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Evan Davis gets to the heart of the big finance stories at The Bottom Line.

In the turbulent 20th Century, you could start a riot with a piece of paper – it just had to be printed with revolutionary slogans and handed out to disgruntled crowds. In the atmospherically obsessed 21st, the same mayhem can be triggered by rolling it up and smoking it, yet soon there’ll be a bigger sin than lighting a cigarette in the building; bringing out a banknote at the checkout. Paying by cash is fast becoming a form of anti-social behaviour – the point-of-sale equivalent of wearing safety-pin jewellery, watching Jonathan Ross or window-shopping with a brick.

Seasoned users of ‘ready’ money may already be noticing a backlash against cash. While cardholders swipe and type, cash customers must ride the glare of chafing chip-and-pins, maddened by the mutual fumbling over miniaturised coins. Travellers’ only rescue from a ticket queue longer than their journey is a machine which laps up plastic, but chokes on all but the most freshly-ironed banknotes and gives no change. Sales are shifting at double-digit rates to an internet which recognises Mastercard, Visa and PayPal infallibility, but sees no virtue in any non-virtual token.

Paper profits

Not long ago, people in power loved paper money. It was a commercial invention, devised to circumvent the physical inconvenience of gold and silver. Instead of issuing invoices which then had to be swapped for precious metal, buyers and sellers started trading the bits of paper, only rarely visiting the bank to withdraw the underlying riches. Private debt had become a convenient form of currency, fulfilling the traditional requirement of storing value and speeding up exchange. This also had immense political advantages, freeing rulers from the fiscal inconvenience of scarce and theft-prone bullion.

Governments could now print notes to represent their official reserves, keeping these locked in suitably fortified central banks, and once people trusted the paper currency, more could be issued – an especially useful tactic for rulers struggling to squeeze subscriptions from their nobility, or keener to raise an army than the accompanying tax. Medieval kings and emperors could only expand the money supply this way by clipping the gold and silver coins, or smuggling base metals into the mint. Their modern successors have the happier option of issuing public debt, spending more now while passing the bill to taxpayers still too young to vote.

Issuing more public debt than private investors want to hold – today’s innocuous sounding ‘quantitative easing’ – is traditionally condemned by monetarists as cruelly clawing-back the handouts through a hidden inflation tax, but this is an occasional public indulgence in a practice that’s second nature to commercial banks. They routinely make loans that are a multiple of customer deposits, pushing assets (and corresponding liabilities) far above what is actually held in reserve. Indeed, governments only rush to quantitatively ease when banks are on their collective knees because their credit has ceased to flow.

Paper money enables the same capital to be put to work in many places simultaneously. Productivity is multiplied by turning each asset into collateral for another, and re-lending many times the wealth that used to sit idly in a vault. Securitised debt may recently have stalled the world economy, but it’s only an extension of the forces that previously drove it. That’s why governments splashed the blank cheques to redeem the chequered banks.

A bullet through the wallet

If paper money opened all these doors, why is its future in any danger? For the same reason that an abstract axe hangs over the Royal Mail, printed newspapers and music on disc. Just as we could get value from precious metal without minting it, we can now get value from an invoice without printing it. Once money’s more manageable as an electronic pulse, suspicion surrounds those who still want it in physical form.

The problem with paper money is that it leaves no ‘paper trail’. Governments have long resented the way cash transactions enable legal traders to sidestep taxes, and illegal traders to launder their profits into regular circulation. The growing skill of forgers also challenges the most jealously guarded monopoly of sovereigns, who aren’t flattered when their likeness runs off someone else’s printing press.

More influentially, big retailers and manufacturers curse cash deals that fall outside their customer databases, so it can’t then be ‘mined’ for appropriately personal marketing ploys. They also regret needing a fleet of armour-plated couriers to empty and fill their cash-heavy tills. Finance directors declare war on the ‘off card’ transaction, which lets executives scupper the expense tracking system with improbable taxi fares and budget-busting bar bills.

Cash stands accused of causing banks to crash and civilisations to clash. Lenin famously viewed debauching the currency as the quickest way to undermine capitalism. Hitler came close to putting such pecuniary subversion into effect, with a wartime scheme to bomb Britain with banknotes, a road to ruin via rampant inflation. Guy Fawkes’s belated knighthood, for services to the global firework industry, is obstructed by his financially illiterate choice of tactics. Instead of lighting the blue touch-paper, he should have been faking the banknote paper and causing an unsustainable credit explosion.

Governments seeking faster, cheaper and more visible transactions are keen to kill the dollar bill – and its counter-clogging counterparts in the euro, yen and sterling zones. Corporations are equally concerned to stamp out logistically wasteful, electronically untraceable cash flows. To meet their demands, innovators who once promised a licence to print money now offer grand designs for making it vanish. Amid a general dearth of political visions, that of cashless society stands out like a viable mortgage in a sea of sub-prime debt.

Why cook the books when they can be vaporised?

In the brave new banknote-free world, cards will rule even at the bus stop and corner store, with mobile phones as an alternative means of payment. The mobile internet will move against cash by spreading direct transfers that have already shot down the once-mighty cheque. Formerly well-thumbed Adam Smith, Charles Darwin and Elizabeth Fry will be banished to the portrait gallery, while royal heads retreat to the postage stamp.

If robbed of officially sanctioned cash, won’t people just invent their own? Economies that ran short of legal tender were famously quick to adopt a replacement, from cigarettes in prisoner-of-war camps to elaborate IOUs in post-Soviet Russia.

However, the death of cash means only the de-materialisation of money, not its disappearance. Indeed, the biggest danger is that paperless money be further detached from underlying wealth, drowning us in devalued riches. Air Miles already rival the world’s major currencies in terms of quantity and acceptability, but so many have been created that running flights for them all would fry the world before a fraction of the holders could fly round it. Second Life is shielded from excess of virtual currency only by the infinite expandability of online real estate.

Prophets of the cashless economy promise that risks of monetary excess will be reduced, with every deposit and withdrawal electronically matched. New regulatory schemes to avert further meltdowns, including a giant register of to check that banks’ balance sheet assumptions really add up, underline the faith in data-based trading to guarantee transparency and monetary stability.

What of those who can’t afford a plastic card, aren’t online and don’t carry a mobile? Cashless commerce will compound an already serious digital divide. Those barred from the virtual marketplace may have to form their own cash-trading communities, until connections to new networks are as ubiquitous and affordable as those of the savings banks and post offices they replace. Pulling out a banknote could soon be an act of solidarity with the socially excluded, but you’ll still have to swap them on windy street corners, after the tobacco smoke has cleared.

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Getting a good deal - things to think about when shopping online.

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About the author

Alan Shipman is lecturer in economics at the Open University, and a former financial journalist. His books include The Globalization Myth, The Market Revolution, and Transcending Transaction. He is involved in OU's new courses on personal finance, and research on insurance pools, 'chaos pricing' and Eastern Europe.

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As Christmas approaches Dick Skellington heralds the first panto season since the banking crisis.

I say, I say, I say. Latest news, the Isle of Dogs Building Society has collapsed. They've called in the retrievers. Have you heard this one? A masked man holds a bank cashier up with a gun. He says: 'I don't want any money - I just want you to start lending to each other’.

Boo-boom!

Sorry, it’s the way I tell ‘em. Let’s start again.

Les Dennis in pantomime.
[image © copyright BBC]

What have Captain Hook, the Wicked Fairy, Cinderella’s stepmother, the Evil Baron, King Rat, the Evil Wizard, the Giant, the Sheriff of Nottingham, and the Wicked Queen got in common? This Christmas, whatever your panto and wherever it is in the land, the villain is more likely to be portrayed as a banker. Let’s hear it for the Lehman Brothers as the Ugly Sisters. Just think of poor little Goldilocks lost in the Bear Market being pursued by three nasty brokers! And think of poor Puss trying to pay those prices in Boots! Don’t forget to boo and hiss!

This Christmas it will be the banker who will be lurking menacingly behind the principal boy who will be played by a vulnerable single parent recently evicted for falling behind with her mortgage.

So when Dick Whittington pops onto stage left with Tommy the Cat at his feet, Dick is more likely to ask the audience:

What’s the difference between a merchant banker and a pigeon?
A pigeon can still make a deposit on a BMW.

And then, not to be outdone, up purrs Tommy with this one to the Gods:

What’s the difference between an investment banker and a large pizza?
A large pizza can feed a family of four.

Boo-boom!

How we’ll all cheer when master villain King Rat gets utterly custard pied by Tommy the cat and Dick gets a tracker mortgage with a Bank of England interest rate and returns home to marry Alice and live happily ever after in a nice semi in Sidcup.

For this year it’s the bankers who will be getting the slap and stick. So let’s hear the cheering throughout the land. Rejoice. Whatever the panto you can cajole your kids into heckling: ‘come on you bankers pass the interest rate cuts on to me mum and dad!’. This year’s panto season promises to be a hoot. I mean who would want to trade places with the head banker at the Royal Bank of Scotland (RBS)? I can just imagine the chorus singing ‘I’m a Banker, Get Me Out of Here!’.

No really. There is nothing more likely to get us chuckling in the Gods than the bankers getting their comeuppance. The suffering proletariat have had it so bad. We need a little bit of festive humour to roll back the impact of the credit crunch with its rising mortgage debt, repossessions soaring 70 per cent compared to the same quarter last year, the lowest pound since 1992, and with unemployment expected to top 3 million before the next panto season.

To the nation this parsimony sums up the public image of an already discredited menagerie of fat cats. Since the bail-outs the banks have done little to improve their stock by helping those whose money – what’s left of it – keeps them in offshore accounts and Christmas parties.

Politicians too can expect a panto drubbing after allowing banks to profit enormously in a deregulated culture for so many years, and lending poor Red Riding Hood a 130 per cent mortgage. It is not for nothing the phrase 'Houses of Parliament' is an anagram of 'shameful operations'!

At the King’s Head in London, Dick Whittington’s nemesis King Rat is a banker and property developer intent on bringing the economy of the paradise island of Gran Canaria to its knees. The audience will wince as the shameless speculator greedily buys up property, lends money to local businesses and causes havoc when he calls in the loans and buys the island’s central bank. On the way he evicts the show’s Dame from her bar and sells off the premises as luxury flats. Now where have we heard that one before?

It is hardly surprising this festive season will witness pantomimes all over the country revising their storylines and casting the evil villain as a banker, updating daily as the credit crunch unfolds. Since ancient Greek and Roman times panto script writers have had a keen eye for contemporary events. Pantomimes have always told morality tales. And who can blame the script writers with the banks so reluctant to pass on any good news as they use Government bail outs to restructure their own finances with little thought for the rest of us. Never has A Christmas Carol been more relevant. Scrooge is so 2008.

Here’s Dick again:

Talked to my bank manager the other day and he said he was going to concentrate on the big issues from now on.
He sold me one outside KFC yesterday.

The Gods groan in disapproval.

But Tommy the Cat soon wins them over with a real Christmas cracker!

What’s the capital of Iceland?

Shouts Tommy!

About £3.50.

But should your panto fail to cheer this Christmas remember the old saying.

What’s the definition of optimism?
A banker who irons 5 shirts on a Sunday.

About the author

Richard Skellington edits Society Matters for the Faculty of Social Sciences at the Open University. He’s an administrator who manages the Environment, Development and International Studies programme.

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Money Programme

Get the facts behind the big business and finance stories from around the world – and down your street, in The Money Programme.

'The AA; Rescue or Wrong Turn?' highlights the advantages of private equity to at least some stakeholders. Whilst the private equity takeover of the AA has not been a good experience for all employees, or even customers, private equity investors have already got their investment capital back, and are looking forward to billions of pounds of profit when they sell the AA on. How did they do it?

Firstly, by taking advantage of the glut of money around the world. Banks are falling over themselves to lend money, at ultra-low interest rates and with no strings attached. And the private equity firms do not even need to have a good credit rating. They secure the debt they borrow on the assets of the companies they buy. With pre-determined debt interest costs, any increase in profits from reducing staff numbers, for example, goes straight to the private equity investors.

But there is another reason why private equity is a ‘no brainer’. Debt interest payments, and not equity dividends, are tax deductible for corporation tax purposes. All private equity investors have to do is to buy a company, load it with debt, and benefit from reduced tax bills. The stakeholders who pay for this are a country’s taxpayers. Lower corporation tax receipts usually mean higher taxes elsewhere. This has had such a major impact that some countries have changed their tax laws.

For example, the private equity purchase of the main Danish telecoms operator, TDC, in early 2006 for 13bn euros (with a special dividend of nearly half that paid to private equity investors less than six months later) was 90% debt funded. It is estimated that this private equity financing alone has reduced Danish corporation tax revenues by more than 12%, and the recent private equity takeover of Danish cleaning company, ISS, will have made matters even worse for the Danish government – and for Danish taxpayers. The Danes are currently conducting a review of the tax deductibility of debt payments. And the German government is reforming its corporation tax rules, also with a view to limiting the tax deductibility of debt. However, Ed Balls, Economic Secretary to the UK Treasury, said recently that the government had no plans to review the tax deductibility of debt principle as far as UK-based firms were concerned.

This tax game is nothing new. Leveraged buyouts in the 1980s aimed to exploit exactly the same tax relief. That boom ended when interest rates went sky high, and a recession meant interest payments had no profits against which to be offset. If interest rates go up this time, or if there is a recession, we will experience a sense of déjà vu. But the secretive nature of private equity companies will make it much harder to find out exactly who is bearing the pain this time around.

Further reading

•  
• The AA: rescue or wrong turn? - are private equity investors saving or savaging The AA? The Money Programme investigates.
• The private equity rollercoaster - 2005 was a record year for UK private equity deals, but many in the industry see dark clouds on the horizon.
• Corporate accountability and ethics - a disregard for ethics can lead to trouble: remember the Enron saga.
• Tax shelters - nobody likes paying tax, but how far would you go to avoid it? Liberia? Monaco?
• Is tax avoidance only for the rich? - can everyone pay less tax? Or is it a rich man's game?

About the author

Janette Rutterford is Professor of Financial Management at the OU Business School, having previously worked in corporate finance and investment. Jannette's research includes pension funds, equity valuation and investment history, in particular the history of women and wealth.

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