It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.
Adam Smith observed that when individuals buy and sell, their efforts to pursue their own interest may frequently benefit society more than if their actions were directly intended to benefit society.
It is a simple idea, but it has been misinterpreted to mean that if people are selfish, they are more likely to do good for society than if they set out to do good. Unfortunately, the real world does not match this interpretation and economies built on selfishness become increasingly expensive to operate. Giving buyers and sellers license to be selfish destroys trust as people are ethically permitted, even encouraged, to take advantage of others, leading to a breakdown in trust. Once trust is broken, economic activity becomes expensive.
The alternative that builds trust is trading for mutual advantage. Fortunately, most commerce still works on this principle. It is the idea behind trusted brands, regulated prices, and many government regulations providing an advantage to both sellers and buyers to honour agreements.
Money markets are difficult to regulate because money is an abstraction rather than a physical thing. It is made real with coins, notes and accounts that reflect the value of goods and services. Value is subjective and depends on the context. In modern society, money tokens cost nothing to produce, yet they have value as soon as they exist. We have invented ways for the money tokens to increase in value with time through the idea of debt. Debt gives a return by increasing the number of money tokens.
Markets of tangible goods and services have issues of trust. Markets in money have more trust issues as value depends on others agreeing to money tokens' value. Debt requires trust that the borrower will pay the debt in the future.
There are ways to overcome the lack of trust in debt. One way is for the buyer and seller to share the investment's profits and remove the need to give money value over time. This article outlines how sharing the profits from the product produced from loans reduces the cost of investment by increasing trust as it removes the need to create extra money tokens to give a return on investment.
With debt investment transactions, the investor receives back more money than they provide, and they do not share the profit (interest) with borrowers. The money generates more money with all the profit going to the lender. On the borrower side all the profit from using the money, minus the debt cost, goes to the borrower. It means selfish lenders want to increase the cost of debt while selfish borrowers want to increase the price of goods and services and not pay their debts.
Removing the Time Value of Money
One way to share profits is to replace interest with discounts on goods and services. Instead of giving back the profit as interest, the investors can agree to accept back more goods and services produced by a given investment. Sharing with discounts is easier to administer, and the investor has confidence in an investment return.
Community Loans are loans where discounts give a return on investment. The lender receives a discount when they prepay for the goods and services. Compared to a traditional loan, the same amount of goods and services are produced, the investor receives the agreed profit, but the borrower does not have to pay interest.
It means the cost of producing goods and services funded with prepayments drops by the amount of interest paid with traditional finance. The parties can share savings created by the increased trust. These savings include reduced insurance, legal and accounting expenses.
When both the lender and borrower share in the profit from the investment, both parties have an incentive to reduce production costs. Sharing the profits of production with prepayments contrasts to traditional debt finance where the lender gets all the profits from financing, and the borrower gets all the profits from production.
The invisible hand of the market has become the visible hand of a transparent agreement between the lender and borrower on the price of tangible goods and services at the time of delivery. The profit comes from the difference between the cost of production and the price of the goods at the delivery time. It means both parties benefit when production costs decrease.
Funding Roof Top Solar Panels
Replacing traditional debt finance with prepayments requires different information systems and agreements. One such system is not for profit Pre Power Co-ops to fund the installation and operation of Roof Top Solar.
Pre Power Cooperatives use the principles of mutual advantage using money from investor members. Some members put in savings to buy solar panels while others consume the electricity produced. All members can do both.
With traditional debt finance, the Co-op would borrow money from members, banks or other financiers and pay rent on the money.
It costs about $7000 to install panels that generate 8,000 kWh of electricity each year. Assume banks charge interest at 8% and want repayments within ten years. Assume the Co-ops charge 15 cents per kWh for energy produced by the Co-op. With traditional funding, the Co-op repays $10500 to the bank.
The Co-op redeems $7000 of member investors prepayments to pay for $10,500 worth of electricity with prepayments. The return on investment is about twice the return provided by the Average Australian Superannuation Fund.
The $3500 not paid in interest is a real saving and reduces solar panels' cost to the Co-op. With traditional finance, the cost to buy the panels is $10,500. With prepayments, the cost is $7000. It means the Co-op can share the savings with consumer-members and investor members.
Ownership and Incentives
With traditional finance, ownership is of a productive asset. With prepower, the cooperative owns the legal asset while members own prepayments or the right to purchase the asset's output. When a prepayment is used, the asset does not lose its ability to produce output and ownership of future prepayments transfers to the buyer. For prepower cooperatives, the rule is that 50% of the payment becomes available to the purchaser to pay for future output.
The change in incentives to producers, lenders and buyers leads to greater cooperation and trust between parties. Greater trust leads to lower prices and more efficient use of assets. More efficient use of assets leads to higher returns, so producers, lenders, and buyers benefit.
Traditional debt puts a time value on money as borrowers rent money. With prepayments, borrowers give back more goods and services to repay debt and return on investment. No extra money is needed to pay for interest, so the investment cost drops by interest value.
Using prepayments instead of traditional debt retains consumers' market choices as it leaves markets in goods and services intact. Markets encourage efficiency as they allow for innovation and better ways of doing things.
Community ownership of assets with member ownership of the asset's future output gives all community members an incentive to keep the asset profitable.
If there are changes to the environment that interferes with production, the members are incentivised to work together to solve the problems rather than resort to out of date contracts and agreements. Working together provides better solutions and is lower cost than resolving disputes where there are winners and losers.