Central Banking Doesn't Work - Just Ask the Fed!

By Tom Mullen
Tom Mullen's Blog
Tuesday, January 26, 2010

http://thomasmullen.blogspot.com/2010/01/central-banking-doesnt-work-just-ask.html

It is still a tiny minority who understand that central banking is a collectivist institution that is completely hostile to liberty. It is, by definition, an instrument of theft that purports to stabilize economic conditions for the collective by controlling the supply of money and credit. The fact that its only means to do so is to steal from savers to finance well-connected borrowers is a seldom-mentioned detail. That people only use the central bank’s currency because they are forced to do so by legal tender laws is spoken of even less. In this late stage of the Age of Government, the rights to liberty and property are expendable as our rulers “get the work of the American people done.”

Hopefully, the question of whether there should be a Federal Reserve will be on the table soon. However, once one concedes the existence of the Fed, there is a further question to ask: Can it do what it purports to do?

According to the Federal Reserve’s website, its mission is as follows:

Today, the Federal Reserve's duties fall into four general areas:

• conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates

• supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers

• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets

• providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system[1]

Of these four stated goals, the first is the most expansive in its scope. Let us leave it until last. The second, to ensure the soundness of the banking system, seems to have been answered by history. Since the Fed’s launch in 1914, the nation has suffered banking crises in every generation that have dwarfed the Panic of 1907 or any of its predecessors. In addressing the Great Depression, the Savings and Loan Crisis, and the 2008 Meltdown, the Federal Reserve’s only answer has been, “Without the Fed, it would have been much worse.” History is not on the Fed’s side. Only a general ignorance of the facts allows the Fed to keep fooling most of the people most of the time.

Refuting the third stated goal is so easy it’s almost embarrassing. For those not trying to regain their seats after falling on the floor laughing, I need only to point out 30-1 leveraging, $60 trillion (or more?) in derivatives [2], or the subprime mortgage disaster. I believe that to go any farther would be, to borrow a football analogy, "piling on."

In fact, Alan Greesnpan's now famous (or infamous) mea culpa on the "flaw" in his beliefs about the self-regulating nature of financial markets effectively amounts to the Fed admitting that it has failed in goals two and three. If the "Maestro" himself doesn't speak for the Federal Reserve, then who does?

Regarding that fourth goal, one is tempted to give this one to the Fed. The important objection would be of the "should they" rather than of the "can they" variety. The fact that the Fed provides these services with an exclusive monopoly and claims only that it will play a “major role," rather than a positive one, makes this the least significant of the four.

That leaves the first goal, which is stable prices, full employment, and moderate long term interest rates. There can be no doubt that the promises of stable prices and full employment in particular are now the principle justifications for the existence of the Federal Reserve. Almost exclusively, when the subject of the Fed comes up, these two goals are discussed. Even the Fed chairmen themselves, when testifying before Congress, often state these two goals exclusively in describing the Fed's overall mission.

It should not be forgotten that until the late 1970's, full employment was not part of the Fed's mandate. Even using the logic of central banking proponents, these two goals are mutually exclusive of one another. Since the only means the Fed has at its disposal to try to achieve full employment is expansion of the supply of money and credit, which puts upward pressure on prices, the Fed must balance these two goals to try to find the optimum level of money and credit where everyone is employed but prices remain stable.

Ironically, the best source of information on the Fed's performance in terms of its principle goal for the first sixty years of its existence (price stability) is the Fed itself. Among the collections of historical data on the Federal Reserve of Minneapolis website, there can be found a table documenting price inflation rates for every year since 1800 (Appendix A of this article). There, one can see for oneself whether or not the Fed provided price stability during any period in its existence.

The first fact that jumps off of the page is the stark difference in the trends before and after the creation of the Fed. For the period from 1800-1913, the general price level (a statistic that Austrian economists object to) was cut almost in half. In other words, products that on average cost $100.00 in 1800 would only cost $58.10 in 1913 (Appendix A). While there were some years where prices rose, prices generally fell overall during the entire 19th century.

This would probably be a startling revelation to most modern Americans. There isn't an American alive whose parents or grandparents haven't remarked at current price levels and gone on to say, "When I was your age, I only paid a dime for that." As unbelievable as it might seem, that conversation would have been exactly the opposite in 1890. Grandpa would instead be saying, "When I was your age, I had to pay a lot more for that." Today, Americans resign themselves to constantly rising prices as a fact of life. However, that is a phenomenon that has only occurred since the creation of the Fed.

In contrast to the century preceding the Fed, the century following has seen exactly the opposite result. Those same products whose average price had fallen from $100.00 in 1800 to $58.10 in 1913 rose to $1,265.14 in 2008. That is an increase of over 2,000%!

Without addressing the subject of which result is "better for society," inflation or deflation, the data speak directly to the question of "price stability." From 1800-1913, the average annual fluctuation in price was 3.4%. From 1914-2008, the average annual fluctuation in price was 4.5%, a 33% increase over the previous period. In fact, the numbers for the Fed would be far worse if the same methods used to calculate the price inflation rate were used for the entire period from 1914-2008. In the 1990’s, several changes were made to the methodology used to calculate the Consumer Price Index. They all have the effect of lowering the price inflation rate given a particular set of price data.

Regarding the goal of "full employment," the Fed's results are also poor. Similar to that of the CPI, the methodology for calculating the unemployment rate was also changed in the 1990's. These changes in methodology, which include no longer counting "discouraged workers," lower the unemployment rate from what it would be for the same data if calculated using the old methodology. Despite this handicap, the Fed still fails to achieve positive results. The average annual unemployment rate in the U.S. between 1948 and 1978 was 5.1% (see Appendix B). Even without compensating for the changes in methodology during the 1990’s, the average annual unemployment rate in the U.S. between 1979 and 2009 was 6.1%. So, unemployment was almost 20% higher during the period that the Fed actively tried to manage it than it was during the prior 30 years.

Once you undo the methodological changes in calculating price inflation and unemployment that were put in place in the 1990’s, the Fed’s results on price stability and unemployment get much uglier. Nevertheless, even after the Fed fudges its own numbers it still comes out a failure. Everyone can remember the ne’er-do-well from school that cheated on tests and still couldn’t pass. Would we want that kid managing the entire economy?

The arguments that the Fed makes to justify its existence are fraught with false assumptions. One is that “stable prices” are a good thing. Remember, the industrial revolution occurred amidst steadily falling prices. It was this period of steady deflation (gasp!) that saw the common people become the prime market for society’s output - for the first time in human history. It was this period that saw the United States transform itself in a matter of decades from an indebted hodgepodge of former colonies to a world economic power. The natural result of economic progress and increased productivity is falling prices. That is what raises the standard of living for the great majority of society.

However, the most absurd assumption underlying the arguments for the Fed is one common to all collectivist arguments: that there is some strange entity called “society” whose needs outweigh the rights of every individual that comprises it. Every citizen surrenders his right to liberty to legal tender laws because being forced to use the Fed’s worthless notes as currency supposedly benefits “society.” He surrenders his right to property in letting the Fed steal his savings through inflation for the same reason. In the end, however, the Fed fails to achieve its “societal” goals of full employment and stable prices, so he gives up his rights for nothing. Isn’t time he took them back? There is a way: End the Fed.

Appendix A - Price Inflation Rates 1800-2008 (Federal Reserve Bank of Minneapolis)

Appendix B - Unemployment Rate (Monthly) 1948-2009 (Bureau of Labor Statistics)

[1] http://www.federalreserve.gov/aboutthefed/mission.htm

[2] http://www.newsweek.com/id/164591

Reprinted with permission.

Digital Precious Metals Consistently Under Attack

The digital precious metals and digital currencies continue to come under attack from the anti-money laundering profession. In the latest U.S. study by Saskia Rietbroek of AML Services International, LLC, "Emerging money laundering methods: Digital precious metals" (November 2009), the anonymity is cited as the lure for criminal behavior without any deference to legitimate financial privacy or monetary freedom. This is a serious impediment to widespread digital currency adoption and it must be factored in when considering physical and legal jurisdiction for issuers. Rietbroek writes:

"With digital currencies you can move money internationally in a manner that approximates money remittance or wire transfers. Digital currencies are denominated into internationally recognized weights of precious metals, such as gold or silver. You can open an anonymous digital precious metal account online. A digital precious metal account is very much like an online bank account except your funds are held in precious metal and not paper currency. The balance on your statement is denominated by weight in grams of gold and not dollars or euro."

"Anonymity is heavily marketed characteristic of the digital currency industry. Because digital currency accounts are obtained online and are not subject to the customer identification procedures associated with obtaining a traditional bank account, they often can be opened and funded anonymously."

Unaware that digital currencies via international exchangers will one day supplant anonymous but cumbersome paper cash to fuel the digital economy, Rietbroek continues:

"To fund the account, you can use wire transfers, money orders, or by making cash deposits directly to an exchanger's bank account. Many exchangers will convert digital currency balances into anonymous prepaid (stored value) cards that can be used to withdraw funds by various methods, including at ATMs all across the world."

"The anonymity and international features are very attractive to a money launderer. Digital currency accounts also allow individuals to execute multiple currency-to-currency exchanges in a short period of time and therefore they can become an ideal layering mechanism."

Who Owns Mobile Money?

By Ari Hyytinen and Tuomas Takalo [1]
The Lydian Payments Journal
November, 2009

http://www.pymnts.com/who-owns-mobile-money/

It has long been predicted that the digital revolution will transform the way people pay at their point-of-sale transactions. The end of the cash era could indeed have dramatic consequences, not least since it might eventually even lead to the obsolescence of central banks.

While many digital payment media innovations have failed to take off and the paper form of cash has turned out to be surprisingly resilient, many commentators argue that mobile phones and other similar portable electronic devices finally enable digital cash to solve its chicken-and-egg problem.[2] For example, mobile phones can currently be easily equipped with payment features, and since almost all consumers in the developed countries carry mobile phones, shopkeepers are willing to install systems to handle mobile money. The prospects of mobile money are even greater in poorer countries where it often constitutes the only feasible digital payment medium. Moreover, mobile phones' display and ability to act as a mobile ATM add to mobile money's utility. But in contrast to the supply of paper cash, which is the monopoly of central banks, it is not clear who owns the property rights over mobile money.

Since the mid-1990s it has been clear that the emergence of new mobile technologies represents an untapped business opportunity. But who has tried to seize the opportunity and invested in the development of mobile payment technologies? What kinds of firms have tried to enter into this new, promising market? Where do these entrants come from?

At least two distinct industries should have had an incentive to innovate in and compete for the market for mobile payments. On the one hand, traditional incumbents in the market for payment media are financial institutions, such as banks and payment card companies, who obviously had a head start in capturing the emerging new market. On the other hand, ICT firms, equipment makers, and telecommunications operators, for example, are specialists of mobile communications technology and have been vying for new applications and revenue sources for their devices and services. Moreover, the economics of payment media markets is quite similar to that of the communications industry: both are two-sided markets characterized by network externalities and platform competition.

It is, of course, equally possible that new entrants could come outside these two main candidate industries. For example, Internet marketplaces and service providers, software and operating system producers (such as Microsoft and its rivals and collaborators), or completely new research-based entrants with unconventional business models could be interested in developing mobile payment media applications and entering the market.

The new mobile and digital payment media markets are emerging. While their eventual landscapes are yet unknown, patent statistics provide a window to the future and potential entry, characterizing innovative activities and intellectual property strategies of potential entrants at the birth of new mobile payment media.

Based on our own preliminary data analyses and Hall, Thoma, and Torrisi's research, some clear and interesting patterns seem to emerge from the patenting data.[3]

First, as Table 1 shows, patenting activity picked up late 1990s and accelerated after the millennium. This pattern emerges from the world-wide patent data on mobile payment technologies to which we have had access (covering publications from 42 patent offices and coming from Derwent World Patent Index -database). The same pattern can also be extracted from the European Patent Office (EPO) data on European financial patents compiled by Hall, Thoma, and Torrisi. While their study aims at covering a broad range of financial patenting, their data appear to cover a lot of payment methods and technologies. Hence their results could be seen as providing an upper bound for payment innovation patenting in Europe.

Table 1: Average Number of Patent Applications per Year

Second, U.S. firms are the most important source of mobile payment patent applications. In Hall, Thoma, and Torrisi's research, it is reported that 49.9% of EPO financial patents originate from the U.S. In our technologically targeted but geographically broad data, the U.S. innovators account for 31% of the (global) patent applications.

Third, the involvement of incumbents (financial institutions) is modest. Some payment card platforms figure in the statistics, but banks and other financial intermediaries are nearly absent. In our patent data on mobile payment technologies, traditional financial institutions are virtually entirely absent; among the top 20 patentees, none is coming from the traditional financial sector. From Hall, Thoma, and Torrisi's research, we can infer that out of 52 top financial patentees in EPO, nine (17%) come from the financial and insurance sector. These nine include four major payment card platforms and service providers (First Data, Mastercard, Visa, and American Express) but only few financial intermediaries.

In contrast, established ICT firms, device manufacturers, and operators in particular, seem to account for most of the mobile payment and European financial patents. In Hall, Thoma, and Torrisi's data, top five patentees include IMB, Citicorp, NCR, Fujitsu, and Siemens. In our (unweighted) data, they are Ericsson, Siemens, Nokia, Motorola and IBM. This suggests that ICT firms, which are entrants into the financial service sector, have begun to create and compete for a new market.

Interestingly, the patterns of patenting of mobile payment technologies are in stark contrast to some other areas of financial innovation, such as financial exchange systems and infrastructures. In this area, most innovations (according to the patent statistics) arise from the traditional incumbents, such as investment banks and financial exchanges.[4]

There are a couple of potential explanations for the absence of financial institutions and dominance of the ICT firms in the patenting of (mobile) payment technologies.

The first potential explanation is that the different industry backgrounds of the most likely entrants have repercussions for their innovative strategies. Investments in R&D and IPR management have long been the core competitive strategies in telecommunications industry, whereas financial institutions have hardly bothered to document their R&D investments. This view suggests that both incumbents and entrants may innovate equally but use different intellectual property strategies. It is possible that financial institutions waive patent protection, resorting to their traditional appropriability strategies (e.g., lead time and secrecy) to protect their mobile payment innovations, whereas ICT firms just follow their patent-based intellectual property management systems.

However, it is well documented that the Court of Appeals for the Federal Circuit's landmark 1998 decision in State Street Bank & Trust Co. v. Signature Financial Group, Inc[5] has raised the awareness of intellectual property issues not only in the U.S. but also in the global financial services sector. In some cases the State Street decision is also known to have drastically changed the management of financial innovations in financial services, prompting a large scale use of patents as an appropriability strategy. For instance, the active innovators and patentees in the field of financial exchange systems and infrastructures have been investment banks and exchanges themselves. It therefore seems a bit unlikely that different levels of awareness and interest would account for the difference in the patenting patterns over the past ten years, i.e., over the period when the most of mobile payment patent applications have been filed. Indeed, if one only looked at the overall patenting of payment inventions over time and across regions, one could easily make the misleading conclusion that the State Street decision prompted the U.S financial institutions to patent their payment method and technology innovations, too.

The State Street decision also implies that the research and innovations of financial institutions are hardly unsuitable for patenting. Moreover, many of the (mobile) payment innovations are inherently technological and as such have been always patentable. For example, according to the USPTO, one of the first U.S. patents was granted on March 19, 1799, for an invention used for "Detecting Counterfeit Notes".[6]

An alternative explanation for the lack of patenting by financial institutions in the area of mobile payment technologies is that they do not innovate. This fits well with the classic argument, associated with Kenneth Arrow, according to which incumbents generally may have weak incentives to innovate since they recognize that the new innovations cannibalize the revenues from their existing products.[7] More recently, Raghuram Rajan and Luigi Zingales emphasize that incumbents may prefer to conspire with the politicians to preserve the status quo and to prevent entry rather than to engage in innovative activities and competition for new markets. This could account for the cross-country variation in the pace of financial development over time.[8]

Whether some firms can eventually create and conquer the market for mobile payments and enforce effective property rights over the mobile money so created is a question on which existing data or research has little to say. Since this is an industry in which network externalities are crucial, it would be tempting to predict that the market will eventually "tip" towards a dominant solution. But politics and regulation creates a particular source of uncertainty, as the global financial industry and therefore a large part of the payment media markets (e.g., deposit services) still operate under extensive regulation. The limited prospects for further deregulation in this area suggest that potential entrants with the most radical mobile payment media innovations face a rocky road ahead.

If we had to bet a euro now on the future of mobile money, we would bet it on a rather fragmented market outcome, with different technological solutions and business models co-existing in different geographical and business areas.

Ari Hyytinen is Professor of Economics at University of Jyväskylä and Associate Research Fellow at the Research Institute of the Finnish Economy (ETLA), Finland. Tuomas Takalo is Research Supervisor at the Bank of Finland and Professor of Economics at University of Jyväskylä, Finland. This article has in part been prepared as part of ETLA-BRIE collaborative research program "Networks, Services and Global Competition." The underlying research has partially been funded by the Jenny and Antti Wihuri Foundation. Reprinted with permission.

---

[1] Hyytinen is Professor of Economics at University of Jyväskylä and Associate Research Fellow at the Research Institute of the Finnish Economy (ETLA), Finland. Takalo is Research Supervisor at the Bank of Finland and Professor of Economics at University of Jyväskylä, Finland. This article has in part been prepared as part of ETLA-BRIE collaborative research program "Networks, Services and Global Competition." The underlying research has partially been funded by the Jenny and Antti Wihuri Foundation.

[2] See, e.g., our own work (Ari Hyytinen and Tuomas Takalo, "Consumer Awareness and the Use of Payment Media: Evidence from Young Finnish Consumers," Review of Network Economics 8 (June 2009): 164-188), and the references therein.

[3] For details, see Bronwyn Hall, Grid Thoma, and Salvatore Torrisi, "Financial Patenting in Europe," NBER working paper no. 14714 (2009); Bronwyn Hall, Grid Thoma, and Salvatore Torrisi, "Financial Patenting in Europe," European Management Review 6 (2009): 45-63.

[4] See Mari Komulainen and Tuomas Takalo, "Does State Street Lead to Europe? The Case of Financial Exchange Innovations." Bank of Finland discussion papers 22/2009 (2009).

[5] 149 F.3d 1368.

[6] Patentability of payment media innovations is discussed further in Robert M. Hunt, Samuli Simojoki, and Tuomas Takalo, "Intellectual Property Rights and Standard Setting in Financial Services: The Case of the Single European Payment Area," in Financial Innovation in Retail and Corporate Banking, eds. L. Anderloni, D.T. Llewellyn, and R.H. Schmidt (Edward Elgar: Cheltenham, UK, 2009).

[7] Kenneth J. Arrow, "Economic Welfare and the Allocation of Resources for Inventions", in The Rate and Direction of Inventive Activity: Economic and Social Factors, ed. R.R. Nelson (Princeton University Press: Princeton, 1962).

[8] Raghuram Rajan and Luigi Zingales, Saving Capitalism From the Capitalists (Princeton University Press: Princeton, 2003). As also Rajan and Zingales point out, the notion that in particular (financial) intermediaries have an incentive to lobby for restrictions in competition goes back at least to Adam Smith (see Adam Smith, The Wealth of Nations, Book I, Chapter XI, ed. E. Cannan (1776; Chicago University Press: Chicago, 1976, p. 278).

How MMOs Decriminalize Real Money Trading

By AJ Glasser
GamePro
Friday, January 29, 2010

http://www.gamepro.com/article/news/213786/analysis-how-mmos-decriminalize-real-money-trading/

GamePro investigates the hazy intersection between law, economics, and gameplay that many massively multiplayer online gamers cross so many times when they buy or sell virtual goods.

Real money trading (RMT) may not be something you read about in your high school economics class, but it’s something every massively multiplayer online gamer encounters every day. If the buying and selling of virtual goods using real money isn’t something actively encouraged by the game itself, you at least hear horror stories about gold farmers causing prices of in-game goods to go up, or find eBay auctions of in-game items for crazy-huge sums of money.

Earlier this month, the topic of real money trading in MMOs made some ink when a South Korean Supreme Court acquitted two Lineage gamers of criminal charges related to selling in-game currency for actual money. At issue in that case was whether or not the gamers had violated a South Korean law against unsanctioned gambling; but by clearing them of the charges, South Korea effectively legitimized RMT in MMOs.

Don't quit your day job to take up Epic Gear brokering in World of Warcraft just yet, though; RMT is still a sore point for many game developers. In particular, you'll find that games like WoW frown on RMT within their End User License Agreements (EULA) or Terms of Service documents. People who violate those pieces of paper may not go to jail – but Blizzard can sue the pants off them for breach of contract (not to mention ban your account altogether).

Rutgers University law professor Greg Lastowka explains the legal side of the RMT issue as a case where first, the game developers have to decide how vigorously they want to regulate RMT and second, where players might consider violating the game's EULA because RMT really pays off.

Greg Lastowka

"Most game companies are concerned about the trade of real money for virtual property because they see it as a potential way of creating liability for them," Lastowka tells GamePro. "If [fraud] occurs in a virtual world, the game is in the middle, the game company has to be dragged into litigation. So if players can have property rights and legal claims to their virtual property, I think that scares game companies for the most part."

However, as long as there is no criminal law on the books with a country's government – like the anti-gambling statute that sparked the South Korean case – it’s all on the game companies to go out and find people who violate their EULAs by engaging in RMT.

This is apparently quite the pain in the ass. Scan eBay auctions right now for Epic Gear in WoW (a game that explicitly bans the sale of in-game items for real money), and you'll find dozens of in-game things for sale, even fully leveled characters ready to be handed over to the highest bidder. Even without Blizzard responding to our request for comment on this story, we can just imagine how much of a headache it would be to keep track of every auction site and track back every contract violation to the actual perpetrator and then sue them for breach of contract in whatever country they’re based.

Lastowka sympathizes with game developers’ plight. "Many companies decided that they weren't going to vigorously go out and try to shut down people who are trading real money for virtual property," he said. "The can say 'we don't care whether or not you trade virtual goods for money' and in a way with Ultima Online, Electronic Arts basically turned a blind eye to those kinds of trades."

This attitude among game developers is where RMT turns into a gray area instead of a clear-cut contract violation. "If the company says you’re not allowed to do this while you're on our servers and then they do it, they're liable for contract violation, right?" Lastowka says. "But some lawyers think that breaching contract in some situations can be socially beneficial. That's called 'efficient breach.' Real money trading is not illegal in the same way that the government says you can't sneak into someone's house and steal their stuff. That's clearly illegal – but [RMT] is not criminal. It's only illegal in the sense that you could land in court if [game developers] decide to sue you and most of them won't."

Finding RMT's place within MMOs gets more complicated than EULAs and lawsuits, though. Game developers have to consider whether or not it might actually benefit their company to allow RMT – and then take a cut of the virtual transactions. Lastowka explains that this is what's going on with Live Gamer in all Sony Online Entertainment games. By moving in as a third party that operates like an online auction site behind the scenes within all microtransaction-based MMOs, Live Gamer is basically engaging in a one-way RMT exchange that benefits both it and SOE – and the user as well, because it's clearly stated that nobody will sue them or ban their account for paying money to own better items.

A game company could go even farther with RMT and build it directly into the game for users to control. This is how Second Life and Eve Online have always handled virtual transactions; and both companies are enormously proud of the economies that have grown up in-game around RMT.

Linden Labs sent us this statement when we requested comment on their reaction to the South Korea ruling: "Real money transfers have always been acceptable in Second Life. Linden Lab released this morning that Resident cash outs for 2009 were $55 million USD – an 11 percent growth over 2008. More than 50 people earned more than $100,000 USD each and the top 25 accounts earned a combined $12 million USD."

All that money is certainly nothing to sneer at; but it's also something a developer has to work hard to keep track of. We caught up with Eyjolfur Gudmundsson, Lead Economist at Eve Online developer CCP; as far as we can tell, he’s the only full-time economist whose job it is to monitor an in-game economy. Even before CCP brought Gudmundsson on in 2007, the Eve Online economy was growing at an amazing rate as users latched onto the RMT mechanics built into the game.

Eyjolfur Gudmundsson

"All that you needed to make [the economy] work was to get as many people as possible into the game world so that people could specialize," Gudmundsson explains. "They actually managed to do that early on. In 2004, they already had 50,000 people online. Today with more than 330,000 subscribers we can say with full confidence that this is an economy that is driven by the players. In economic terms, we can say that the players make the decision on what to produce, for whom to produce, and when to produce it. These are often stated as basic principles of economics and that decision is made by the players, not by CCP."

Gudmundsson says that the economy in Eve Online follows basic economic principles, even though there aren't real-life economic constraints like the need to buy food for your character to survive. For example, if the player base shoots up, but there aren't enough in-game resources to accommodate them, prices go up; if users get more efficient at mining resources to the point where there's plenty to go around, prices go down.

"The problem I have seen with real money trading to date is that it is often or in most cases it is related to using exploits, hacking, using illegal methods to acquire these items in games,” Gudmundsson explains. "Therefore, [RMT] has gotten a really bad reputation."

Issuing a blanket ban on RMT, however, isn't something Gudmundsson sees as entirely practical for an MMO developer or even a government to enforce. Not only is it "one hell of a monitoring problem" to keep up with every transaction that goes on both inside and outside of a game, he says, but RMT is sort of something that comes with the MMO territory.

"In general, players tend to exchange items between them," Gudmundsson says. "If you design a game that has at least two individuals within that game and those individuals can exchange items – I give you this and you give me that – you can rest assured there will be a market developed whether you like it or not."

Instead of RMT being a legal issue or a financial incentive for MMOs, Gudmundsson says it should be a game design issue. "You have to think about it if your world is supposed to be an open world or a closed world," he says. "In an open world, you exchange and [trade] items but since it's an open world, you are restricted [by] real life regulation."

A closed world game, however, doesn’t have to use real life rules because it’s not supposed to be real life. “It’s like going to a theater,” Gudmundsson explains. "You're living in an alternate universe. And therefore it's important that those worlds be kept apart, that they can work and function by themselves. The restrictions would then be that those games cannot exchange the items outside of the game, even though players can still exchange with in the game – this is completely different. So when people are thinking about these game transactions, they have to make a distinction between open world on the one hand and closed world on the other."

Ultimately, defining and regulating RMT all comes down to the game developer on the legal side, the financial side, and the gameplay side. With rulings like the one in South Korea this month attracting the attention even of gamers who can't balance a checkbook, turning a blind eye to RMT might not be an option anymore.

AJ Glasser is a writer for GamePro. Reprinted with permission.

For further reading:
"The Most Efficient Way To Acquiring Gold In A MMORPG", We Fly Spitfires, December 8, 2009
"Click to Agree: Virtual Currency and RMT Provisions in Virtual Worlds and MMO Games", Jay Moffitt, Virtually Blind, October 31, 2007
"Xfire 'Virtual Gold & Real Money' Debate Today", Benjamin Duranske, Virtually Blind, August 21, 2007
"Virtual Worlds Draw Real World Lawyers", BusinessWeek, May 15, 2007
"How big is the RMT market anyway?", Tuukka Lehtiniemi, Virtual Economy Research Network, March 2, 2007
"The New New Economy: Earning Real Money in the Virtual World", Knowledge@Wharton, November 2, 2005

Dubai's Dark Side Targeted by International Finance Police

By Nick Mathiason
The Observer
Sunday, January 24, 2010

http://www.guardian.co.uk/business/2010/jan/24/dubai-crime-money-laundering-terrorism

Fears are intensifying that the emirate has become a global centre for terror funding, money-laundering, drug money and mafia cash

Naresh Kumar Jain, an Indian multimillionaire suspected of being one of the world's biggest money launderers, ran from the law, but last month it became obvious that he couldn't hide.

Having skipped bail in Dubai – where much of his vast empire was based – 18 months ago, Jain was finally arrested in Delhi by India's Narcotic Controls Board for allegedly moving hundreds of millions of dollars for drug dealers. It had taken an international manhunt involving law enforcement agencies spanning three continents to catch him.

The 50-year-old is suspected by the UK's Serious Organised Crime Agency of being at the heart of a drug money-laundering network shifting up to £1.35bn a year across jurisdictions. Jain has reportedly admitted to Indian police that he has laundered cash, but denies being involved in the drugs trade.

However, investigators believe that his businesses are based on huge sums of cash originating in Africa and passed on to him by diamond smugglers and drug dealers – and that most of that illicit cash flows into Dubai. But the allegations against him do not make him unique in the emirate. "[Jain's arrest] was an important incident, but many wanted men reside in Dubai," says Dr Christopher Davidson, an expert on Gulf economics at the University of ­Durham.

To many, Jain is the latest, perhaps the biggest, example that proves the United Arab Emirates is not so much awash with vast oil wealth but built on a toxic tide of illicit cash: a place where Russian mafia and drug cartels clean their dirty cash and al‑Qaida finances terror atrocities. And at its heart is Dubai, a world financial centre that in the past 15 years has grown exponentially.

As Dubai's ruling elite pick through the wreckage of its bombed-out economy, which exploded under the weight of $60bn of debt last year, an equally pressing issue threatens to undermine not just Dubai but the UAE as a whole.

Next month, a meeting of the Financial Action Task Force (FATF), the powerful intergovernmental body responsible for combating money laundering and the financing of terrorist networks, will meet in Abu Dhabi. The meeting is expected to establish which countries to put on a high-risk jurisdiction list following a request by G20 finance ministers last year. It is thought likely that the UAE will feature on the list. Such a development would be a serious blow to the money men of Dubai, but would confirm many people's fears that it remains a port of choice for dirty cash.

The notion is causing renewed concerns among senior US officials. Last month an American ambassador to Afghanistan, E Anthony Wayne, said that every day $10m in cash was being smuggled from Kabul to Dubai in briefcases, much of it from the Afghan heroin trade, which has boomed since the US invasion. Wayne said a US investigation found that $190m in cash was smuggled in just 18 sample days.

Insiders say that obtaining a UAE passport, which allows the bearer to open a bank account, is still relatively easy. Experts suggest that airport customs in some of the UAE states provide easy routes to move goods and cash around. In addition, Dubai real estate has a notorious reputation as a front for laundering, where apartments are bought up by unknown entities who never live there. "After 9/11, there was a crackdown on corruption, but they're careful not to talk about money-laundering because it is part of the lifeblood," says Davidson at the University of Durham.

"The place is built on it," insists one seasoned Dubai businessman. "It's a commercial port. There's a free trade zone. That's what made its livelihood."

Expatriate UK financiers say that new rules have not had any appreciable effect: "Russians are still coming with suitcases of cash to buy flats which they never live in," says one. "It's easy to get resident permits. These sort of stories are rife. Russia is the biggest source. A lot of it is mafia."

"There are weak links in every country," says Bryan Stirewalt, director of supervision at the Dubai Financial Services Authority. "There are weak links in the US, but they are different types. Money launderers choose the US because of [its] size… they don't stick out. There's an inherent conflict between the ease of doing business and the potential for money laundering. Unfortunately, they work contrary to each other. The easier it is to open a business, the easier it is for money launderers."

So easy, in fact, that the latest FATF evaluation of the UAE's efforts to combat financial crime is a devastating critique of its laws and agencies. The report, ­published in November 2008, points to the low number of suspicious transaction reports (STRs) submitted in a region where so much wealth is banked.

The FATF also criticises the low number of staff in the UAE central bank's anti-money laundering unit, as well as an inadequate legal framework that places few obligations on the region's authorities to ensure customer due diligence checks are made and monitored.

The task force also points out that standards vary on the identification of the true owners and beneficiaries of companies in the UAE, and expresses concern about the region's securities and insurance sectors, which adopt less onerous regulations than even its banking sector.

Alarmingly, regulations on wire transfers still "fall well short" of FATF requirements, the report says – an observation that will shock many, since six-figure sums were wired from Dubai to bank accounts in America to finance the 9/11 suicide bombers. The FATF also states that lawyers and accountants face no specific due diligence requirements under UAE money-laundering law.

To be fair, the FATF spares the Dubai International Finance Centre – the 110- acre Middle East and North Africa capital markets hub – from some of its fire. In fact, the Dubai Financial Services Authority, which regulates the centre, says that last year it posted a 20% rise in STRs, though it admits the overall number recorded was still not as high as might be expected. Much of the increase, it says, came in the wake of the Lehman Brothers bank collapse, when huge amounts of money came looking for new safe havens.

Stirewalt, who has been in charge of fighting money laundering and terrorism finance in the Dubai International Finance Centre for more than a year, has set up systems that are going a long way to identify illicit flows. As well as turning up a "significant" increase in STRs, he is focusing on accountants and lawyers, and has stepped up inspections of banks as well as improving links with the UAE Central Bank, which has overall control of money laundering issues.

Stirewalt points out that Dubai, which is close to a number of conflict zones, is vulnerable to criminal penetration, made easier because of its role as a port. He has still not completely come to terms with the region's long-established informal money-transfer network known as hawala, suggesting that reform in this area still has "further to go".

When it comes to claims that Dubai is a destination of Afghan heroin cash, Stirewalt is candid: "I don't disagree with it. I can't say it's not true."

He is keen to stress that Dubai is just one place through which dirty cash flows. When the emirate was cited as being part of an international £60bn carousel fraud five years ago, it was among a host of other countries including Switzerland and the UK. "We have to think about the whole globe," he says. "No one is perfect; no one is bulletproof. The UAE is taking the issue seriously post-9/11 to strengthen the system."

But it is not just Dubai's reputation that is at stake if the authorities fail: the apprehension of international crime and terror gangs dep­ends on its ability to stem the tide of illicit cash washing through the emirates.

For further reading:
"Underground Banker", Little India, January 9, 2010
"'Hawala King' Naresh Jain arrested in India", The Telegraph, December 9, 2009

"Hawala Banking And Currency Controls Part I, Part II", Trace Mayer, November 18, 2009

"Suspected Hawala Kingpin Naresh Jain says he is being trapped", Thaindian News, September 25, 2009
"Anti-money laundering expert warns of dangers facing UAE financial services firms", AMEinfo.com, June 14, 2007
"Informal Value Transfer Systems Report", Nikos Passas, U.S. Department of Justice, January 2005

Hunt Brothers Demanded Physical Delivery Too

By Jon Matonis

"A billion dollars isn't what it used to be." --Bunker Hunt on the Sunday after Black Thursday when confronted with a significant payment demand from Engelhard.

If you want to know what happens when multiple long positions demand physical delivery of a commodity all at once, you need look no further than the Hunt brothers silver saga of 1979-1980. They did nothing illegal, the Chicago Board of Trade (CBOT) and COMEX changed the rules in the middle of the game, the Commodity Futures Trading Commission (CFTC) implemented new regulations, and the Hunts were bankrupted, unjustly. All they really did was simply request the delivery of the physical metal for which they held valid, legal contracts. The shorts were unable to meet the delivery at any price because enough deliverable silver did not exist - a classic short squeeze and the panic was on.

This is their story. In conjunction with wealthy investment partners from Saudi Arabia, the Hunt brothers, Bunker and Herbert initially, amassed a legendary silver hoard that had supported itself with ever-increasing prices propelled along the way by their continued margin buying on the exchanges.

Beginning in 1973 and continuing into 1974, they slowly began purchasing silver futures contracts totaling 55 million oz and then took physical delivery of all the contracts. Since Bunker was concerned with impending inflation and the potential confiscation of precious metals following Nixon's closing of the gold window, he arranged for transfer of the bullion to Switzerland. Larry LaBorde summed it up best:

"Meanwhile, back at the ranch, (the Circle K Ranch in Texas) brother in law Randy Kreiling and his brother Tilmon held a shooting contest amongst the cowboys to find the best marksmen. The dozen best marksmen were hired for a special assignment to ride shotgun on one of the largest private silver transfers in history. The Circle K cowboys flew on 3 specially chartered 707 jets to Chicago and New York where they were met by a convoy of armored trucks during the middle of the night. Forty million oz of silver was loaded onto the planes and they immediately flew to Zurich where they were met by another convoy of armored trucks. The cowboys loaded the trucks and silver was dispersed to six different storage locations in Switzerland. The transfer cost Bunker and Herbert $200,000. The storage costs for the 40 million oz in Switzerland and the 15 million oz still in the US amounted to $3 million/year." (from "H.L. Hunt's Boys and the Circle K Cowboys", January 26, 2004)

By the spring of 1974, the markets started to get worried about the amount of silver out in private hands, because annual demand was 450 million oz but annual production was just 245 million oz. Of the estimated 700 million oz. above ground, only 200 million of that was deliverable against futures contracts. Silver had risen to above $6 per oz during this time and then settled back to the $3 to $4 range for several years.

The Arabian Connection

Then, in 1978, a significant development occurred. John Connally, former governor of Texas, introduced Bunker to a Saudi sheik at the Mayflower hotel in Washington. Sheik Khalid bin Mahfouz was staying at the same hotel as Bunker and John Connally, and they met in bin Mahfouz's suite, which consisted of the entire hotel floor, complete with 30 or 40 security guards. The goal was to get the Hunts in the front door with these very wealthy Arab sheikhs, and the Hunts would sell the Saudis on the value of silver over the worthless U.S. dollar with the hope of enlisting them for coordinated joint purchases.

Khalid bin Mahfouz became intrigued, but since he had close ties to the Saudi royal family, Crown Prince Fahd and Prince Abdullah, and since the plan involved the potential elevation of silver to reserve asset status within the Saudi Arabian Monetary Authority, bin Mahfouz wished to be discreet. The operation was to be organized so that his name would not appear in public. Then on July 15, 1979, the company was formally established in Bermuda and registered under the name International Metals Investment Company, or IMIC for short. The stated object was dealing in precious metals and its shares were divided equally between Nelson Bunker Hunt, W. Herbert Hunt, and the two designated Saudi Arabian money men, Ali bin Mussalem and Mohammed Aboud al-Amoudi. The primary silver accumulation would now occur through the IMIC vehicle and two other well-connected middlemen, the Lebanese Naji Nahas and the Palestinian Mahmoud Fustok.

The Accumulation Phase

On August 1, 1979, a new name showed up on the CFTC's daily reports of silver purchasers. The buyer was International Metals Investment Company through an account at Merrill Lynch's Dallas office opened by Herbert Hunt just seven days earlier. Other buying syndicates, including Naji Nahas and the Banque Populaire Suisse, with big money behind them entered the silver market in the first week of August without being noticed.

In all during that period, over 43 million oz of silver contracts were purchased through the Comex and the CBOT with delivery to be taken that fall. In the fall of 1979 the silver price doubled from $8 to $16/oz in only two months and the COMEX and the CBOT started to panic. The warehouses of the two exchanges only held 120 million oz of silver and that amount was traded in October alone. Many buyers, including the Hunts through their International Metal Investment Company were taking delivery on all their contracts. As disorienting as the price escalation was, even more of a concern was the exact identity of IMIC since the CFTC only had a post-office box number located in Hamilton, Bermuda.

The Hunts continued to accumulate silver throughout 1979. Again from Larry LaBorde:

"Late in 1979 the CBOT changed the rules and stated that no investor could hold over 3 million oz of silver contracts and the margin requirement were raised. All contracts over 3 million oz per trader must be liquidated by February of 1980. Bunker accused the COMEX and CBOT board members of having a financial interest in the silver market themselves. Investigations later found that many had substantial silver short positions. Bunker knew that a shortage now existed or they would not be screaming so loudly. He bought even more. The price on the last day of 1979 was $34.45/oz. At this point Bunker and Herbert held 40 million oz in Switzerland and 90 million oz of bullion they jointly owned through International Metals Investment Company. In addition to all that, IMIC had contracts on another 90 million oz due for delivery that March from the Comex, bringing the grand total to 235 million oz. The younger brother, Lamar, had even entered the arena and had taken a $300 million dollar, 10 million oz, silver position by the end of 1979."

Changing the Rules

In early January, it became evident that COMEX intended to change the rules of the game. And then finally on January 7th of 1980, the COMEX changed their rules to only allow 10 million/oz of contracts per trader and that all contracts over that amount must be liquidated before February 18th. Of course, the CFTC promptly backed up the ruling. The escape hatch for the Hunts and some of the other large longs was simply to convert their futures contracts into physicals, lease the physicals abroad at interest rates, which were tax deductions, and shift their future forward buying to the London Metal Exchange. On January 17th silver hit $50/oz, Bunker had continued to buy. At that point in time the Hunt's silver position was worth $4.5 billion dollars bringing their profits in silver to $3.5 billion dollars. The chart below illustrates the great Silver Spike of early 1980.

The "Silver Spike"

On January 21st, the COMEX announced that it was suspending trading in silver and that they would only accept liquidation orders. Predictably with trading suspended and only liquidation orders going through, the price of silver dropped $10/oz and stayed around $39/oz until the end of January. Long lines formed outside of metal dealer shops and scrap silver, old silver coin collections, and family silverware came into the market - about 22 million oz in all. In early February the Hunt group took delivery of another 26 million oz from Chicago. The Hunt's North Sea oil through Placid Oil was coming on line and generating $200 million /year from that venture alone. There was talk of a takeover of Texaco Oil. Bunker was also talking to other Middle Eastern rulers about putting together another silver buying group.

Forever the optimist, Bunker faithfully believed that he could maintain the silver spike if only he had cooperative fresh buying. From Larry LaBorde:

"By March 14th silver was down to $21/oz, Paul Volcker had raised interest rates, and the dollar had firmed up. International Metals still held 60 million oz of futures contracts. Their margin calls on those contracts amounted to $10 million dollars a day! Bunker still believed the price would go back up if only he could promote more buying. He scrambled around Europe looking for a buying partner but the more the price dropped the harder it was to borrow more money against his silver holdings to buy even more silver to hold up the price."

The Hunt's brokerage connection in New York and London, Bache Halsey Stuart Shields, sent the Hunts a margin call for $100 million on March 26th of 1980. Since the Hunts had also purchased vast quantities of Bache stock (more than 5% of issued and outstanding shares), they were technically "insiders" required to adhere to the rules of only fractional stock selling permitted on a monthly basis. With their Bache stock illiquid and silver in free fall, the Hunt brothers had run out of cash. Bunker was in Paris that day so he called Herbert and simply said, "Shut it down". Herbert promptly told his broker the following morning that they could not meet their total $135 million dollar margin call.

The Hunt's brokers immediately sold $100 million dollars worth of silver on that day. Their account only had $90 million dollars worth of equity and they were expected to lose all that the next day. The CFTC chairman, the Chairman of the Federal Reserve, and the US Treasury Secretary began an around the clock silver monitoring session. Whoever could have foreseen the day when a change in the price of silver would cause tremors through the entire stock market and adversely affect the reputations of leading brokerage and commodity firms. Wall Street was on edge.

Silver Thursday

On March 27th (Silver Thursday), silver opened at $15.80 and closed at $10.80. The stock market crashed on rumors of Hunt Brother liquidations of stocks in order to cover his silver losses, but the market then rallied to close roughly at the same level. The Hunt's bullion purchases were all averaged around $10/oz, but their futures contracts were purchased at or about $35/oz. When it was all over the Hunts owed approximately $1.5 billion dollars.

Fearing a financial disaster, Federal Reserve Chairman Paul Volker gave approval for an emergency bailout plan for the brothers and a group of banks agreed to loan the brothers $1.1 billion with the family posting $8 billion in collateral. With this final act the brother's older sister, Margaret, finally put her foot down and demanded to know just what Bunker had intended to accomplish in the silver market? Bunker sheepishly replied, "I was just trying to make some money" (see Larry LaBorde).

Nelson Bunker Hunt filed for personal bankruptcy in September of 1988. Within one year he exited bankruptcy with a net worth of $5 to 10 million dollars and a debt to the IRS of $90 million dollars which had to be repaid in 15 years. In a 1989 settlement with the United States Commodity Futures Trading Commission, Nelson Bunker Hunt was also fined US$10 million and banned from trading in the commodity markets as a result of charges of conspiring to manipulate the silver market stemming from his attempt to corner the market in silver. Bunker's trusts, set up by his father H.L. Hunt, were valued at approximately $200 million dollars. The payments to the IRS finally stopped in 2003.

For further reading:
"The Art of Silver Manipulation", Ed Zimmer, November 13, 2009
"Once world's richest man, Bunker Hunt has 'no regrets' 29 years after silver collapse", Doug J. Swanson, The Dallas Morning News , March 22, 2009
"Let's Be Hunts", David Bond, August 17, 2008
"H.L. Hunt's Boys and the Circle K Cowboys", Larry LaBorde, January 26, 2004
"Move Over Fisk and Gould", James Turk, Free Gold Money Report, August 16, 1999
"Hunts are Ruled Part of a Scheme to Control Silver", The New York Times, August 21, 1988
"Trial of Hunt Brothers In Silver Case Begins", The New York Times, February 25, 1988
"The Hunt Brothers; Battling a Billion-Dollar Debt", The New York Times, September 27, 1987
Beyond Greed: The Hunt Family's Bold Attempt to Corner the Silver Market, Stephen Fay, 1982
Silver Bulls: The Great Silver Boom and Bust, Paul Sarnoff, 1980
"Silverfinger: The Hunt Brothers Story", Harry Hurt III, Playboy, September 1980
"Bunker's Busted Silver Bubble", Time, May 12, 1980
"He Has a Passion for Silver", Time, April 7, 1980

Facebook's Virtual Currency and the Exchange Rates

By Eric Eldon
Inside Facebook
Monday, January 25, 2010

http://www.insidefacebook.com/2010/01/25/as-facebook-gears-up-for-credits-heres-the-exchange-rates-for-the-15-supported-currencies/

Facebook has slowly introduced its virtual currency, Credits, to third parties over the last few years. But it has been planning to make Credits a more central part of its platform for third-party developers, and we’ve been hearing that a bigger launch is planned soon.
So here’s a look at how much Credits currently cost Facebook users around the world. A lot more people are going to care about these numbers if and when Credits becomes a way to buy virtual goods in Facebook apps and games.
The table you see shows how each of the 15 currencies that Facebook supports currently converts to Credits. We convert to 10 Facebook Credits because that’s the lowest denomination available (you can’t just buy a single credit). We also compare the conversion to how each currency converts to the US dollar based on numbers from Yahoo Finance — clearly, Facebook is benchmarking the value of Credits on the dollar for the time being, as the two sets of numbers almost exactly line up. The difference is likely due to Facebok updating the dollar conversion slightly later than real-world market changes.
Despite the dollar parity, Facebook has been making a few moves to make Credits more distinct. The virtual currency appeared in its earliest form as a means to by virtual gifts in the company’s Gift Shop, years ago — it only moved from US Dollars to Credits in November of 2008. Then, last May, it adjusted the exchange rate from 100 Credits per $1 to 10 Credits per $1. In June, it followed this move by introducing the 14 additional currencies you see listed in the table.
We’ll be watching to see how Facebook handles Credits pricing. In order to make virtual gifts more affordable to more of its users, the company may choose to unpeg Credits from the Dollar, and allow users to purchase Credits for a range of prices aimed at local (and often poorer) markets. This is important because around 70% of Facebook’s more than 350 million monthly active users are outside of the US, with many of them in developing countries.
The Credits Timeline
The more users Facebook can get paying at all for Credits, the more money it can make. In May, the company also began letting third-parties sell goods in the virtual shop using Credits. Facebook has long planned to take an Apple-style 30% cut from transactions that go through Credits, as we first reported in May and then in November.
Facebook has been planning some sort of major launch with big developers since last fall; at one point, we heard that the company was aiming for a launch in time for Christmas virtual good sales. Happy Islands, a social game by CrowdStar, launched last month using Credits as the sole means for virtual goods purchases. This month, the company has already made a push to hire for a new payments operation team, tested a payments resolution interface, and released Credits in more apps.
Credits might squeeze out payment services providers who currently provide currency support and other features to developers. We’ve heard unconfirmed rumors that Facebook will offer incentives or regulations that favor Credits over third-party virtual currency systems.
Yet many developers themselves have told us that Credits could them make more money. The reasons are that users will have a more seamless interface for purchasing and spending the virtual currency, all using Facebook’s own brand.
For further reading:
"Facebook Credits - Part I: The Story So Far", Neil Vidyarthi, All Facebook, January 25, 2010
"Facebook Credits - Part II: What's Here and What's Next", Neil Vidyarthi, All Facebook, January 26, 2010
"Revealed! Facebook's Plan To Double Its Revenues", Nicholas Carlson, Silicon Alley Insider, January 25, 2010
"Developers Would Pay 'Whatever Cut Facebook Desires' For Payments Platform", Nicholas Carlson, Silicon Alley Insider, January 12, 2010
"A Running Summary of Facebook’s Virtual Currency Tests", Justin Smith, Inside Facebook, August 26, 2009