Default looms larger for Evergrande

Hong Kong United Times丨香港聯合時報

The main unit of China Evergrande Group (3333), Hengda Real Estate Group, applied yesterday to suspend trading of its onshore corporate bonds while rating agency S&P said it is almost certain that the developer will default.

Hengda received notice on September 15 from rating agency China Chengxin International that the bonds’ ratings had been downgraded to A from AA, and that the bonds rating and its issuer rating were put on a watch list for further downgrades, it said in a stock exchange filing.

Trading suspensions are relatively common in China’s domestic debt market following credit rating downgrades because a score below AA requires bonds to be traded via bid-ask and block platforms, rather than auctions. That prevents smaller investors, some of whom already can’t buy Evergrande’s local notes, from making speculative investments.

S&P this week further downgraded Evergrande to “CC” from “CCC,” with a negative outlook, citing reduced liquidity…

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Part I of IV—A Brief History of World Credit & Interest Rates • 3000 B.C. – 500 A.D. The Ancient Economy | Armstrong Economics

3000 BC – 500 AD—The Rise and Fall of Babylon – Greece – Rome

Credit is usually thought of as a modern invention of perhaps only a few hundred years old. It is true that a few more clever forms of credit have emerged during our current century such as plastic credit cards. But beyond that, credit has existed long before man invented an official form of money. Credit has existed from the very dawn of civilization. Man has always attempted to borrow from his neighbor if not cold hard cash, then at least a cup of sugar now and then. Some say that prostitution is the oldest profession; history actually suggests that the oldest profession may indeed be that of the moneylender.

As civilization emerged, a gradual need for a legal system became apparent. Much of the earliest recorded laws concerned the issue of credit and the price thereof – interest. A chap named Hammurabi, King of the first dynasty of Babylon, authored the earliest known formal laws around 1800 B.C. within which we find the first recorded attempt to regulate interest rates. Hammurabi established a ceiling or maximum rate of interest that a moneylender might charge a borrower. On loans of grain, which were repayable in kind, the maximum rate of interest was limited to 33 1/3% per annum. On loans of silver, the maximum legal rate was established at 20% – although some records have revealed a few rare instances when the rate of interest charged was as high as 25%.

Although interest rates of 20-25% in Babylon may appear excessively high, in India comparable rates of interest were quite similar. The legal limitation on interest rates during the 24th century B.C. in India was established at 24%, according to the Laws of Manu.

Nonetheless, every loan in Babylon, according to the laws of Hammurabi, had to be witnessed by a public official and recorded in a written contract. The penalty for charging more than the legal rate through any means was quite severe – the debt was simply cancelled. Collateral could be pledged in the form of land or some possession. A debtor could also pledge his wife, children or slaves. In extreme cases, the debtor could even pledge his person but the law forbids personal slavery of a debtor beyond three years.

The Law of Hammurabi remained unchanged for most of the next 1200 years. It is quite obvious that interest rates had often been charged well in excess of 33 1/3% during previous periods. Unfair practices also existed and many of these were addressed by Hammurabi. For example, creditors were forbidden from calling a loan made to a farmer prior to harvest. If the crop failed due to weather conditions, all interest on the loan would be cancelled for that year. In the case of houses, due to the scarcity of wood, a door could be used as collateral and was considered to be separate from a house. Architects were held responsible for defects in construction and could be put to death if the building collapsed and killed the occupant.

One who is unfamiliar with archaeology might suspect the ability to trace the price of gold, commodities or interest rates back thousands of years. Nevertheless, contracts etched into clay tablets have been uncovered recording all aspects of man’s early social and economic behavior several thousand years before Christ. Many loans took the form of a bearer note or bill, which the creditor could then sell, to another party. Some loans were subject to call while others bore a fixed rate of interest and a fixed maturity.

Records of international loans from one nation to another have also survived in clay tablets involving the Babylonians, Assyrians, Elamites, Hittites and Syrians. The Egyptians were more of a state-run economy highly authoritarian in nature leaving few records of interest and credit.

Another popular belief is that modern banking began following the Reformation, which marked the dawn of Capitalism. Again, this notion gives far too much credit to modern civilization while ignoring the archives of history. Although in early times moneylenders existed, they rarely accepted deposits. But in Babylon, records have revealed two major banking establishments that closely parallel the functions of our modern-day bank. The banking houses of the Egibi Sons and the Muradsu merchant bankers engaged in large-scale operations. Lending took place to individuals, merchants and governments. Deposits were accepted and transferred to another account upon a draft being presented. Deposits also earned interest and notes would be discounted as well as bought and sold. Even venture capital transactions took place where the bankers became the financing partner.

The sophistication of early banking institutions is quite surprising too most. There may not have been the instantaneous transfers but there was evidence of drafts, accounts, transfers, deposits, bearer notes and even overnight rates of interest during some periods.

As a result of formalized banking and widespread use of credit, history is littered with countless debt crises that have occurred regularly since the Babylonians right through into modern times. It appears that the endless cycle of borrowing more than one can repay has sealed the fate of just about every government that has ever existed.

Records of the Babylonian era illustrate quite clearly that cyclical regularities in the rate of interest charged exist from the very beginning. Silver loans at one point were over the legal limit reaching 25% clearly as a result of a short-term credit crunch. Nevertheless, the state during other periods granted silver loans as low as 12%. Additional evidence of the period establishes some temple loans of barley given at 20% and silver at 6.25%.

A history of credit and interest reveals one major trend that has been consistent through all time. The stronger an economy the lower the rate of interest. Interest rates are always at their lowest level internationally when capital reaches its point of maximum concentration. This normally results in a strong currency and high levels of confidence in general.

Interest rates also remain substantially above world rates in nations where confidence is low. Currently, this is true for South and Central America as well as in most third world nations. This observation does not arise merely from the events of today. Even during the days of Babylon, we find the same variance in rates with the lowest rate dominant in the strongest economy, which was the center of the Babylonian Empire. However, interest rates were usually much higher in neighboring nations which at times were more than twice those in Babylon. As the decline of Babylon came about during the fourth and fifth centuries B.C., interest rates soared with minimum rates reaching around 40% on silver loans. During the sixth through ninth centuries B.C., silver loans in Assyria and Persia were often in the 40-50% range.

The Bronze Age (2400-1200 B.C.) produced a vibrant economy around the Aegean Sea. Few records have survived so our knowledge of credit and interest is a bit vague for this period in time. It is known that the standard value was cattle – not gold. Gold formed the medium of exchange but it was not the standard unit of value. This is similar to our period of the modern Gold Standard insofar as cattle would be gold and gold would be the paper currency. We also know that there were fluctuations in gold relative to the standard unit of value – cattle. It is also highly probable that credit was once again abused and contributed to the economic decline along with changes in weather and increases in natural disasters.

This was the “golden age” of the Minoan-Mycenaean era that came to an end with the fall of Crete in 1400 B.C. followed by the Dorian invasion of 1200 B.C. This was period of which Homer wrote so memorably recording the great Greek Heroic period and the glory of the Trojan War. It was followed by barbarism and the period known as the Dark Ages.

As the world emerged from this dark period, civilization began to flourish once again. It is during this period when money was first coined by the Lydians – known today as a part of modern Turkey. This invention of money greatly aided in the expansion of international trade. The Greeks were the rising stars of the period much like the Japanese of the late 20th century. Capital began to flow back to mainland Greece bringing with it inflation, hoarding and wild speculations. In the Ibid we find references to this new age of materialism…”In next to no time the commercial genius of the Greek rises to the notion of speculation…capital accumulated is only an investment with a view to accumulating more.”

As history has shown time and time again, every great speculative boom has been inevitably followed by the proverbial bust. A severe credit crisis had materialized in Athens in 594 B.C. that had prompted major reforms in credit prescribed by the Laws of Solon. Solon was a poet that was named by Athens to revise her laws in hopes of correcting the economic devastation. Farmers were threatening rebellion in Attica and a debtor not only risked personal slavery but that of his entire family as well. Once a slave, creditors could do with them as they saw fit. Many families were broken up and sold in overseas markets. The debt crisis was indeed severe and the widespread personal slavery had become a major problem that threatened to destroy the Greek Empire.

The Laws of Solon were the first major reform to the legal code of Hammurabi. Although the Greeks lifted all maximum limitations on the legal rate of interest a moneylender might charge, personal slavery was completely banned. All those who had been enslaved for debt were freed and those sold into slavery in foreign lands were brought back at the expense of the state. Many debts were cancelled and others were secured by land when possible. The issue of inflation was dealt with by devaluing the drachma by 25% and weights and measures were increased in size. Political power had shifted from landowners to capitalists and this was reappointed once again back in the hands of the property owners. Citizenship was also granted to immigrants who were skilled. The speculations had indeed prompted stories throughout the Aegean that must have been similar to those concerning the United States with its streets paved in gold. You might say that this was perhaps one of the worst debt crises in ancient history. The Laws of Solon in 594 B.C. was indeed a major reform that dealt directly with the issues of a major debt crisis.

Over the following 100 years, the laws of Solon had helped insofar as avoiding massive debtor slavery but interest rates were still free to float without legal limitation. The customary rate on secured loans tended to move back and forth between 16%-20% per annum. The scarcity of precious metals also aided in creating somewhat of a depressionary atmosphere at times. This may have been a contributing factor to the widespread political upheavals that came in 508 B.C. – the birth of democracy in Athens. Often overlooked, however, was a similar political change in the new emerging empire – Rome. In light of modern-day political change, which first attempted to emerge in China during 1989 and quickly spread to Eastern Europe, the period of 508-509 B.C. was just such a period in ancient times. Revolution broke out in Rome in 509 B.C. less than a year following the political changes in Athens. This revolution in Rome marked the birth of the Roman Republic.

Interest rates in general tended to decline in Athens following the emergence of democracy from the customary rate of 16% down to 10-12% for fully secured loans on real property. This was also aided by the major silver discoveries of Athens in 483 B.C. that vastly expanded the money supply. After 400 B.C., speculation and the capitalistic system re-emerged in full bloom. Hoarding of coinage had become quite commonplace – particularly when dealing with the temples. The temple at Delphi is often referred to as the financier of the Greek Empire lending money for interest regularly. Not only were there typical moneylenders, but professional money managers also emerged. Socrates was reported to have entrusted his capital for investment with just such a personal friend. Finance and capital had become very sophisticated. Interest rates rose during this period quite sharply. Common rates of interest for a merchant voyage were 30% during wartime and 22.5% in peacetime. But as speculation flourished, maritime interest rates rose as high as 60% and in some isolated records appeared to be as great as 100% for more risky ventures.

Strangely enough, there is more recorded history on interest rates of this late Greek period than there is in much or early Rome. Perhaps the most interesting fact is that public credit of the state was considered to be the worst. Government more often than not simply never repaid its debt. Interest rates to a state or city were recorded to be as high as 48% annually. This was also the case during the Middle Ages in Western Europe. The credit of Greek states was so poor that often the only means of obtaining a public loan required the co-signature of a wealthy citizen willing to guarantee that state’s obligation. At times, the states were forced to pledge all revenues as security. Some states even resorted to borrowing based upon what was known as a life annuity. In return for a loan of 5000 drachma, the state agreed to pay the creditor 500 drachma each year for the remainder of his life. In the record of the Delos temple for the years 377-373 B.C., only two out of thirteen loans to Greek states or cities were repaid resulting in a loss of nearly four fifths of the original principle. This illustrates why there was such a low-level of confidence in government during this period.

At the dawn of the Roman Empire, credit regulation was again part of the legal code and as always was prompted by severe debt crisis. The legal limitation on interest was established at 8 1/3% per annum as set forth in the Twelve Tables – circa 450 B.C. Anyone who violated the maximum limit was subject to a fourfold penalty. The Roman law did substantially lower the maximum rate of interest. Nonetheless, personal slavery was permitted but provisions in the law did protect the well-being of the debtor slave.

The Roman experience with credit forms yet another long list of trial and tribulation. Major widespread debt crisis affected the Roman State many times through the early Republican era. In 367 B.C., the debt crisis was alleviated by charging all previous interest payments against principle and then writing off the balance of all debts. Julius Caesar used a similar tactic during the debt crisis of his era which had undoubtedly provided some incentive for his assassination since many of the moneylenders were in reality the senators of Rome.

Interest rates during the Roman Empire reached their lowest levels of about 4% during the reign of Augustus by 25 B.C. but soon gave way during the debt crisis of 33 A.D. when it was difficult to borrow at the legal limit of 12%. This debt crisis or 33 A.D. marked the beginning of a long rise in rates that continued for the following 400 year period. Nevertheless, the trend toward lower rates of interest that came under Augustus was confined to the core of the Roman Empire largely in Italy. Interest rates ranged between 12% and 48% in the provinces similar to what took place during the Babylonian era.

 

Interest rates during the Roman Empire reached their lowest levels of about 4% during the reign of Augustus by 25 B.C. but soon gave way during the debt crisis of 33 A.D. when it was difficult to borrow at the legal limit of 12%. This debt crisis or 33 A.D. marked the beginning of a long rise in rates that continued for the following 400 year period. Nevertheless, the trend toward lower rates of interest that came under Augustus was confined to the core of the Roman Empire largely in Italy. Interest rates ranged between 12% and 48% in the provinces similar to what took place during the Babylonian era.

 

The chaos of unfunded pension brought a collapse to the social structure during the third century. The collapse in the currency contributed to massive reforms and tax-hikes as well as the introduction of passports that people could not travel until they paid their tax. The chaos also led to the rise in Christianity as people prayed to their gods and nothing happened. This economic chaos of the 3rd century set in motion the eventual outgrowth to the collapse in interest rates and banking after the fall of Rome in the West in 476AD.

Ironically, the last Western Emperor took the name Romulus who was the founder of Rome and Augustus the firm Emperor. Hence, Rome died with a man named for the beginning.

Consequently, with the fall of Rome, there was a view that borrowing was evil and we ended up with the Sin of Usury – the charging of interest of any kind as Christian philosophy began to emerge. We can see from the above chart that as capital shifted to the East, the lowest interest rates emerged there and Roman rates rose singaling the fall was on schedule.

Much of the recorded history of early Byzantine economic policy is littered with this battle over interest. Justinian’s Code of the sixth century favored the bankers who were quite important to the state. He declared that “the ancient rate of interest is exorbitant” and thereby reduced the old Roman legal limit of 12.5% set by Constantine The Great down to a range of 4-8% according to the creditor. Bankers were allowed to charge the highest interest rates of 8% while private citizens were limited to charging a 6% rate. Curiously enough, public officials were restricted to charging 4% rates of interest per annum. Maritime loans were always much higher due to risks at sea and these were capped at 12%.

 

Source: 3000 B.C. – 500 A.D. The Ancient Economy | Armstrong Economics

Corporate Finance Entry #1: Credit

My credentials to give advice on these matters stem from my undergraduate and graduate school studies in Finance, Accounting and Information Technology as well as my CPA license having worked in public accounting and risk management consulting for nearly ten years. There are alot of people with aspirations to put their already operational small business into compliance; establishment of legal and tax protections.

Also, people that read the content on my site tend to understand WHO developed this playing field therefore I find it important to share some insight on how to adapt to the underbelly mechanisms of small business management, regulatory compliance and internal corporate financial oversight.

Obtaining a line of credit is NOT vital to run a successful business. However, obtaining a line of credit and mismanagement of this leverage – I have seen it CRUSH small businesses. I found an excellent website in which the author has very neatly categorized and compartmentalized many facets of corporate finance and accounting in language that is easy to understand.

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Incredible new research: how small businesses can be saved post-Covid

Posted Mar 7 2021 by Dave Darby of Lowimpact.org

It seems pretty obvious that there’s a giant economic slump on the way that’s going to sweep away millions of small and medium-sized businesses around the world, so that Amazon can step in to continue to try to take over the entire global economy.

I attended a wonderful online presentation on Friday, attended by around 80 key people working in the field of monetary reform, that showed how we can counter this trend, and keep small businesses alive.

There’s going to be a huge scarcity of money in communities for small businesses, and banks aren’t interested in lending to them – too much admin and risk, not enough profit.

I’ve blogged about mutual credit here many times, as a way to allow small businesses to trade with each other without requiring money. Now research has been carried out that looks at data from transactions totalling millions of euros between thousands of small businesses, and that provides the evidence that we’ve been looking for. It shows that businesses can reduce the need for cash by 25% by using mutual credit, and by another 25% by using something called continuous clearing. I’ll explain that now.

Continuous clearing

Imagine that at the end of the month, a circular trading loop of 10 businesses each owe £5000 to the next business in the loop. In normal business practice, 10 invoices are waiting to be paid, but none of the businesses knows the full story, and so they don’t realise that if they did see the whole picture, all those debts could be cleared without making any payments. Imagine that there’s a recession, and none of them has any spare cash. Some of them might arrange overdrafts so that they can pay – or worse, take out an expensive loan; or worse still, all the businesses might do the same thing. Then there’s interest to pay to the bank or the loan company, as well as the usual bank charges. ‘Trade credit clubs’ provide the solution to this problem. No-one needs an overdraft or a loan, no-one owes anybody anything, cashflow problems are eased, the banks don’t get any interest, and with a bit of luck, a few payday loan companies go out of business.

Businesses are already familiar with trade credit, and it’s much more common and more useful to small businesses than bank loans when it comes to providing ongoing liquidity. Most business-to-business invoices include payment terms of 30, and sometimes up to 90 days. This is quite risky for small businesses – but coming together in a trade credit club can reduce that risk drastically. Imagine a small club of three businesses (there could be a hundred businesses in a club, but for simplicity’s sake, let’s say there are just three). Business A buys something from business B for £10; Business B buys something from business C for £15; and business C buys something from business A for £5. But – instead of actually making those payments, they send the invoice details to a convener (or any trusted third party) to be ‘continuously cleared’, (which is is exactly what happens between banks).

So in this case, the convener can see that business A owes £10 and is due £5, so overall, owes £5 to the club; business B owes £15 and is due £10, so owes the club £5; and business C owes £5 and is due £15, so overall, is owed £10 from the club. The convener ‘clears’ those invoices and works out how each business’s balance changes, and then (maybe at the end of the month, or any time period agreed by the club members), instructs business A and business B to pay £5 each to business C, and everyone is square. So in this simple case, instead of three transactions totalling £30, there are just two transactions totalling £10. But, the interesting thing is that if there had been hundreds of transactions totalling hundreds of thousands of pounds, it might still have ended up with just a few payments of around £10 in total to bring everyone back to zero. This system drastically reduces the number of payments required, as well as the amount of cash that each business needs to enable all their transactions. It helps massively with cashflow and drastically reduces admin and bank charges.

Additionally, at the end of the month, the club might decide that, within limits, they won’t even bother making cash payments at all. So in the example above, business A and business B will both have a balance in their account of -5 units, and business C will have a balance of +10 units – which means that this is now also a mutual credit system. If someone is up or down by a huge amount, there might be an agreement to make a cash payment to bring them back to within pre-agreed limits (i.e. the mutual credit debit or credit limits). So for a club of businesses that trade with each other a lot, this is a double whammy – continuous clearing and mutual credit together could mean that they have no bank charges, no cashflow problems, no overdraft requirements, and possibly no cash payments to make at all.

The continuous clearing aspect is much easier for businesses to understand because it’s just common sense really – especially in a time when there’s not much cash around. The mutual credit part is a beneficial add-on, but in time, if it works well, the club could treat the continuous clearing as a warm-up act for mutual credit – like having stabilisers on a bicycle when you’re learning to ride. They could take off the stabilisers and become a dedicated mutual credit club if they want to.

The research

Here’s the paper. It’s quite heavy going, so here’s a summary:

There’s a pretty incredible addition to the trade credit story, and it’s that one country – Slovenia – has been operating what is in effect a giant, nation-wide trade credit club for over 30 years, with remarkable results. After independence in 1991 was immediately followed by a war against the Yugoslav army, and with inflation at more than 200%, the Slovenian economy wasn’t in good shape. To help protect Slovenian businesses, the government set up a system whereby businesses could send invoices for trades internal to Slovenia, to be cleared by the state payments agency. In the first year, the system resulted in a saving of cash payments by small businesses representing around 7.5% of the entire economy. Since then the proportion has fallen during good times, and grown again during slumps, which is to be expected. Slovenia has a small internal market; most of its firms are geared towards exports, and therefore can’t take part in national credit clearing. A bigger country with a larger internal market could achieve even more impressive results. This system helped Slovenia through the post-2008 slump without losing small businesses. Note that they don’t use mutual credit however – just continuous clearing.

In November 2020, Tomaž Fleischman of Slovenian software company Be Solutions, together with Paolo Dini of the LSE and Guiseppe Littera of Sardex, produced an academic paper investigating the benefits in terms of cash-saving for small business of a combination of continuous clearing (or obligation clearing as they call it) and mutual credit. They used Tetris software developed by Be Solutions to analyse almost 140,000 transactions totalling over 30 million euros between more than 3000 businesses. What they found was incredible – that continuous clearing alone can reduce the need for hard currency by 25%, but in combination with mutual credit, another 25% saving can be achieved. So these two mechanisms together can mean that 50% of the turnover of a typical small businesses can be conducted without the need for cash. This provides evidence to confirm one of our main assumptions about mutual credit (and credit clearing) – that it can keep small businesses alive during times of economic hardship, when money is scarce. Of course the continuous clearing doesn’t have to be carried out by the government – it can be provided at the local level, for example as part of a trade credit package offered by MCS.

Tomaž has since read the Credit Commons white paper, and is very interested in the possibility of global federation.

This research is quite a leap forward for what we’re trying to do with Mutual Credit Services. Any business network or local authority with vision should be able to see that they could help reduce the cash requirements of the small businesses in their network or local area by up to 50%! Hopefully we can help to set up Trade Credit Clubs around the UK and overseas (one of our team is talking to local authorities in the Czech Republic, and we’re in contact with groups on every continent).

Here’s an introduction to mutual credit, and here’s more on a book that’s coming out early next year. I’ll see if I can arrange an interview with Tomaž soon.