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Ultrahedge™ is a Long Finance Production of a McDowell/Mainelli Film in association with Interactive Investor & Z/Yen Group Limited. Starring Luminiferous Ether as Ultrahedge™, the film is based on the bestselling novel “The Road To Long Finance: A Systems View Of The Credit Scrunch” by Michael Mainelli and Bob Giffords, with a screenplay by Steve McDowell and Michael Mainelli. It has been produced by iBall TV and Steve McDowell, directed by Steve McDowell and edited by Richard Noble, as part of the Long Finance movement.
On 31 March 02010 Ultrahedge™ premiered at 8 Members Club courtesy of iBall TV.
The film is an intense three minutes long and is now on global release. Plot synopsis: "Imagine a world devastated by financial crisis, one in which liquidity and debt are impossible to come by. It is a world created by greed, fear, finance, erratic mathematics, unpredictable weather and human existence. There is a way to fix it all, and it has been discovered and developed by large brains in white coats - Ultrahedge™."
Watch the trailer Warning: longer than film
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[An edited version of this article first appeared as “The Eternal Coin – Made From Real Money: Risks In Fiat Currencies”, Journal of Risk Finance, Volume 11, Number 1, Emerald Group Publishing (January 2010), pages 111-116.]
Something threatens the entire global financial system: the entire global financial system. We place our confidences in a number of conventions. According to Con Keating, “In order for financial markets to function it is necessary that uncertainty is bounded. Unfortunately there is always some ineradicable uncertainty in the world. In order that markets may function, we (collectively) adopt a convention that we will ignore this uncertainty so that we may reap the gains to trade while hoping it doesn't all unwind… But every so often, it really does become obvious that the uncertainty isn't bounded to a comfortable extent, so we all go home and refuse to play.”
One overlooked convention at the core of the global financial system is fiat currency. So let’s talk about it. Fiat money is any money whose value is determined by legal means, rather than the strict availability of goods and services which are named on the representative note. Typically, these legal means have been that the money is acceptable for the payment of taxes. Fiat money is created when a type of credit money (typically notes from a central bank, such as the Bank of England) is declared by a government act (fiat) to be acceptable and officially recognised as payment for both public and private debts. The early modern approach to money has been fiat money.
Perhaps the post-modern approach to fiat currency has been the credit created by private sector leverage and fractional banking under the watch of the central banks. And what a lot of creation! As Professor Niall Ferguson notes: “By the end of 2007, 15 megabanks, with combined shareholder equity of $857 billion, had total assets of $13.6 trillion and off-balance-sheet commitments of $5.8 trillion – an aggregate leverage ratio of 23 to 1. They also had underwritten derivatives with a gross notional value of $216 trillion – more than a third of the total.” [“There’s No Such Thing As Too Big To Fail In A Free Market”, The Telegraph, 5 October 2009]
The University of Toronto economics professor Harold Innis (1894-1952) was influential in developing modern theories of communication. He dwelt on the interaction of empires and communication. His theory was that the media people choose affect the shape and durability of their society. He divided media into two types, “space-binding” and “time-binding”. His most famous example is the distinction between space-binding papyrus and time-binding stone.
“The concepts of time and space reflect the significance of media to civilization. Media which emphasize time are those which are durable in character such as parchment, clay and stone. The heavy materials are suited to the development of architecture and sculpture. Media which emphasize space are apt to be less durable and light in character such as papyrus and paper. The latter are suited to wide areas in administration and trade. The conquest of Egypt by Rome gave access to supplies of papyrus which became the basis of a large administrative empire. Materials which emphasize time favour decentralization and hierarchical types of institutions, while those which emphasize space favour centralization and systems of government less hierarchical in character.”
[Innis, 1950, page7]
Given Innis’ theories we should expect our extremely light information age to emphasise centralisation and less hierarchical government. So is money just communication? Interestingly, Innis influenced his vastly more famous Canadian colleague at the University of Toronto, Marshall McLuhan. In the same book that McLuhan points out that “the medium is the message” and spots local culture being overwhelmed by globalisation, Understanding Media, he too touches on money as a medium of communication:
“… money is a language for translating the work of the farmer into the work of the barber, doctor, engineer, or plumber. As a vast social metaphor, bridge, or translator, money - like writing - speeds up exchange and tightens the bonds of interdependence in any community. It gives great spatial extension and control to political organization, just as writing does or the calendar. It is action at a distance, both in space and in time.”
[McLuhan, 1964, page 136]
‘Money as communication’ begs the question of whether money is space-binding or time-binding. An old economics rhyme for money is “Money is a matter of functions four, a medium, a measure, a standard, a store.” Modern definitions of money tend to be more fastidious, stating that money is a medium of exchange with two properties – it can be used as a unit of account and it can be used as a store of value. My personal definition is that “money is a medium to exchange value across space and time”. This definition highlights the point that money must diversify value across space and time, geographical diversification and temporal diversification. Equally, this diversification connects the holder of money to risks across space and time. A simple demonstration is that if you hold a nation’s currency, you are connected to the risks for that country. If you hold a company points card, your points are only of value as long as the company exists and agrees to honour them.
One can rapidly conclude that money is both space-binding and time-binding. To be a useful unit of account, the reckoning of money must span space and communities. To defer payment, the value of money must span time. In short, non-barter transactions communicate across space and time, and import risk across space and time. A coin in the hand is clearly connecting us geographically with others in the world, and simultaneously with future generations. So truly “money makes the world go round”.
“How does noise affect information? Information is, we must steadily remember, a measure of one’s freedom of choice in selecting a message. The greater this freedom of choice, and hence the greater the information, the greater is the uncertainty that the message actually selected is some particular one. Thus greater freedom of choice, greater uncertainty, greater information go hand in hand.”
[Shannon and Weaver, 1949]
When we have tremendous freedom of choice, we have tremendous uncertainty. So paradoxically, the more that money is a medium to exchange value across more space and more time, the more uncertainty it must contain. At the extreme, an Eternal Coin, a coin that will always be accepted at never lose its value, must simultaneously connect us with all the risks of geography and time, and all the uncertainties society holds about the future.
Recently, the Euro debate has raised its head – should some countries join the Euro who are out and hurt by the financial crisis (e.g. Iceland, the UK), should some countries leave (e.g. Italy)? This debate highlights an interesting related question for a currency – how much you do or don’t trust politicians. At one extreme, if you don’t trust politicians, then you’d like their hands as far from the levers as you can. A gridlocked entity with strict rules and over 30 nations participating is almost ideal to ensure they can’t muck around with the currency. Yet, if you do trust politicians and they are very close to your community, why not give them more control of the levers of the economy and even bring out your own local currency?
There are alternatives to fiat money, when people voluntarily agree to exchange in a medium rather than use the legally enforced medium. There are numerous proponents of local currencies such as Ithaca dollars, Brixton Bricks or Manchester Bobbins. One popular approach is a local “time bank” where people can swap hours of each other’s time. Jorge Luis Borges said, “You can’t measure time in days the way you can money in dollars because every day is different.” Despite Borges, for every hour you spend helping someone at Rushey Green, you are entitled to an hour’s help in return. Rushey Green Time Bank was one of the first of its type to be established in the UK, and since 1999 it has proven to be a radical, empowering and transformational form of volunteering that gives self-confidence and stewardship to people who had previously been passive recipients of care or marginalized. Local Exchange Trading Systems (LETS) such as Rushey Green Time Bank are trying to link up; there is a UN programme, UNILETS; there is a shareware system, Ripple. While time banks are an excellent example of community exchange, they supplement rather than supplant traditional money.
Still, in this age of Credit Crunches, an hour of labour stored in some of these time banks doesn’t sound so stupid when we hear the wild fluctuations in the value of government-based currencies. One interesting way to look at corporate risk management is that many companies outsource their medium of exchange to nation states. Companies depend on government to exchange value across space and time. A company that uses 10 barrels of oil and 10 tonnes of steel to produce 10 widgets per year worth a combined 15 barrels of oil and 15 tonnes of steel might sensibly choose to manage risk by storing 10 barrels of oil and 10 tonnes of steel this year. The extra five barrels of oil and five tonnes of steel could then be exchanged in monetary form for distribution in wages or as profit.
Unfortunately, both oil and steel fluctuate against all currencies, so companies need to manage it. Further, currencies fluctuate against other currencies. Governments steal value from the future store of value via inflation. Suddenly, any large company finds itself devoting a fair chunk of resource to managing its money. Large treasury units are expensive to run and maintain. They can also be dangerous. The more inept governments become the more the company needs to manage its outsource arrangements. In most other cases, the company would fire the outsourcer or re-contract the outsourcing assignment or bring the value storage task in-house. Some people would argue that major currencies such as sterling, the dollar or the yen have been mismanaged over decades, and the recent financial crisis just highlights the mismanagement more than usual.
A partial inspiration for this article was reading David Boyle’s 1999 book Funny Money whose publicity states, “Only our limited idea of money is keeping us poor”. So some companies are restructuring their ‘outsourcing’ relationships, if unconsciously, in two ways. First, they are examining other currencies. For large corporates, local exchange trading systems are unlikely to supplant fiat currencies as local currencies would probably require even more management. Another approach to currency is to rebase the corporate accounts in another unit of account, e.g. Special Drawing Rights (SDRs, an IMF currency basket). Some Asian countries are discussing alternative SDRs. This naturally leads to more business-related baskets, such as a basket of commodities. A long-term proposal has been Bernard Lietaer’s Terra, a currency he would base on a basket of the twelve most important commodities in world trade. Another attempt to produce a less volatile world currency unit has been launched as the Wocu, a tradable derivative of the exchange rates of the World's top twenty currencies as measured by GDP.
Second, some compajnies are bringing more tasks in-house. As a start to bringing currency management in-house, companies and groups of companies can develop their own currencies. Technology is lowering those barriers. Not surprisingly, given the harsher conditions, these newer currencies are emerging earliest in developing countries. Widespread successes include Africa’s M-Pesa, Zap, Wizzit, or Celpay and the Phillipine’s Gcash or Smart Money. Of course, telcos globally are well-suited to supplanting monetary systems and have been circling around this area for years, think Western Union. Bringing money in-house sounds absurd, but of course that’s what full-scale risk management involves across the company – maximising return by storing value so that the company purchases in the lowest ‘currency’ and sells into the highest ‘currency’. Cheap oil and steel today, more expensive widget markets tomorrow. It may well be that the larger corporates, perhaps beginning with the larger mobile phone companies, begin to issue their own currencies. Then we would have a shadow currency system to replace a shadow banking system.
One interesting thought experiment, the Eternal Coin, has been suggested by Z/Yen Group and the Long Finance project. The aim of the Long Finance project is “to improve society’s understanding and use of finance over the long-term”. Long Finance is a collaborative vehicle dedicated to creating long-term finance from an intellectual and systems perspective. A “kitchen cabinet” of enthusiasts and visionaries from different organisations, many senior individuals from traditional capital markets backgrounds in investment management and banking, but also journalists, Sharia financiers, government officials, regulators and academics, intends to move commercial, regulatory and government thinking from responsive to anticipatory and from local to global.
The iconic focus of Long Finance, comparable to the Long Now’s focus on the Clock of The Long Now, is the paradoxical concept of Enduring Value expressed as The Eternal Coin. The Eternal Coin is a discussion project where people try to build the coin best suited to the long term. The Eternal Coin project should be explainable to the ‘man on the street’, and link through most of the research. Imagine a website where people can create their own currencies and talk about what enduring value means in a sustainable financial system. Will it be combinations of bonds or shares or commodities or forestry or land or ‘peak’ – a basket currency weighted by the remaining life of key resources - or water or carbon or the dollar or Euro or yuan or SDRs?
Eternal Coin logos are based around a Möbius strip – the coin you can’t flip because it has one side. The coin’s motto is “Real Money, Made From Eternal Coins” and “Eternal Coins, Made From Real Money”. These days it’s tough finding Real Money in many fiat currencies. Mobile phone applications might permit people to trade their own personal currencies. Of course a Möbius strip is also without end, an endless conveyor belt from the past to the future. Money as a medium to exchange value across space and time cuts to the heart of what our society values. The aggregate Eternal Coin, the summation of the underlying commodities, currencies and other things of value, would encapsulate the hopes and fears of everyone in the project. If people believe enduring value is in oil, then oil will feature strongly. If people believe the world is going to go clean-tech, then perhaps carbon emission permits will feature strongly.
The Eternal Coin would be a reasonable projection of a global scenario plan. If you had an Eternal Coin, would you need to invest or could you just save what you needed for your retirement? A coin that buys five chickens today should buy five chickens tomorrow. This Eternal Coin global thought experiment forces us to debate what will be of value to our great great grandchildren. People have been able to sell gold, pretty but mostly useless, to their great great grandchildren ever since the Lydians invented gold coins some 2,600 years ago. Will it be oil or renewable energy for us? Intellectual property in films, stories and art, or property in land and buildings? What will society value in the future?
Commerce only exists within the context of social communication. From Marshall McLuhan again:
“In a word, money is not a closed system, and does not have meaning alone. As a translator and amplifier, money has the exceptional powers of substituting one kind of thing for another.”
[McLuhan, 1964, page 142]
What McLuhan notes is that Commerce and commercial transactions and money are inextricably linked to their societies. This implies that antiseptic, neutral exchanges of currency don’t exist. Each transaction with another person links us just a little bit more to the other person’s societal mores, and them to ours. Increasing the number of monetary transactions results in increasing degrees of trust, and equally raises the spectre of a single point of failure – loss of trust.
And a final observation is to point out the potential terrors in ‘money as communication’. Like “The poor Babel fish [in The Hitch Hiker’s Guide To The Galaxy], by effectively removing all barriers to communication between different races and cultures, [money] has caused more and bloodier wars than anything else in the history of creation.” [Adams, 1979, page 50]
ADAMS, Douglas, The Hitch Hiker’s Guide To The Galaxy, Pan Books (1979).
BERNSTEIN, Peter L, The Power Of Gold: The History Of An Obsession, John Wiley & Sons (2000).
BUCHAN, James, Frozen Desire: An Inquiry Into The Meaning Of Money, Picador (1997).
INNIS, Harold, Empire and Communications, Oxford University Press (1950).
MAINELLI, Michael and GIFFORDS, Bob, "The Road To Long Finance: A Systems View Of The Credit Scrunch" , Centre for the Study of Financial Information, 62 pages, ISBN: 978-0-9561904-4-4, (July 2009).
MCLUHAN, Marshall, Understanding Media: The Extension of Man, Gingko Press (1964).
SHANNON, C E and WEAVER, W, The Mathematical Theory of Communication, University of Illinois Press (1949).
My thanks to numerous people, but especially Bob Giffords, Con Keating and Jan-Peter Onstwedder for checking the sanity of some of my thinking. This article contains extracts from two lectures given at Gresham College, “It’s A Mad, Bad, Wonderful World – A Celebration Of Commercial Diversity” on 17 November 2008 - http://www.gresham.ac.uk/event.asp?PageId=4&EventId=801 - and from “Local Or Global? Network Economics And The New Economy” on 26 January 2009 - http://www.gresham.ac.uk/event.asp?PageId=4&EventId=823 – so thanks are certainly due to the Gresham College community.
Z/Yen operates as a commercial think-tank that asks, solves and acts on strategy, finance, systems, marketing and intelligence projects in a wide variety of fields (www.zyen.com), such as developing an award-winning risk/reward prediction engine, helping a global charity win a good governance award or benchmarking transaction costs across global investment banks. Z/Yen’s humorous risk/reward management novel, Clean Business Cuisine: Now and Z/Yen, was published in 2000; it was a Sunday Times Book of the Week; Accountancy Age described it as “surprisingly funny considering it is written by a couple of accountants”.
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Market Indices for London Insurance
Call for Participation
IndeZy is a Z/Yen project to evaluate the feasibility of establishing price indices and process benchmarking in wholesale insurance.
The London wholesale insurance market lacks a vital ingredient, public price information. Markets consist of people trading something with each other and some evidence of prices. In the London insurance market brokers and underwriters trade, but the market lacks clear price signals and is, consequently, rather opaque. This opacity diverts business from London.
The insurance industry is under increasing cost pressure and regulatory pressure. Clients seek evidence that the industry is genuinely cost competitive. Regulators want assurance that market reforms are working. More authoritative evidence would come from prices that in turn forced more rigorous benchmarking of processes and costs.
In contrast, the investment banking sector is price rich and over the past 15 years has developed several process benchmarks managed by Z/Yen Group (Z/Yen). There are global Z/Yen cost/transaction benchmarks on equities, derivatives, FX and money markets; quality benchmarks on the operational performance of brokers (the sell-side); and process benchmarks on the operational performance of clients (the buy-side). Can we have similar prices and benchmarks in insurance?
A great opportunity beckons, indices for policies and claims. If the insurance industry had reliable indices, then capital markets could use those indices to provide tradable markets for policies and claims. Tradable markets in policies and claims would allow customers to hedge and underwriters to improve the use of their balance sheets. For example, a large marine or aviation customer (shipping company, airline) could hedge against a rise in policy costs next year. An underwriter might want to hedge against a rise in claims, thus reducing regulatory capital requirements. Indices would permit an enormous, liquid market in price movement making the insurance industry more profitable and safer.
There are significant movements in insurance prices, and thus opportunities to provide hedges against those price movements. An insurance hedge would be of interest to:
finance directors of large corporates who wish to control insurance cost volatility;
reinsurers who may wish to hedge price movements across periods;
brokers/underwriters who wish to offer options, perhaps for a limited period of time, on policies;
finance directors of insurers seeking to optimize regulatory capital requirements;
brokers/underwriters trying to hedge returns on new product launches;
investment bankers seeking to stabilise prices in deals.
However, insurance prices are difficult to express simply. Policies contain specific clauses and exceptions; they are not commodities. What is needed is a trustworthy index that gains acceptance as a valid indicator of true prices over time.
Indices would need to be offered class-by-class for policies initially and later for claims. There would be a taxonomic tree of standard contracts, e.g. a 5,000 tonne marine hull, a Y tonne hull, likewise similar standard contracts in aviation, etc. After indices gain acceptance, then products such as forwards, puts and calls can be offered against the index. The long-term model is to charge for services such as:
licensing to launch products linked to IndeZy indices;
Entire books have been written on benchmarking but, in a nutshell, benchmarking is a process comparing two or more business processes in order to understand how to improve them. Processes can be compared within an organisation (e.g., a multi-national contrasting finance processes in subsidiaries in different countries) or among different organisations (e.g., a club of companies sharing information on their finance processes). Good benchmarking has been the starting point of many successful change programmes. Equally, poor benchmarking has scuppered change programmes or has overlooked opportunities for improvement.
Organisations obtain benefits of many different sorts from benchmarking:
cost reduction and quality improvement: by understanding where your organisation stands on cost/transaction and process turnaround, you get an overall measure of performance and an indicator of where effort should be placed, e.g. cost-reduction or quality-improvement;
new levels of performance: learning about other organisations expectations in order to set your own. One investment bank with which Z/Yen worked set about contrasting their product control with internal audit, sparking a healthy internal competition in efficient practice;
new targets: seeing what others expect and how they measure it. In one instance, an organisation which thought of one process as an overhead, turned its measures into those of a profit centre;
new ways of working: learning tools and techniques from others. One organisation started using cost/benefit analysis to determine the areas of greatest potential benefit from risk management techniques. The emphasis of risk management was shifted from large risky projects which had full-time project management attention to more mundane operational work activities. Another organisation started to require demanding incident reporting times;
new roles: changing process objectives and structures by understanding best practice. Many organisations find that benchmarking leads them to adopt new techniques such as genuine profit centre deductions or more formal management systems, e.g. ISO9000.
A Benchmarking screen might look something like the following examples from the capital markets:
Current ACORD messaging could already provide important benchmarking information, e.g.:
process times time to write a policy, etc.;
process outcomes policies written, quotes unused, failures, etc.;
process efficiency messages per policy written, etc.;
policy analysis breakdowns of amounts, classes, brokers, etc.
Z/Yen would also like IndeZy to provide pricing and anomaly detectors at data entry points for participating underwriters and brokers on a field-by-field basis using its PropheZy risk/reward software. PropheZy works on an historic data stream to predict what seems sensible, e.g. this policy seems to have been under-priced given what PropheZy has seen to date. The screen below is a sample of PropheZy detecting anomalous equity trades:
IndeZy the Project
Z/Yen has held discussions with numerous organisations, e.g.:
capital markets investment banks, exchanges and index providers;
capital markets technology companies;
insurance markets suppliers IT providers, messaging and hub providers;
Our objective is to see whether a reasonable sample of trades between underwriters and brokers permits us to estimate prices accurately. This would be a statistical study. Similar work in other traded markets has shown that a small sub-set of information can rather accurately predict prices. The IndeZy project seeks information either from a set of underwriters and brokers, or from a messaging information/hub provider, or from a core market organisation.
The most important proof-of-concept is not discussion, but to get a sample of actual insurance policies and prices to see if the information content is rich enough to predict prices.
Z/Yen welcomes discussion on any aspect of IndeZy. For further discussion on any of the above, please contact:
Professor Michael Mainelli
Z/Yen Group Limited
5-7 St Helens Place
London EC3A 6AU
tel: +44 (0) 207-562-9562
as well as specialist studies such as:
Z/Yens clients include virtually every significant global investment bank as well as numerous key financial firms, such as: