades.

Deflation isn’t necessarily bad btw. Monetary deflation is (where the money supply shrinks), but when prices drop because more things are being produced, i think that’s a sign of society growing richer.

But yes you’re quite right, QE is entirely a bandaid solution for the current banking system’s structural issues, so at least until people start lending bit coins to each other, we’re safe there :slight_smile:

Basel III, anyone?

Jacky, a technical point: in many countries, including mine, the (banking) money supply is supposedly contracting because of Basel II and III agreements (Wikipedia). Essentially, these agreements are there to make banking loans more solid (given that subprimes turned out to be a bad idea), and this means tightening up reserve and other requirements. As a consequence, almost every bank found itself in breach of Basel II (and later III), and had to call up on debtors to cancel their credit lines. This has been a major problem with corporate credit in Italy: companies, even profitable ones, found it hard to access the liquidity for day-by-day operations, let alone investments. These credit lines feed cutrrent accounts, so canceling them destroys banking money.

All Banking Systems are different…

Unfortunately, it’s a bit more complicated than that.

FIrst, there is something we shouldn’t forget. This all started when the US mortgage market collapsed in 2007. Prior to that, the US and elsewhere had been engaged in a practice called securitization (Mortgage Backed Securities primarily), which allows banks to make loans and then sell them as investments. A large number of those securitized loans were sold to European Banks.

Those loans rapidly became worthless, as the US housing market collapsed, and the European Banks lost a lot of money. (Or perhaps to be more precise, should be receiving money now from the US that they’re not.)

The now weakened European banks then got hit by the separate European crises. Some of which is caused by securitization of loans here, especially Ireland, Spain, Belgium, and I believe Italy, and some of which is caused by something by more insidious, which is that inside the Eurozone, the money supplies of the various countries, because of differences in their banking systems are expanding at different rates.

None of the Banks that I’m aware of were in breach of Basel 2, which is not exactly a very strict set of requirements when you really understand it. It basically requires that Banks have a certain proportion of capital, to back their outstanding loans, and the proportion of capital required depends on the type of loan being made. Critically, loans to Governments with AA* rating and above have a 0% capital requirement which essentially means they can lend as much money to the Government as they want. Keynsian economists rejoice.

Of course, if you’re lending to the Government with a 0% risk weighting, or to somebody to buy a house which you’re then going to sell off to a pension fund (so also no risk), the one person you are not going to lend to is some cap in hand entrepreneur who has an idea for starting a company, or even an established business that wants to expand. So over time, there goes the industrial base.

So then specifically to Italy. If the short term commercial lending market has frozen up, that’s very bad. That’s basically what the US had to intervene to prevent in 2007 and was what led to the TARP program (which may well be what Europe now needs to do). Although, I do question the business sense of the people involved, in relying on borrowed money for short term liquidity.

Looking at the Bank of Italy’s latest statistics, here:

it’s not entirely easy to wade through, but it looks like there is a very slight contraction over the last couple of months in the money and loan supply, and probably more significantly they are not expanding as fast as they were. But this shouldn’t effect the short term market to the extent you’re said. It probably is enough to cause problems to one specific class of business, which is the economic niche occupied by people who borrow money, and make just enough profit to pay the interest on their debt, and take out a new loan to avoid repaying it. The 50% bad debt ratio on the securitized loans is rather eye popping too.

What’s really interesting is on p18, the reserve requirement appears to have been dropped, as of February 2012, and on p19 the negative Intra-European Net claims. This gets nasty to explain, but basically banks have their own accounts with each other, and when our deposit money is moved between banks, this is what’s used to actually transfer the money. From that table it looks like there’s a fairly sizeable net flow of money out of Italy, and that will cause fairly major problems with lending by the Italian banks, because they have to also take that into account when the make loans. If you want to get into the guts of how that works, I just posted a very technical paper trying to explain it on arxiv:

So if i were to guess, and that’s all it would be, it’s that that’s where the real problem is. But who really knows. When you get into it this, this thing is a monster, and i don’t honestly think anybody really understands it properly.

Wow, thanks!

Thanks for taking the time to explain all this.

Well, the reason why the banks were not in breach of Basel II is that they called around to recall outstanding loans and refused to make new ones. And yes, that’s tough, but the whole point was to increase capital requirements. In principle, of course, banks could have gone to shareholders and ask for more capital, and some did, but in a recession there is just not going to be enough capital to go around in the short term. So they balanced it by reducing outstanding loans. I am talking of what I heard from various people that work in industry and baniking starting 2009, not specifically of the last few months.

To get commercial lending unstuck the ECB used, in my understanding, an operation called LTRO (two actually), as I am sure you know well. It did work to a point: the situation improved. But in the end, not sure it actually solved the problem: banks did what banks do in Italy, which is “when in doubt, buy sovereign debt”. Only, they did it at an extraordinarily bad time for that…

Capital Requirement increase is being phased in

The increased capital requirement is being phased in, and doesn’t really take affect for several years. Also, it’s not that hard for Banks to increase capital - they can do it from their own profits if they want to - and they only have to increase it as a small fraction (between 1/10 and 1/20 or more) of their total loans. However, if they take sufficient loan losses then that they can’t cover them from profits, then it does hit their capital, and of course the multiplier relationship is fatal when it goes into reverse. Which is why the high securitization losses are so interesting.


Banks are also restricted from lending by something called “liquidity” which is essentially the amount of money they have within the clearing system, and on deposit at the central bank. This is a completely different set of restrictions on lending - and what i was getting at with the issue of money being transferred from Italy in the Bank of Italy’s report. That’s a more likely explanation for the short term market to seize up.

Part of the problem is that economists don’t seem to want to think about there being a ceiling on the total amount of debt any society can support, and that this gets split between government, business activity and personal activity. If you allow or encourage governments to borrow excessively it comes out of the economy somewhere else.

No, it does not add up

Interesting explanation! But if it were so, you would expect to see negative Intra-Eurosystem claims strating from much earlier, when companies started to feel the crunch (2009). Instead you see it starting from mid-2011. I guess this is people losing faith in the system and investing in safe assets abroad, like German Bund. Possible?

As for increasing capital, in 2009 there was not a lot of banking profit to go around. Anyway it is totally possible that some banks just used Basel II as an excuse to get rid of “bad clients”.


It looks like it was dropping steadily from 2009…

it’s hard to say. In terms of monetary expansion(and unfortunately i only have comparative figures for 1999-2009), Italy is about in the middle at 2x over that period. Germany by comparison is 1.37, and Spain is 3x.

So very approximately, that means things are getting cheaper in Germany and more expensive in Italy and especially Spain, just because of differential expansion rates. So some of this could just be shopping being displaced over to Germany, and consequent flows of funds.

So yes, some of it could well be investment of people moving money out.

Then there’s the fairly high rate of securitization - which probably means that there’s a not insignificant flow of money out of Italy due to loan repayment.

I haven’t looked at Italian banking profits - but one of the inherent moral hazard problems with banking is that they can either pay out bonuses, and excessive salaries or use their profits to build up their capital and rely on the EU to bail them out…