Banks and ice

Some years ago, I happened to be reading William Bernstein’s A Splendid Exchange: How Trade Shaped the World when I was mildly startled to see a reference to the magnitude of America’s 19th century ice trade. Startled because I’d never heard of this trade despite that fact that ice was America’s second largest export tonnage (second only to King Cotton) at the time of the Civil War! I immediately resolved to learn more and a few moments of augmented intelligence (ie, Google) threw up the name of Frederic Tudor, the “Ice King” who invented the industry. From there it was a quick jump to Gavin Weightman’s The Frozen Water Trade, one of my favourite books.

The story of Frederic Tudor (perhaps “yarn” might be a better description) ranges over most of the seven seas, taking in privateers, shipwrecks, invention, speculation, enterprise and vision on the way. Tudor had an idea and spent years, in a truly American fashion, pursuing it until he had created an entirely new market and had satisfied it through an entirely new industry. When he shipped his first cargo of New England ice down to Martinique in 1806, he thought he would have a sure-fire success. But the inhabitants had no idea what to do with it: if you’ve never seen ice, would you buy some? Eventually he found using it to make ice cream a moderate economic success and was encouraged to continue. A decade later, his breakthrough came when he began shipping not to the Caribbean but to Charleston, Savannah and New Orleans and the business began taking off.

At the same time, an ice ecosystem began to develop. Downstream, the waste water coming off of the melting ice was sold as a cold draught rather than poured down the drain. Upstream, the demand for sawdust (used to insulate the ice cargos) from the Maine timber industry (previously a nuisance) generated more wealth. New technology was applied to cutting, storing and hauling the ice.

Frederic’s marketing strategy was dynamite. He created an insatiable demand for two main products: ice cream and cold drinks. When opening up a new town, he would provide free ice to bartenders knowing that customers would never go back to warm drinks once they’d tried a mint julip or an iced tea. It seemed to me slightly reminiscent of the bottled water industry today: create a demand, satisfy it and the use brand to drive up the price. Indeed, Weightman notes that the only difference between “Wenham Lake Ice” (one of the main brands of the time) and other ice was purely marketing.

Tudor was a ruthless businessman, seeing off competitors by lowering the price of his ice to ruin them, but not a perfect one. Some of his enterprises outside ice went well (graphite mining and property) and some not so well (he lost a fortune speculating on coffee futures). In any case, by 1849 the ice trade he had created was going so well that he ran out of ice in Boston and had to send a ship and a crew north to cut chunks off of icebergs!

“To speak literally, a hundred Irishmen, with Yankee overseers, came from Cambridge every day to get out the ice. They divided it into cakes by methods too well known to require description…” — Henry David Thoreau, from “The Pond in Winter,” Walden

From The ice men come to Walden Pond (Walden 186) | The Curious People

By the time Thoreau was moaning about the ice trade disturbing his peace on Walden Pond, Tudor was shipping ice to Calcutta (where the grateful British Raj coined him a medal), round the Cape to San Francisco and even to Australia. In America, ice was no longer a luxury item but an essential comfort.

Naturally, as I followed this wonderful tale, I couldn’t help but try and extract key messages around the intersection between economics and technology. In this field, there is a definite paradox around Frederic and I find it fascinating. Frederic was not a luddite by any means and appears excited by the new inventions of the time. In 1830, he predicted that “steam will soon take the place of horses” and went on to say that “the times are surcharged with novel inventions and improvements of all kinds… steam seems now the ordinary power: in all probability some other and more convenient one will be discovered”. And, of course, it was.

Yet as Weightman notes in passing, it never seems to have occurred to Frederic that someone might “undermine his ice trade by manufacturing ice or making an artificial refrigerator”. Perhaps it is some kind of innovator’s curse, to imagine change in all businesses except the one they have created: it’s why Bill Gates didn’t invent Google and why Akio Moirta didn’t invent the iPod.

As it turned out, when artificial refrigerators did arrive, they at first bolstered the trade by providing an inexhaustible, year-round supply of clean ice for shipping through the existing supply chain before, in time, they destroyed the trade by decentralising ice making to the point of consumption. Destroyed the trade so thoroughly, in fact, that few people remember that it ever existed. The market that Frederic’s genius created is still with us, but the industry he created to service it has melted away.

This is how I see the banking sector. As the former CEO of Barlcays, Anthony Jenkins, said (I paraphrase), banks digitised banking rather than make it digital and are facing the “Uber moments” to come. The digital financial services revolution has barely begun. Our cool new finance stuff is running on some very old rails.

The banks have indeed spotted the invention of refrigeration and they have taken the first primitive refrigerators (e.g., the blockchain) and are using them to make blocks of ice that are then packed in sawdust and sent off in sailing ships just as they were before (by which I, of course, mean the legacy information technology infrastructure). Meanwhile, other people (the fintechs, the internet giants, new businesses yet to be born) are looking at decentralisation and are shipping the fridges rather than the ice. They are looking at using blockchain technologies to create new and decentralised markets founded on translucent transactions and ambient accountability.

I hope this isn’t too clumsy a metaphor for taking a look at the 21st century technologies that are already upon us (ranging from biometrics and the blockchain to artificial intelligence and the internet of things) to try and see what they will really do to the financial services sector in general and the banking industry in particular. I think I have a fairly structured way of thinking through these issues and, more importantly, I think I have an idea for a new book…

The Taylor report is right: we should get cash out of the “gig economy”

The Taylor Report was released today. It’s a report about the “gig economy” and contains a number of proposals for reform in the labour market to modernise the various systems (e.g., tax and benefits) and improve the lot of workers. I don’t propose to comment on any of those proposals, also having recently entered the gig economy myself, I can attest to both benefits and annoyances, but I do want to comment on one point made by the report that was picked up in the media. 

Cash-in-hand payments to builders, window cleaners, plumbers and other trades people should be discouraged through a technology revolution to collect up to £6 billion more in tax, a Government-commissioned review urged today.

From Abolishing cash-in-hand jobs ‘would raise £6bn in tax and benefit workers’ | London Evening Standard

The report notes, entirely correctly, that allowing people to exist in a cash-in-hand economy is not only bad for them (because law-abiding employers get undercut) but that it is bad for the rest of us too. Here’s a short extract from my new book Before Babylon, Beyond Bitcoin on this point:

Professor Charles Goodhart (London School of Economics) and Jonathan Ashworth (UK economist at Morgan Stanley) have studied the subject in some detail. They note that the ratio of currency to GDP in the UK has been rising (as you will recall from Figure 7) and argue that the rapid growth in the shadow economy has been a key cause. In their detailed examination of the statistics, the authors make a clear distinction between the “black economy” (e.g., drug dealing and money laundering) and the “grey economy” of activities that are legal but unreported in order to evade taxation. When your builder offers you a discount for cash and you pay him, you are participating in the grey economy. When your builder offers you crystal meth and you pay him, you are participating in the black economy. They define a total “shadow economy” as the sum of the black and grey economies.

…Two rather obvious factors that do seem to support the shape of the Sterling cash curve are the increase in VAT to 20% and the continuing rise in self-employment, both of which serve to reinforce the contribution of cash to the shadow economy. The Bank say that there is “limited research to confirm the extent of cash held for use in the shadow economy”, but Charles and Jonathan make a reasonable estimate that the shadow economy in the UK could have expanded by around 3% of UK GDP since the beginning of the current financial crisis.

…According to Tax Justice UK, that expansion means that there were £100 billion in sales not declared to UK tax authorities that meant a tax loss of £40 billion in 2011/12 and that will rise to more than £47 billion this year. The IMF have noted that while Her Majesty’s Revenue and Customs (HMRC) is not good at estimating losses outside the declared tax system, which is why their latest estimates for the tax gap are low at £33 billion for 2011/12. And while we all read about Starbucks and Google and other large corporates engaging in (entirely legal) tax avoidance, half of all tax evasion is down to SMEs and a further quarter down to individuals (according to HMRC).  There are an awful lot of people not paying tax and simple calculations will show that the tax gap that can be attributed to cash is vastly greater than the seigniorage earned by the Bank on the note issue. Cash makes the government (i.e. us) considerably worse off.

The suggestion made in the Taylor report should be uncontroversial. However, there are people out there who think that forcing law-abiding persons such as myself to subsidise money launderers, drug dealers and corrupt politicians is a reasonable price to pay because the alternative is unpalatable.

In a world without cash, every payment you make will be traceable.

From Why we should fear a cashless world | Dominic Frisby | Opinion | The Guardian

My old friend Dominic Frisby is of course, completely mistaken about this.  Whether the electronic money in your pocket is completely traceable, completely untraceable, or somewhere in between, is a design decision. As I point out in my new book (did I mention that I had a new book out?) where exactly that dial is set between anarchy and totalitarianism is something that our elected representatives should decide and then ask technologists to deliver. This is subject that I know a rather a lot about and so I can assure you that the technology that we already have is perfectly capable of delivering electronic money anywhere on that spectrum.

My own prediction is based on William Gibson’s prediction in the pages of Count Zero. There, one of the characters in this future fiction notes in passing that “it wasn’t actually illegal to have [cash], it was just that nobody ever did anything legitimate with it”. Therefore I expect to see a variety of different kinds of anonymous electronic value transfer systems that are used to deliver pseudonymous electronic money systems and I expect some of those pseudonymous electronic money systems to be used by banks and others to deliver the special case of wholly traceable payment systems.

That, however, isn’t the point of this post. The point that I want to make is that we need an intelligent and informed debate on what we want to replace cash, since it’s going to happen. It should be society that determines how it wants electronic money to work. Whether cash is going to burn out or fade away, we should be planning its 21st-century replacement now. It’s an interesting question to ask whether that means Bank of England Bitcoins or not!

Csfi jun audience

On which topic I was invited along to take part in the CSFI roundtable on “‘Formal’ digital cash: The currencies of the future?” with Ben Dyson from the Bank of England and Hugh Halford-Thompson of BTL Group last month. The event, held at the London Capital Club, was hugely oversubscribed, which I took to be evidence of renewed City interest in the general topic of digital cash and the specific topic of digital currency.

My good friend Andrew Hilton, long-standing captain of the good ship CSFI, framed the discussion in his invitation ask the basic “what if”. “What if some central bank issued a digital coin that was as widely accepted as a bank note? Or, if not a central bank, what if a group of banks or payments operators issued a similar digital coin?”.

For me, the roundtable was both an opportunity to plug my new book (did I mention that I have a new book out by the way?) and an opportunity to learn in the best possible way: by answering hard questions from smart people. I won’t attempt to summarise the discussion here except to say that there seems to be a lot of confusion about what form a central bank currency might take and it wasn’t limited to the people in the room.

“Such risks could be reduced if central banks offer digital national currencies, which the IMF defines as a ‘widely available DLT-based representation of fiat money’.”

IMF urges central banks to study digital currencies | afr.com

Now, why the IMF would define digital national currencies this way is unclear. A national digital currency, or e-fiat for short, may be implemented in any number of different ways. A “widely-available DLT-based representation” would be only one such option and even then it is not entirely clear what “DLT-based” actually means in this context. For that matter, it is not entirely clear what “DLT” means in this context either.

It’s important to separate the topics to move the conversation along: do we need e-fiat and if we do, then how should it work? To the first point I think the answer is probably yes. To the second point, the answer is “well, it depends”. It depends on what we want the e-fiat to do. Should it deliver anonymity or privacy, for example. Should it work like M-PESA or Bitcoin? That’s a fun discussion. How much would it cost to set up “Bank of England PESA”? It wouldn’t even have 100m accounts and Facebook has a couple of billion. If they were to look at some form of shared ledger solution, where copies of the “national ledger” are maintain by regulated financial institutions (e.g., banks – whereby taking part in the consensus-forming process would be a condition of a banking licence) and the entries in those ledgers related to transfers between pseudonymous accounts (i.e., your bank would know who you are but the central bank, other banks and auditors would not) then it would be a permissioned ledger (without proof of work) that could work pretty efficiently. Either way, my point is that it’s doable, so we ought to do it.