Counter intuitive = Low rates / ZIRP/NIRP policies are actually bad for economy

We are told that when interest rates are too low, they are encouraging entrepreneurs to take risk. So we have low interest rate policy LIRP, Zero interest rate policy, ZIRP and negative interest rate policy NIRP.

However, these policies impacts the business models differently. At one end are business models, like infrastructure projects, that cannot add threshold value in the initial years of the venture. The low interest rate regime, allows a valuable gestation period for such business models. Often, government artificially lowers interest rates for such projects. At the other extreme, there are weak business models, those that are viable only in low return scenario. These business models, however, die out once the interest rates start rising. In between, there are experimental and innovative business models. Some of these use the low interest rate period to forge better, more robust models. Such businesses thrive later. Others, however, end up going bust. The role of banks is to identify each of these business models and fund them while appropriately mitigating the risks. 

How low interest rate leads to mal-investment 

A bank takes risk by investing in a venture. Interest rate is also a reward bankers get, for taking the risk. Ideally, even in lower interest rate scenario, those projects with best risk-return trade-off should get financed. 

However, in reality, lower yielding large borrowings backed by reputed corporates get access to financing more easily than new ventures. This means, irrational mega-projects or mal-investments of large corporates get financed at the cost of genuine investments of new ventures. Typically, such irrational mega-projects consume a lot of credit requiring load syndication. This has twin benefits for bankers. 

First, there is a higher degree of comfort in being with the herd. Secondly, bankers do not have to go through credit appraisal of many small entities of questionable risk profile. This makes them assign a lower risk to these projects than appropriate. Intelligent investors will find that this contradicts with the "diversification as risk management" strategy. But being with herd has a stronger lure and is treated as risk mitigation (though wrongly).

Further, at lower interest rates, debt starts being used as an instrument to amplify equity returns. With unchanged return on capital employed, you can have higher return on equity when return on debt reduces. Return on debt is function of interest rates and lower share it claims from the total returns made by the firms. 

Thus the second blow to new ventures comes from crowding out. It implies that even in a low interest rate environment, small businesses and entrepreneurs may not have access to lower cost capital. Therefore this impacts the long-term strength of the economy. 

In high interest rate scenario, the irrational mega-projects seem less promising. Hence, contrary to popular belief, it may be easier for smaller businesses to compete in high interest rate scenarios.

This is particularly true when there is some demand in the system.

What happens when there is no demand?

When there is no demand in the economy, low interest rates / ZIRP / NIRP etc are said to stimulate this demand. This, to my simplistic mind, sounds like offering desserts to the already overfed diner  (AOD) with the hope to eliminate world hunger. Let me explain.

We hope this AOD, when offered with a free desserts will take them and pass them along to the hungry. In this method we depend on the magnanimity of intentions of our already overfed diner. Then we presume he shall act on his instincts and find worthy hungry who can transmit the benefits to others. It is quite possible our Glutton may pass the desserts to his friends or family and each can be a little more fatter. Are we, then to wait for all the gluttons to be severly beefed up or porked up before the trickle down starts to the hungry?

It sound like bull-shit method to me. Particularly I cannot understand why you are preventing the hungry from feeding themselves - either by employing them or letting entrepreneurs do it by financing them with reasonably priced debt/credit. These entrepreneurs are left to finance their ventures with credit cards, overdrafts and other very high cost financings at considerable peril. Now since these financing schemes are not on the business side, they are paid out of the post-tax income generated by the firm (but they should have been tax deductable at firm stage itself). This is doubly onerous for the entrepreneurs. 

Treat Interest rate like friction

A better model is to think of interest rate like engineers think of friction. Some is good, too much is bad, too little is bad too. In fact friction analogy should be best suited for determining neutral rate of interest. 

Economist too think of interest rate as friction. To the economist - road mileage of the car represents growth, fuel represents capital availability or liquidity. The economists' metaphor of friction is flawed. They need to get their metaphor right.

Engineers will tell you - you need to maximize friction at the tyres and eliminate it from the engines. At the clutch and brakes too you need friction. So you need interest rates high at some places and low at some others. So Economists better figure out where you want low interest rates and where you want high interest rates. Note the question is where not when. 

In Sum

The hazards of the LIRP, ZIRP and NIRP far outweigh the benefits. These policies do not pass the smell test. We need a better understanding of interest rate as a tool for improving economic growth.

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms". A version of this argument was made in Subverting Capitalism back in 2010 and also posted on this blog in 2012. Nothing, it appears, has changed.

Destabilised Eurasia and possibility of War - The SE Asia - East Asia equation

The events of the past few weeks and years have had a decisive geo-political point to them particularly concerning South-East and East Asia. Let me enumerate a few here. 

1. In 2015 Japanese parliament permitted their army to go aggressive( with US blessings). They have been making ships and aircraft carriers since few years ago  displayed in Aussie, Singapore, Japan and US joint exercise - small allegedly helicopter carrier or something.  
2. Last week I was seeing Singapore Air Force Fighter planes on evening patrols. Also every day they have the another surveillance plane - it is not the boeing posiedon in the air. 
3. On friday, India announced surgical strikes on terror bases in Pakistan Occupied Kashmir. 
4. Last week, Singapore PM met Japanese PM Abe. Last month he met Obama. Chinese news paper is accused Singapore of siding with US. This week Singapore PM is meeting Narendra Modi.
5. Last week Japanese PM Abe met Narendra Modi and promised him some military tech and other assistance including manufacturing assistance.
6. Phillipines has abandoned US and is courting China. Durtete made a statement that he received encouragement from China and Russia on his anti-US remarks.
7. Last month the International Arbitration Tribunal restrained China from claiming rights on South China Sea.
8. Last month Austrailia published a white paper on maritime defence highlighting the need to protect the interest in the northern coasts and in the Pacific. Australia does not have any threat from any country in the Pacific save China. It is way far out and super friendly with most of the major powers. It has a love-hate relations with some island countries where China has become active.
9. US is offering F-16 (yeah the old ones) to India for make-in-India option. (The tech is old but the offer is quite lucrative)

So what is happeneing?

China is being encircled. Japan south Korea Taiwan Singapore, Australia and India are coming together step by step. South Africa is in the mix too. Philippines has chosen to side with China - or so it seems. Vietnam is on the fence blowing hot and cold. Laos is stuck between Vietnam and China but I sense it is more pro-china. Thailand is becoming more democratic but depends on their king who is about to die or may have died. 

Since China is being encircled, it thinks it can break the mix by encircling India. China thinks it can corner India because of its alliance with Pakistan. So Pak will keep India engaged on west and china will keep it busy on the east taking India out of the equation. So a day after announcement of surgical strikes we had reports of China reducing Bramhaputra waters for dam construction.

But, on day of surgical strike Iran attacked pakistan (which is weird). Afghanistan is already sick of  Pakistan. Now Pakistan thinks it too is being encircled by adversaries. Tajikistan is not really happy with Pakistan either. But it is more worried about China. So goes for Kyrgyzstan and we come to Mongolia and Russia which surround China. 

Within China too,  in Hong Kong separatist sentiment is acting up, mostly without encouragement of the west. Then there are other prennial problems in China - including Tibet, Uyghurs and others.

So we have China trying "string of pearls" strategy around India. World trying "string of pearls" around China. 

Why India is crucial element in the mix?

India is important because it is a navy that controls the major trade routes to Europe and East america. It saves a trip across Africa. So China wants to circle indian ocean by involving Africans - twin benefits resources and strategic support. So this is a move-counter move strategy. India is but small player if you ask me. I think US is the big bro here. We are seeing Obama's east pivot in action. 

Why is China all riled up?

China is being choked economically by all - sort of as a payback for its merchentilist begger thy neighbour policy. Actually when Milton Friedman was asked about dumping of low cost products, his argument was simply it benefits the importer. It means (to me, Milton did not say it so) that after the value is over you can reverse the equations by ring-fencing the excess capacity from creating problems for you.

The second narrative Chinese use is that its almost $4Trillion US Dollar reserves may lose value and thus cause wealth loss. This narrative is easy to sell to general pulic and it will make for a good anti-US story.

This has a lot of implications for China. It may wreck it from within. An empowered peasantry   / rural-folk may bring down the corporates to its knees using exactly the same arguments that Mao used. The citizenry may become subversive when faced with no jobs, or rapid decline in wealth as a result of capacity destruction. These will be difficult to control in a country of 1.6 billion. The cost of political unrest for Chinese Communist Party is too high. That could be one reason for Chinese aggression.

The first narrative fits the bill better because of the related developments. There was no reason for announcing a "make in India" policy when there is excess global supply. Not unless the Chinese capacity was suddenly going to be unavailable. And someone could pick up the slack. Indian PM Modi saw an opportunity in this and embarked on the picking up pieces. FYI none of the Chinese investments into Make-in-India have materialized. Foxconn which promised to set up an iPhone factory has backed out. Others are mostly European and american cos who continue on.

Is China a potent threat to US?

At present China is not a threat to the US. 

It does not have a wherewithal to pick up a fight with US. At least that is the public view. China needs at least 5 aircraft carrier units to be as aggressive as they are trying to be. It has none at the moment. Big daddy US has five major assets in Pacific including Okinawa. US also has two Aircraft carrier groups in Mediterranean Sea and Indian Ocean. India has two in the Indian ocean. 

China is a threat to India. It is an ally of Pakistan and has a long border-dispute with India. India needs to be wary and after fall of Soviet Union there is no regional counter-balance. India must ally with US. There is no other way. US knows this and promoting technology transfer to Indian defence. 

China is also a threat in South China sea. It is here that US is more worried. It is claiming more land and nautical area and becoming more assertive.

The least-expected strategy for China will be to challenge US. That will be a surprise and alter the military-power equations. For this it needs some greographical spread. By itself, China has tough geography which makes it difficult for it to create big trouble that could alter global balance of power equations.

The solution - A China circle

The Chinese circle comprises China, Pakistan, North Korea, some countries in Africa, some in Pacific Oceans including Laos. These countries have received heavy Chinese aid and China supports some questionable regimes in certain regions. Phillipines is becoming a China ally. The Burmese junta enjoys some support from the Chinese.

Clearly with this motley crew China cannot take on US or other major country. But what it can do is create strategic assets in these countries from where it can create trouble. The dirty work still comes to China's share. 

The tools

If China wanted to be a credible threat it should be building at least 10 Aircraft carrier units (including cruisers, frigates, destroyers, submarines, logistics ships). A better strategy would be to build them inland somewhere in Hainan (lake) or more likely in Sichuan (totally on dry land). Then one fine day plonk these in the sea. An event like that could alter the geo-political equations quite rapidly.

Yet such kind of shifting of balance of power is not possible easily. There are pretty unpredictable players in the mix.

The no-nonsense player -Russia

Russia is sitting on the fence. The Russian approach is just like in world war 2 - corrupt but away from the mess. It will take sides when it is forced to take sides. It has hinted that it may start supplying aircrafts to Pakistan and may have helped china build their J20 fighter which is copy of the F22 raptor. Russians are playing both sides as of now. They are cooperating with the West in Arabian geographies and counter-balancing them in Asian geographies.

Their problem is that they are too close to conflicts but not too powerful to force a resolution anywhere. Even Soviet Russia would have found difficult to contain China in its present state.

Pakistan the unpredictably-unpredictable player

The issue was easy to solve if Pakistan was not a long-term US ally. Because Nehru sided with Russians, Pak went to the US and US is feeling guilty of abandoning pak even when it housed Osama. If Pakistan was just another country in the equation, the US policy would have tilted pro-India by now and we would have been in a new stable-stalemate situation. The world would be chugging along by now.

The problem is that US would always help build Pakistani capability to counter-balance India. To the US, pakistan-India parity was the policy objective. US realised it late that Pakistan was playing double game. With US technology seeping into China and the inventory falling into the terrorist hands, US realised Pakistan is not a strategic asset but a mere pawn. It is China that was the new threat.

My guess

It is possible that the China is using the uncertainity related to US presidential election to test some destabilisation strategies. They see a window of opportunity and it expires on November with elections in US as the new president (even if Trump wins) will be briefed about all important issues and most likely toe the usual line. The uncertainty will reign till November as Obama may not be able make longer term commitments right now. So we have to sit tight for 1or 2 months. This is peak of crisis as we get to see. Then big daddy will be back in the saddle and world will be back to its normal stalemate situation. If this is indeed correct, then we should see a major policy decision by the new US President immediately upon taking office. It could be a pro-India change or opening of a full-functional base in South East Asia augmenting the one in Singapore and Okinawa.

In Sum

Something is definitely going on in the SE Asia / East Asian region. 

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms".

The smart cards in smart cities

Everyone is familiar with the oyster card in London and similar cards world over. Singapore has its own ez-link card. Yet, I carry few debit cards, few credit cards, School Access card (for parents), the Museum passes, Office access card, home access card and the works. There are simply too many cards.

Too many cards that I carry SIGH!

How about just 3?

Is it difficult? Not at all. Let us imagine 3 cards. One is your all-in-one Government ID. Second is high-security-access card (HS Card)— used for all debit card / credit card processing/home access and the like. Third is a lower security card (LS Card) — pre-paid cash card, travel, office access and the like.

Well, this system is in fact easier and more cost effective to setup. The service provider (say a bank, home security system) need to do is to add the card number and details present on the face of the card itself to their system and bingo your card can now function as a Citibank, HSBC or Chase or whatever card you prefer. On the back of the card they can stick a little sticker so that I remember what cards option I have. By limiting its access you can control what data the “swiping device” can collect. So one way could be to use photo of the card. Other way would be to simply tap that card — this would allow basic data for shopping say upto $2000/-. A swipe would let you swipe more than $2000 till your limit. A house access would require a tap and pin (say).

Same goes for the LS Card too. In fact all the shops who want to give you “points” and reward your “loyalty” can do so with this LS Card. Anyone wants you to give access can enter this card number in his system and you will have access to it. This could be transport systems including taxis and buses, boats and the works. It could also be your office door etc.

The government ID card can be kept separate because of the legal issues that result in case of mishandling of the card. If some vendor makes a mistake you may lose access to your insurance or something far worse — you may no longer be a citizen. The redundancy allows for the system to be more stable than depending on simply the transaction card.

Who mentioned Apple Wallet or Android Pay?

At its best I would have Apple, Android and mobile phone manufacturers do this. Just by getting my mobile number all the companies can give me access using the phone. I should be able to share basic data with companies wanting to reward me for my “loyalty” just by sharing my phone number and a sms based pin and then it should be easy for the companies to keep rewarding me.

However, I am wary of putting ever more power at the hands of these companies. For one, it seems difficult for these systems to work together at least till now. Therefore, we have cards that are not Apple pay compliant or the shops don’t have terminal for Apple pay. These problems are easily solveable — we simply need a will to do it. It would be beneficial if these companies adopt a universal standard for such operations.

This otta make cities Smart

Now I am not a fan of smart cities focussing on useless tech without convenience. But the smart card concept we discussed above seems to be practical and it should make cities smarter, peoples lives easier.

A city state like Singapore should initiate experiment in this direction. Singapore already has its own payment standard called NETS, formed by collaboration between various banks and adopted by monetary authority of Singapore. Now all cards should be NETS compatible — debit cards, credit cards and yes access cards, transport cards etc. With this in place we will take the first step towards card utopia.

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms".

Why is QE — ZIRP/NIRP not working?

Most people wonder as to why Quantitative Easing (QE) along with low interest rate policy is not making their life easier. John Mauldin and Neil Jensen in their letters are wondering where the road to recovery is? Where is the inflation? Where are the corporate profits? Where is the growth? QE and low interest rate policy were the response of FED to the crisis of 2008. Some central banks have already gone Negative interest rate policy. But as yet, they are not working. Why? Because they are not supposed to work.

The crisis of 2008 was the result of few forces striking together — an over leveraged borrower, inflated prices of collateral and banking system with management’s hand in the cookie jar (lower provisioning and accounting gimmicks to announce record profits), resultant working capital -denied supplier and a proprietary money-desk betting on failure of the main street engineered by bank runs. When the crisis unfolded the prop-bets made a X amount of money, main-streets bets lost a 10X amount of money and banks ended up in trouble. FED’s response — lowering interest rates and priming the pump through QE was designed to recapitalize the banks and not rebalance the economy. When viewed through this lens the action of the FED makes more sense.

With low-yield funds from the FED, banks bet in the markets and earn capital gains to buffer their balance-sheets. With the balance-sheets bolstered with excess capital, the banks may, if they take fancy to it, then start lending to the main street thereby kickstarting the main-street which will hire more, jobs will come back, incomes will rise and debt will be repaid and world will be glorious once again.

This lens also tells us that FED is not going to raise interest rates any time soon. Not yet. The reason is that banking system is ever more skewed. The banks figured out way to make money for the management and shareholders without going through all that trouble. Just bet on the markets — inflate the asset prices (we are at upper end of the PE multiple band for stocks, Housing prices are recovering when quality of jobs is declining) make the bets, earn the money, keep provisioning low but DON’T announce record result as some costs have gone up. If you are wondering which costs are going up when inflation seems to have losts its mojo — don’t ask me. “The math dont add up mate!” Since provisioning is not adequate, if asset prices were to correct, banks will be in ever more trouble. The “Too big to fail” have become “If I fail you really get fucked” big. They need high asset prices and INCREASING asset prices to justify and unwind this shit.

Oh and if you want a way to fix the banking for real — fix the main street and banks will fix themselves.

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Was European Federation possible at the end of 2008 crisis?

European Federation — a political integration of Europe, seemed to be one solution to the European Crisis. Then again others argue it was doomed to fail.

A political integration is an emotional, cultural and political process. By themselves, these each of these are quite challenging. Secondly, the budgetary/financial discrepancies between member countries had to be resolved in a Federal style — even before a federation came to being. Again a big issue. So was federal Europe possible? It was. In fact, “other things being equal” European people would have had no problem integrating — this time or a bit later. But other things were not equal. The central issue, I think, was the political situation.

The compulsion for political union came at the time of immense political turmoil. What started as a refugee crisis, quickly turned into a religious friction and today Europe sits at a major inflection point. Instead of expanding their identity into a bigger European identity, the citizens are faced with reducing it to exclude some religions, minorities and others-not-like-us. The reductionist forces are winning — radicalisation of european muslims, terror attacks, rise of IS and other thorny issues are shoe-boxing the European identity further and further. Without guidance of able leadership, the mindset will become closed. Hate will once again building up.

There was a massive leadership crisis. A great european leader would have focused on the migrants who were malleable and worked on them. She could have identified the refugees keen to integrate and empowered them to expand the integration process to their communities. Sadly, european leaders tried to shepherd their own population into a forced acceptance of refugees. Like a forced marriage, it was bound to fail. At such stage, we wish we had leaders of caliber. If there was an insurmountable obstacle this is it. The level of politics is shameful.

The fault is also with the people. The pedestrian politics of our times is narrowing our minds into seclusion and hate. That it is so possible in the time of internet and social media is the blight on our humanity. And past 10–20 years have brought the peoples of the world closer through the internet. Our choice, the one our politicians ignore, is to expand our minds. We need to remember that eventually the identities must expand and embrace all of humanity. To expansion, there is no end.

Similar circumstances faced the American a few hundred years back. They expanded themselves into a federation, bet on humanity and came to lead the world. The people of Europe face a similar test today. Sadly, there is no Washingtons, no Jeffersons and no Franklins. Or are there?

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Why are taxes so complicated?

Apple’s skirmishes with the taxman have brought the issue of taxes to the fore again. It all started with Warren Buffet’s assertion that he paid less tax than his secretary. We wondered what magic formula achieved that!

What is wrong with taxes? Why don’t we understand what is going on? Many reasons but mainly because tax is complicated — too damn complicated. I haven’t met a person who can mentally calculate his or her taxes even when they know their income precisely — not even with a calculator. These calculations aren’t even in the ballpark. So why is tax so complicated? Politicians and taxmen alike tend to confuse the debate with many terms and jargon.

What is a Tax?

Tax is actually a charge paid to the government for the services it renders — i.e. maintaining law and order, national security and general governance to cover the costs for that (such as salaries of army, police, judiciary, bureaucracy etc). It is also a source of finance for government investments say in infrastructure (think highways, dams, railways, space program etc). Taxes also pay for government expenditure on other things such as bailouts, promotion of job-creating industries, pensions, healthcare etc.

To pay for all these activities, government formulates a “tax strategy”. Tax strategy is combination of various taxes imposed on the public (citizens and non-citizen residents) to make up its income. It generally combines Direct and Indirect taxes, income and expenditure taxes etc. It may also include tariffs, duties, cess and fees under many different names.

Direct versus Indirect Taxes

Now government can take the taxes in two ways. Direct taxes are taxes those directly collected by the Government like, say, income tax etc. Indirect taxes are levied on the manufacturers or employers and these are then passed on to the citizens.

The direct and indirect taxes are important because of ease of collection. Indirect taxes are easier to collect but increase the transaction costs in the economy. Thus, if there are excise duties across the value chain, then such products have to be that much more competitive with respect to other global products just because of tax accounting.

Income Tax and Expenditure Tax

Government has at its hand two types of taxes. It can tax income at the hands of the earner. It can tax the consumer at the time of consumption. Notice that the timing the taxes are collected is different. That has an important bearing on this discussion. Between receipt of income and actual consumption is a quantum of time that can be controlled by the citizen. This has important bearing on the nature of tax government wants to impose.

When recessions strike the government is required to give a fiscal stimulus. When the tax backing such investment can be collected is now left to the consumer. After recessions typically, the consumers are reluctant to spend thus delaying the tax collection and putting government commitments to lenders at risk. An income tax, however, comes in as soon as income recovers. That used to create a big problem for the governments. However, with present technology and statistical analysis, governments need not have these

Expenditure tax has its advantages. It penalises those who consume more as against those who consume less. The argument against expenditure taxes is that incomes are higher than expenditures and thus tax collection is more. The counter argument is that expenditure tax leads people to invest rather than consume.

Tariffs, duties, cess and other fees

All these items are basically a charge on specified group of persons (natural persons i.e. people or legal persons i.e. corporations). These charges are meant to nullify some anomalies arising out of policies. Thus, if tax on cars is 30% on price of car, then if you import the car then you will also have to pay 30% “import duty” to bring you inline with those buying locally.

Why are taxes so complicated?

There are three sources of complexities in taxes. First is that tax law itself is complicated. Secondly, the constitution of the country creates complications that show up as complexity in taxes. Third type of complexity is result of Governments using tax laws and bending constitutional mandates to further their public policy.

Complications of Tax law

When you read the tax law, it is usually in two parts — tax rates and “interventions”. Interventions generally take the form of exemptions,deductions and tax breaks.

First part deals with tax rates. Tax rates by themselves may be different. Income tax rates are decided on slabs. For example, income below $20,000 may not be taxable, between 20,001 to 50,000 be taxed at 10%, between 50,001 to 100,000 be taxed at 15% and so on. It is easy to understand that the higher the tax exempt income, higher the tax rate others have to bear.

Exemptions are incomes or expenditures by law exempted from tax. Thus, income from renting a housing may be exempt. So when computing your taxable income, you don’t include the rent in it.

Deductions are amounts you invest in certain schemes that you can deduct from your taxable income. Thus, amount invested in pension plans may be deducted from your taxable income before tax is computed.

Then there is something called Tax-break. These are most notorious of all interventions. By this mechanism certain persons (natural or legal) can be made exempt from paying taxes if they satisfy certain conditions.

If taxes seem complex by now wait till you hear of this new type of complexity.

Constitutional complexity

The constitution in most countries grants the right to the government to levy tax. Now no country has one government, there are at least three sets of government in any country — city level, state level and national government. Constitution has granted each of them some tax they can levy. It is different for different countries but the principle is the same. These taxes taken together result in massive compliance exercise that is both time consuming and complex.

Governments overreach when they want to increase tax collection. So they invent some other thing to add to the tax burden adding to complexity. For example, if state or city government can tax land, national government may impose environmental cess on those lands which are not tree covered. It may be so that environmental policy is with national government, and land taxes with city government but now national government has got its pound of flesh out of land taxes.

Tax as an instrument of public policy

Governments, with all nice intentions, tend use taxes to further their public policy aims. For example, to promote job growth, they may want to give tax exemptions to various industries, tax breaks, they decide what the level of exemptions — what incomes are exempt from taxes. Or, say when they want to support home buying, then the government may give you deductions if you buy a house and lighten your tax burden. All these things combined make the tax calculations too complicated. These interventions are nothing but Government trying to influence society — they are using tax as instrument of public policy. It is wrong for many reasons.

The concessions given to further public policy have two ill effects. Firstly, they do not convey transparently what benefits were given to whom and thus it is underhanded. Secondly, they are wasteful as they cannot be pin-pointed to deserving persons. There remain, deliberately or not, various loopholes that creep into the legal draft of the law when it does come out. US tax code is rife with instances where industries on one side of the road has received tax-break while that on other side hasn’t.

I once heard a (fictional I think) story about Britain. In the 90s it was noticed that more Brits preferred to stay single than to marry. Naturally, the cable channels were quick to host debate shows on declining moralities of the Brits. It was then discovered that despite not marrying, Brits tend to stay with same partners. Quickly the hollow debates went after religion values of marriage etc. Ultimately it was discovered that this so-called moral decline was because of an innocuous clause in the tax code which imposed additional tax on married couples than two single adults. Talk of unintended consequences!

If government wants to subsidise certain industry let it do it by direct transfers or refunds. The problem with this argument is that citizens themselves do not accept it because government is quick to accept money but very lethargic when it comes to a refund. In corrupt countries there are palms to grease — if you are in India you have to grease the entire bureaucratic system and bureaucrat themselves.

The resulting of Complexities

The complexities in Tax system are not the only problem. They are genesis of the worse problems.

Individuals v/s corporates

There is a fundamental flaw in the tax system that treats income tax of individuals and corporates differently. The tax system believes that income of the corporation is its profits which is revenue less costs (crudely). In case of individual no consideration is given to expenses. Thus individual is taxed on revenues while corporates are taxed on profits. This difference has to go away. Now to be fair, individual tax rate is lower than corporate tax rate for precisely this reason. Yet, this difference coupled with tax avoidance mechanisms and other invented devices contribute heavily to discrepancy between the individual who cannot game the tax system and the corporate which can.

Tax avoidance

When the underlying system is complex, private parties more than government agencies are able to take advantage of the system. In the 2008 financial crisis, the average paying rating agencies were not competent enough to see through the complexities created by highly-paid bankers. Same logic holds for tax too.

With loopholes this wide, rich people with boundless ingenuity come up with schemes that help them avoid taxes. So people invest more in housing if rents are tax free. Such tax avoidance has created an industry of accountants whose only job is to avoid taxes. It is also in the interest of these accountants to keep tax codes unnecessarily complex.

When tax avoidance increases the burden falls on the poor who are ill-equipped to handle the complexities of taxes.

Transfer pricing — The bigger problem Tax evasion

One of the worst ways of evading taxes is by using transfer pricing technique. Let us imagine I make shirts under my company X Inc. and it costs be $50 to make the shirt which retails for $100. But I am based in a country where tax rate is 20%. So I make incorporate a different company X Ireland Inc. where tax rate is 1%. So X Inc. sells all the shirts to X Ireland Inc. at $51. And I pay tax on $1 at 20% i.e. 20 cents. Then X Ireland Inc. sells the shirts at $100 world wide. I pay 1% on $49 profit i.e. 49 cents. So my total liability is 49+20 = 69 cents. If I was doing business completely from my home country I would have to pay 20% of $50 i.e. $10 in taxes. This $9.31 is deemed to be legitimately avoided. I think not! This is tax evasion not tax avoidance. A small business cannot compete with this company.

This transfer pricing game is played at various levels. Corporates play countries v/s countries, pit state v/s state and city v/s city to extract maximum benefit. This benefits are solicited through industry bodies, professional institutes and other mechanisms of lobbying. Eventually tax payers are paying for this too.

Money laundering

The Global cooperation in taxes was brought about because of money laundering. All money laundering channels were discovered and they remain operational because of their use in tax avoidance / tax evasion. These networks have now been used to finance terror network which brought them into focus.

Taxes need urgent global reform

We need a simpler tax system that is easy to understand and easier to comply with. The complexities need to be resolved. Most of the countries in the world have a unified expenditure tax system (GST it is usually called). Such a system should be created for all taxes. We need to do away with exemptions, deductions and tax-breaks. The government aid, if necessary, should be given directly by cash transfer.

Second, we need international cooperation with respect to tax regimes. It is in the interest of all the countries of the world that tax is paid to the government to which it is due. There are efforts being put together to track and prosecute tax evasion through Global Forum on Transparency and Exchange of Information for Tax Purposes. This is a welcome initiative, though too many bureaucrats are discomforting. I hope it does not end up complicating the Taxes rather than simplifying and checking evasion.

If tax is a necessary evil, it is unnecessarily complex convoluted evil. May the Founding fathers should have put in a fundamental right that taxes shall be simple to understand and easy to compute and pay. Taxes should be simple and straight-forward. A healthy global tax system will empower our governments.

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms".

Dollar, the International Currency system and the Ghosts of Connally

US Dollar took over as the world currency thanks to Bretton Woods 1944 at the end of the World War II. With the world facing tremendous calamity, a sensible system was put in place, incorporating the learnings from the failures of Treaty of Versailies.

Begining its inception, the European states set out on a development spree that has since remained unmatched. Even the rise of China in peacetime does not match the speed and quality of development. But with development, there appeared cracks in the Bretton Woods system. Well, not exactly the Bretton Woods system - but the currency system. There appeared an fundamental incompatibility between the unique construction of US Dollar and the structure of Bretton Woods.

The Construct of US Dollar

US Dollar created in the aftermath of American struggle for independance was gold backed as was required to be able to trade in the global system. At the early stage, US Dollar was indeed made out of gold-silver mix (1:15) and each dollar was backed by 1.60gm of gold. The gold-silver ratio was reduced to 1:16 thereby devaluing the gold equivalence which now came to 1.5gm gold for each dollar. The new coins were made by gold-silver mix so exact devaluation can be debated. However, the weights of the coins continued to be reduced over the 19th century.

This bimetallism had to be gradually dropped since the silver coin weights were reduced and later substantial silver deposits were discovered leading to wild price fluctuations. Thus US Dollar came to exclusive gold standard. The formal gold standard act backed the Dollar with 1.67gms of Gold - a smaller devaluation by itself.

Note that at the time, Pound Sterling was the dominant currency and it was exclusively backed by gold. The Pound also fluctuated in its gold peg till early 19th century where the British put in place the gold standard. Their wide-spread empire and british respect for the value of the pound contract meant it quickly became global currency. US Dollar was emulating this precedent. 

In this process the pegs to the gold were altered by World War I and subsequently in 1931 Britain gave up the Gold Standard, leaving American Dollar as strong contender for world currency. All this was formalized in 1944 at Bretton Woods.

The Second part of Bretton Woods Agreement

At Bretton Woods it was also agreed that exchange rates between some dominant currencies would be pegged to the US Dollar and they were backed by Gold. With such a policy in place, European countries started on most ambitious reconstruction plan. This was supposed to be an opportunity for the American companies and it was. But it also created many European companies who became competitive vis-a-vis their american counterparts and started a cross-flow of trade and commerce. In the process, more US Dollars were created and soon there were too many and not enough gold to back it. 

This fact was noticed by the trading community who started bidding up the Gold prices prompting John Connally to push for abandoning the gold standard. He said later "My philosophy is that all foreigners are out to screw us and it’s our job to screw them first."

The Fiat-Dollar era  

The Fiat Dollar continued its run as the global currency thanks to burgeoning US population, US growth and demand from US markets. International trade soon became thoroughly Dollarized. The dollar-peg concept went from Europe to Japan. The latest in that phase came the dollar-peg by East Asian Tigers and mainly China. These countries vountarily gave up their freedom to conduct their monetary policy - depending on prudence of the US FED. This system then created today's unique problems.

Now with US being the defacto currency in the world, US lost its ability to devalue. Faced with this situation, US followed what John Connally famously said "The dollar is our currency and it is your problem". It printed and printed and printed. And so did everyone else - by default. In effect we do not see US Dollar being devalued - the point gold bugs keep making. Without the devaluation US is not getting the turbo-boost to kick start the growth leading many to call the other countries' monetary policy as "predatory". This problem is a corollary of the famous "Impossible Trinity" or "Mundell-Fleming Trilemma".

What should be the decent international currency system?

It is now clear that monetary policy independance can be given up volantrily and also taken away by coordinated action. The solution many propose is to go back to Gold standard - which may be a good intermediate arrangement - but not a good long term arrangement. A better idea is to go for a two-level currency system. SDR may be a good starting point - but SDR's may not give us the true global currency we need.

The global currency and relatively-fixed (stable) peg to global currency could be a good system. It will leave the monetary policy freedom with national central banks and yet keep the system stable most of the time.

Readings

1. Volcker's FT Alphaville interview
2. Economist on Mundell-Fleming Trilemma
3. Yanis Varoufakis - And the weak shall suffer what they must. (book)

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms".

Capitalism V Democracy - Yanis Varoufakis

Yesterday, I saw the TED talk by Yanis Varoufakis (linked below) titled Capitalism will eat democracy: unless we speak up. It is quite a watch so I embed it here.

His suggestion is that we have to choose between a Matrix like dystopia v/s a Star Trek like utopia. The primary observation is that unbridled capitalism will ensure that the democracy works for the super rich but not for the poor. I agree with him as an assessment of the present state of affairs. But that does not cover the issue fully.

Capitalism can eat democracy but what about the reverse?
While it is true that democracy cannot eat up capitalism, politicians can. We have it happening right now - in India, China, Russia etc. These politicians become businessmen and plunder the country. This is no true politics but predatory politics can impair the la and order machinery to quickly discend into anarchy.

Crony capitalism v servile democracy v servile capitalism
Crony capitalism is a misnomer. A crony means friend - sort of an equal. But this is not a relationship between equals.

The government officers and politicians are eager to serve the capitalist. When chairman or office bearers of NRA speak they listen - not both sides listen but enough people on both sides listen. If Zuckerberg or Paige or Dimon or Buffet were to say something both parties will listen. I read somewhere that 80% of 2013 US presidential election funding was made by 150 odd individuals. Please tell me their views carry the same weight as mine. This is servile democracy. Yanis Varoufakis talked about Larry Summers (in other talk in Austin) telling him that if he becomes an insider then he will be given magical things. That is servile democracy not crony capitalism. This is a rich man trying to train a dog with dog biscuits.

There is other side to this too. In India businessmen are servile and politicians are the lord-masters. Things have changed - but not too much. It is easy to scuttle a truly new challenger to established business houses. If you take the paper spending on infrastruture - India can have better infrastructure than the very best countries in Europe - may be twice over. This is servile capitalism. There are whole networks that have come up around these politicians to create extortionist "business models".

Where will the fight between capitalism and democracy lead us is anybody's guess! But one thing is clear.

Capitalism and Democracy as competing systems

Capitalism and democracy are said to be collaborating or complementing systems. But we should start thinking of capitalism (more specifically markets) and democracy (specifically government) as both competing and complementing systems together. They both allow the masses to exercise their opinions. Marktes allows the individual to exercise it through buying i.e. through markets, democracy allows him to exercise it by voting in a government.

Now buying is something we do almost every day. Thus, we this part of the system is more evolved, sensitive. This system is also keenly improving itself to make sure the customer preferences are communicated to the top - it is thus more efficient than the political system. But let us remember they can be inefficient too.

The political system works like a broken market system. Here the opinion or choice of majority is forced on everyone. Imagine if markets worked like democracy - everyone may be forced to wear XXL size blue man shirt (coz majority favours it). 

By now you must think that they operate in different spheres and so it is not a problem. But it is! Notice that the burden on government to make itself more palatable to all of its citizens not just the majority is quite high. It is higher than the burden on market to service all types of demand. That is because there is an alternative when market fails to understand the opinion of minority - some niche player can fill it. In case of government - there is no niche player alternative. Therefore, Government must be held accountable more than the capitalist. And it must uphold the rule of lawso as to ensure capitalism is working smoothly.

Just think - marxism is actually a response to servile politics impairing the demands of working class (the proletarait) by the capitalist (bourgeoisie) who were friends of politicians/rulers. Then the Soveit collapse was actually a response to the politicians exploiting the political system to their economic advantage. In some way reverse of the first wave.

So the point is...

We need a mechanism to ensure the bargaining power between capitalism and democracy is maintained. Without such a mechanism we may end up in some trap or the other.

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The ideas expressed in this post first appeared in my book  Subverting Capitalism and Democracy. Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms". 

Reorienting Singapore - Ideas for a Future Economy

Singapore is unique country. The Singapore government works better and more efficiently than its corporates. So naturally, it wasn't surprising to find the Government of Singapore exploring new policy options to ensure Singapore continues its development. The urgency with which Singapore Government is looking for these new themes is indeed creditable.

There is a Committee on Future Economy. This committee comprises many thinkers and business leaders. The committees presented some ideas at the IPS CFE conference. I am parsing through the ideas in the sessions - all make interesting food for thought but not out of the ordinary. Be ready to sift through jargon and buzzwords while picking the best ideas.

Here are some of my thoughts on these things:

Keeping aging population employed, relevant and highly paid

First we need to abandon the concept of "job" or employment using same skills over entire lifetime. Some skills stay relevant and even appreciate with practise. Surgery, tailoring, etc come to mind. There not much is required to be done so long as the skills remain relevant. But even master tailors and surgeons will also need to be aware of the advancing robotics wave. Thus, we definitely need to reskill the greying workers. The question really is how to reskill in a way that augments the skills they have acquired and makes these workers into super-constributors. One way is to take the skills they have acquired over lifetime and let them impart these skills to new workers. In areas where robots are taking over, these workers can evaluate the robots or augment the research in robotics.

Opportunities for section of population with varying skills

How to ensure employability of part of population of varying skills? 

1. Take the art route. And we need not ignore the digital art - Singapore can become a hub of say world class web-designers, interface designers etc. The key question is what domestic set of skills can be made available to the world that will have sustainable advantage? 
2. Dragon purse effect: Allow citizens to create something artistic and using SMEs explore if it finds relevant demand in the world. If yes, then it can be expanded into a proper global scale product. This is like next step of kickstarter - a place where entrepreneurs can innovate new products and try it on smaller scale. A dragon purse was a hit world-wide. So what can be the next dragon purse.
3. The key question will be how to ensure that the core of what is found in Singapore can be deployed globally in such a manner that benefits will flow to Singapore? 

Reinventing Construction

Singapore is as unique as Netherlands in the fact that it has natural constraints to deal with and has the technology and capital to solve the problem. Netherlands also has innovative ideas. Does Singapore? I think so. Just that we need to look widely.

1. With an eye to global warming, Singapore needs to raise its height by about 5 meters above mean seal level. It means gradual planned buffer creation across most of the city. This area needs to be explored.
2. Singapore can invest in breathable green materials construction techniques for office and residential buildings. The idea is to use architecture, materials and structural engineering to reduce (and if possible eliminate) requirement of air conditioning.
3. Urban agriculture idea is not new. But creating enabling buildings is not given as much a priority. By the looks of it, the future buildings will have to work with plants, crops, animals and poultry. Again needs investigation and trials. A country like Singapore can effectively be leader of such technology.

Hi-tech Industries such as medtech, Predictive Tech etc.

There are a few hi-tech industries that can play to Singapore's advantage - high-tech manufacturing and pure high-tech industries.

1. Medtech is high-tech manufacturing type industry. What is unique about medtech type industries is that they are highly technology dependant and thereafter entire global demand can be serviced through small worker-less fully robotized factories.  Chip-design industry has similar characteristics. While, the intellectual property is difficult to replicate, the production is easily replicable with cheaper capital and easily available robotics. When medtech wants to retain its Singapore advantage then it must create a network of med-tech testing environment (can test in China and India - will be lower cost). Thus, you leverage proximity and access (to ASEAN, India, China, Indonesia - populus markets) for testing and deployment.
2. Similarly, a pure high-technology industry includes Predictive Technologies is rightly highlighted as relevant industry for Singapore. These are pure high-tech industries. Another like Algorithm design, data analytics, etc. will make high return, small team tech companies possible. 
3. For both types of industries, the research in engineering sciences and applied mathematics is essential. Universities can highlight potential candidates and these bright candidates may then be financed to create startups locally.
4. These companise individually may be small teams but collectively will be large employers and require plethora of suppert services that will be employment generating. 

Innovation - always by the SME   

SMEs are preferred entities to undertake innovation. Allow SMEs to fail fast, fail often and fail safe - and then wait that is all it takes for innovation to flourish. Celebrating failure is as important as celebrating success. Yet these three things - fails fast, fail often and fail safe require enormous infrastructure and social development. 

1. Principle-based regulation: The search for light-touch regulation is not easy. Light touch regulation implies a quicker resolution of liabilities and protection of genuine risk-takers from being unnecessarily hounded. That should suffice. Other aspect of light touch regulation are actually ease of doing business which are fairly well developed in Singapore. It is also better to guard against misuse of personal health and financial data than regret the "light touch" later. So right-touch is better than light touch. These aspects are easy to deal with using "principle based regulation" letting the courts follow the spirit of the law rather than rigid enforcement of letter of law. That is advantage of the common-law system as practised by Britain and US.
2. An evolved Intellectual property law framework: Hi-tech industries along with innovation as a focus implies creation of intellectual property. Intellectual property can quickly devlove into what is referred to as "problem of commons" or "gridlock economy". In either case the innovation suffers and the innovator lands in trouble. To counter this, a quick-resolution mechanism for intellectual property is required - starting from registering unique IP, resolving disputes and trading IP. 
3. Government contribution: Government can give access to the international patents database so as to prevent duplicate research and ensure that when IP is granted in Singapore (certain class of IP) then it is really at the cutting edge of the stream and thereafter can be traded across the world.

Future of Work - Implications

It is well accepted that future work will be more like a free-agent rather than life-time employment at specific skill. It will be multi-skilled (may types of work at once), simultaneously (many jobs at once) and within multiple teams that come-together and get disbanded at hyperspeed. All this requires development of infrastructure. 

1. A skill repository is essential: The construction value chain is an example - the developer knows who is best architect for the job, who is a good contractor, electrician, plumbing contractor etc. and they all come together for a project (while some may be working on more than one project) to deliver a unique product. The question is why cannot other businesses do it. It is because transaction costs are too high. If there were a skill repository (indicating who has the best skills for a particular job) and it was easily accessible, then you could hire these experts easily (band and disband easily). 
2. Legal innovation required for future work: Future work also requires development of standardized contracts so that both parties are protected in such transaction. It also requires grievance redressal and dispute resolution mechanisms. It also creates a new set of jobs that addresses background checking, feedback taking, maintaining work histories and customer reviews. Lets say Singapore were to partner with Linkedin and augment the database Linkedin has with fact-checked database. Wont it be easy for prospective employers and service seekers to hire those people? Data on new skills sought by the employers can be mined, appreciated for long-term skill development and it can become input into human resource policy.
3. Safety net: With firms not able to help create employee safety nets, it may be required of the government to create a mechanism for these free-agent workers to bolster their safety nets. Some hand-holding and some compulsion may be necessary so as to ensure that longer lifespans are happier lifespans.

Second mover/ Fast Follower strategy for innovation

Seond mover or fast follower strategy made famous by Panasonic case in business schools has some merit for flexible economies. But sadly the fast follower days are over. These days winner takes all approach is dominant. A more relevant model for this era is the "long-tail" model. There is only one facebook. Singapore may heed the story of mySpace which was the first mover, but lagged in innovation and quickly faded into obscurity. For most of the industries Singapore intends to rely on, this is the reality. In such a case, a fast-follower or second mover strategy cannot help Singapore. In fact Singapore needs to be a leader and additionally be flexible to keep its advantage.

Globalisation and Regionalisation

Singapore is welcome in China as well as India. Singapore should use this advantage to develop supply chains which are regional and supply global products with these supply chains. Just like the Apple HQ is at Cupertino but production is in China, we can have highly value-adding HQs in Singapore and production in China, Vietnam Indonesia, India tc. Engineering excellence is not geography centric. The passionate drive to make your product superior can be recreated anywhere. What you need is an environment where entrepreneurs can fail safely without being judged harshly (socially more than financially).

I think the Future Economy deliberation has just started. Maybe if they could ask me for what I think! ;)

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms". 

Why is resolving Non-Performing Loans (NPL) is so difficult?

The management/resolution of NPLs has acquired renewed focus with banking sector under stress for many years. The Economist comments on it this time about Italy's NPL problem. More significant is the commentary on various approaches, IMF recommendations, KKR's Pillarstone initiative etc. making it a must read. But it misses some quite important issues with respect to NPLs in general.

Failure of NPL liquidation - some blame lies with Accountants

The PwCs, EYs, Deloittes and their ilk must take some blame. Many of the bad loans have accounting folly at its heart - some deliberate and some not, some before loans are made and some after. Time and again, accounting firms have washed their hands off their audit responsibility and liabilities arising therefrom. Recently some firm has sued PwC for their failure to report material issues. If auditors completely trust the company managements they are auditing, then the purpose of the audit is not satisfied. 

The shady entrepreneurs

The proportion of shady, shifty characters in this distressed assets pool is quite high. Some distressed loan assets are deliberately impaired on the books for tax fraud or money laundering. Data mining algorithms cannot detect this - even analyst cannot easily detect this. Such frauds have to be sniffed out - at least till Artifical intelligence becomes more robust.

Slow courts and costly Alternate Dispute resolution (Arbitration, mediation etc.) mechanisms

Invariably, a fair proportion of the distressed asset pool goes for legal resolution. NPL problems are higher in countries with weaker judicial controls, higher cost dispute resolution. The process of dispute resolution quickly unravels both the ability to pay and gives a remarkbly clear insight as to the intention to repay. However if the process is too slow and too costly, it defeats the purpose. This is a problem in Italy and also in India.

Much blame lies on Incompetent Banks

The substantial blame though must lie with the bankers:

1. Lack of accounting analysis skills: Many banks which make loans cannot make proper assessment of accounting statements. Data mining algorithms are good at assessing the "ability to pay". They cannot assess the "intention to pay". Lack of Intention to Pay has created many NPLs.
2. Illogical the use of collaterals: Banks are notorious in having collateral that is highly correlated with loan asset itself, over-valued or pledged in part to many. This is a childish mistake to make for a professional setup. At times, an intellectually superior form of syndicated lending (the whole syndicate holds one collateral) is used. When trouble strikes the legal disputes arise within the syndicate itself. 
3. Poorly-constructed contracts with borrowers: Such contracts make the payments unpredictable in quantum and timing thus surprising the borrower. It quickly cascades into penalties and surcharges and it goes downhill from there.
4. Too Centralized decision making as to loan eligibility: Most borrower eligibility tests are done centrally these days. Thus it leaves no incentive for the bank manager / officer to dig deeper into the borrower's records. It makes the incentives wrongly aligned.
5. Flawed loan portfolio construction: Loan portfolios are too correlated This is a result of too much market focus. Banks push certain products that they find easy to sell - consumer loans, credit cards, personal loans etc. When the lending starts concentrating they do not quickly take corrective actions to balance the portfolio. If the banks' entire portfolio comes under stress at the same time, it cascades into more distress.

Basics of borrower assessment

Any borrower assessment has two component - ability to pay AND the commitment or the intention to pay. Sometimes the last two differentiated. The ability to pay is well understood which refers to  the capacity to bear the repayment of the loans. The intention to pay tries to determine if the borrower intends to cheat or not. The commitment to pay points to whether the borrower intends to pay  but disputes the computation of the payment and hence may have withheld the payments - committed but not paying, or the borrower does not intend to pay at all and is finding loopholes to delay the foreclosure process.

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms". 

Should banks create money?

Bloomberg has a post about centralizing money supply - whole money, as they call it. It is not a very good idea. This is not the first time such suggestions have come up. As mentioned in the article, Irving Fisher first proposed a similar plan in the wake of the great depression. Since then many have proposed this idea but not many understand money creation.

Taxonomy of centralized money creation idea

The money creation ideas are varied:

1. Gold money: This is natural money creation. No one has any control over the money creation. Previously, gold, silver, diamonds, precious stones and other valuables (and sometimes sea shells too) were used. Many serendipitous discoveries of valuables created havoc with the money supply. Discovery of Potosi in South America and thereafter further discoveries of gold and silver had the effect of expanding Spanish money supply. 
1. Not under any control: Neither governments nor banks, no one has any control over the money creation process.
2. But Non-Arbitrary: It depends on the amount of gold you have. If you want more gold, you better import more gold by giving some valuable service to the other countries  who have gold. Over time as the total amount of gold available starts reducing you need to offer more and more to the countries that have gold.
3. Though subject to Nature: If by chance you discover a gold mine, you will be filthy rich, though if you discover too much then it may unleash inflation. Spain is believed to have faced such inflation on the discovery of silver mines in the South American colonies.
4. Deflationary and restrictive: As economic activity grows it becomes too high compared to the total amount of gold available to back it. Thus it tends to slow the economic growth pace. (Don't know if that is good or bad).
5. Favours status quo, old money and advantageous to miserly: Since total value of gold you have increases with time, people tend to postpone purchases and hold on to gold. Spending happens when absolutely necessary.
6. Exploitation and Theft prone: A doctor can charge atrocious fees from a rich person because of bargaining power equations. Gold can also be stolen. Stealing credit cards is less useful.
2. Gold-backed money: Introduced to circumvent the deflationary gold currency, countries peg the value of their currency to the gold they can back it with. When people talk of gold standard they are referring to this type of money creation. 
1. Partly Government controlled: Government issues currency and states the total amount of gold they back it with. So a gold-to-dollar exchange rate is established. The government can improve its reserves and thus improve money creation. 
2. Non-arbitrary: In its pure form it is non-arbitrary and similar to gold-money.
3. Not purely nature driven but subject to shocks: Since the government has control over the amount of money and amount of gold, the money creation is not as whimsical as simply discovering a gold mountain. Governments can reset the exchange rate to compensate for some changes. But arbitrary government intervention results in shocks and disruptions.
4. Mostly deflationary: Governments cannot measure economic activity easily (yes GDP calculations are guess-work and there is no Santa Claus just in case you were wondering). That leaves money creation open to political whims and fancies and invites tampering of measurement of the economic health. Mostly governments are slow to acknowledge the real growth in economy since it is always backward looking. It realises the growth till the growth results in deflationary pressures then increases money supply and causes a spike.
5. Perception of money losing value as government reset gold rate: As total amount of product and services of value in the economy rise more than amount of gold to back it up, the government is forced to alter the gold-dollar exchange rate downward leading to people feeling that each dollar is worth lesser in terms of gold though purchasing power may be higher.
3. Government-created money: This is non-gold standard money. Simply speaking the government issues money and backs it with a promise. This is what people wrongly believe is the current regime. 
1. Full government control: The government has effective control over the process. This is a mixed bag. It depends on the government. 
2. Some central bank control: The exact control depends on how money is created, is it by using government bonds then bought to a certain extent by central banks or some other way (simply printing).
3. Depends on confidence in Government: Prudent governments enjoy advantages but if you are Zimbabwe then you will end up in trouble.
4. Inflation/deflation depends on policy: If a government print too much then it stokes inflation and too little results in deflation. Prudently executed (Milton Friedman's about 3% money supply growth) works fine.
5. Value of money depends on inflation: If the government is able to deal with money creation effectively then a mild inflation - say 2% may result. There is not too much loss in value and it can be notices only over long time frames when quality of life changes are also noticeable.
4. Money created by banks: Mostly commercial banks create money by giving loans. These loans do not exist as money. This is the most misunderstood money creation mechanism. It is distributed money creation, without extreme control. Bankers and regulators forget that its success depends on devising proper incentives. 
1. Less government control:No country uses this method exclusively. Both Government-created and bank-created money is deployed. Thus there is always government control of some sort. Also since government is also a borrower (a big one at that), it has control.
2. Part central bank control: Central bank exercises additional kind of controls in this mechanism. First, it can partner with government in its money creation process by buying government bonds etc. Second, it controls the lending to the banks and thus influences at what levels of risk do banks create money. The key word is influences and not dictates. Thus this process is often likened to "pushing at a string" (which is difficult, you can pull at a string pushing does nothing unless there is pulling at other end by the banks).
3. Control to banks: In this scenario, Banks can ALSO determine whether to create money or not. That decision is based on whether the person demanding the money will be able to repay it or not. If he can, it means he is creating value with this money and thus able to repay it. 
4. Decision at the point of demand of debt: The decision to create money is forward looking. It is made at the point the person makes a demand for the debt. That borrower is expecting to create future value. If by banks assessment that value can be generated ONLY then money is created.
5. Depends on incentives: After reading this if you wonder why banks lend for consumption goods or lend to uncreditworthy borrowers - it is because of incentives. The power to create money is substantial power and with bad incentives, it can cause systemic harm as seen in 2008 crisis.
6. Central bank oversight: Central banks have oversight duty to watch what kind of money is created by the banks. The nature of lending is supposed to be value-focussed. Some consumer lending at the time economy is entering a pro-longed boom phase can be advantageous. But in an economy which cannot sustain a prolonged growth phase, these are risky loans and their proportion needs to be limited.

My suggestion

Out of the options, I prefer the last one - a combination of bank created and government created money. It is quite forward looking and takes place at the point of demand. It needs a lot of oversight and decentralisation. I have argued that IT systems have in fact centralized the loan decision making than allow the front-line managers to make them. This has resulted in an inaccurate assessment of borrowers and partly responsible for the 2008 crises. Amar Bhide also makes a case for intelligent decision making in his book "A call for judgement".

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Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms".