Current Financial System

This chapter describes our current financial system briefly. We will identify all the major systems that we interact with while doing something, either with our money or with our wealth. Most of these systems will be changed in some way in the Utopian Financial Infrastructure. Most of the underlying ideas and concepts stay essentially the same but some change significantly. When describing the current financial system, we will describe topics that are important and widely used and also have some problems or undesirable aspects. Those problems or undesirable aspects will be remedied in the Utopian Financial Infrastructure.

Most of the topics discussed in this chapter are from the current experience and perspective. There are numerous sections, but each one of them is relatively short and is expected to be familiar to the reader and hence we will skip providing overviews for these sections.

Needs, Specialization and Money

The first and foremost concern of all citizens is to satisfy their needs and wants. Society has evolved over several millennia and our ideas of our needs and wants have evolved with it. We can satisfy only some of our needs and wants all by ourselves. Society has progressed and has reached a level of specialization that we cannot satisfy all our own needs and wants all by ourselves; we have to satisfy most of our needs and wants by procuring the products and services from others. Specialization is needed to support and enhance our lifestyle with the material well-being that it brings.

As part of this social evolution, we have come up with the concept of money as the abstraction of "value". Money is used as a store of value and also as the medium of exchange of value.

When we procure products and services in order to satisfy our needs and wants, we do so by giving some of the money that we already have in exchange for those products and services.

Employment

For almost all citizens, earning money is the primary means of "having money".

One can earn money by giving up one's time. How much money one can earn by giving up one's time depends on the knowledge and skills that one possesses. Our knowledge and skills makes our time useful to someone else and that leads to the idea of providing services to others. All citizens have the same amount of time and differing amounts of knowledge and skills. Citizens can let others use their time, knowledge and skills in exchange for money. This is the basic idea of employment. For most citizens, employment is the primary means of earning money for a significant part of their adult life.

Employment involves finding an employer, doing the things that the employer desires and in exchange receiving a salary. The employers are those who seek the kinds of knowledge and skills that we may possess at a location that they desire and offer a salary commensurate with that kind of knowledge and skills. For self-employed individuals, their customers are like their employers.

Having found such an employer, and after being employed, we receive our salary. In the old days it used to be in cash; later it was in the form of cheques (and hence it is called a pay-check); more recently it is directly deposited in our bank accounts.

The possibility of employment gives meaning to phrases like "time is money" and "knowledge is power".

Related to employment is maintaining employment and unemployment statistics and making those statistics available to all citizens in aggregate form and also categorized by various criteria like: industries, sectors, skills, experience, geography, gender, age and other demographic characteristics.

Banks

Once we have money, either because we earned it or someone gave it to us, where do we keep it? Our current answer to that question is "the banks".

Besides storing our money in our accounts, banks provide us with many other services related to our money. Banks provide us with ATMs to withdraw cash. Banks give us debit cards to pay for stuff directly from our accounts. Banks also provide us with safety deposit boxes which are placed in a strong room that is built such that it is very hard for petty thieves to break into and steal from.

We consider our banks as a safe place to deposit our money. The bank keeps it safe and charges us a monthly fee for our account. When we need to use our money, we can use it whatever ways our banks allow us to use it; like cash, cheques, debit cards, electronic transfer, etc.

While we may think that our money is safe in our bank accounts, it is not 100% safe.

The reality of a bank account is this: it is a very flexible loan that we give to the bank. Usually a bank account, be it checking or savings account, pays us some interest on the amount deposited. Why would the bank pay us an interest if the money that is in our account is not a loan to the bank? It is a "flexible loan" because we can withdraw cash, pay bills, etc. and then we get paid interest only on the amount remaining.

Banks pay a very insignificant rate of interest to us for the money we deposit in our accounts. Then the banks lend this money at a much higher rate of interest to earn their profit. This lending by the banks to others has risks. We, as a lender to the bank, are exposed to these risks. Thus when banks mismanage their own lending, their financial situation deteriorates and that causes a "run on the bank".

So, even though we think that our money in our checking or savings accounts is safe, in fact it is not fully safe; it is exposed to the risks associated with lending and the competence of the borrower (that is the bank) in managing this borrowed money and lending it wisely.

The bank account being an interest paying account is never 100% safe. Banks mitigate this risk by insuring against their own failures and this insurance sets limits on how much of an account holder's money is "insured". If an account holder has more money than the limit, then that money is at risk if and when the bank fails.

We know that banks can easily fail; we have seen this occur in the past. Taxpayers have bailed out several kinds of financial institutions, including banks. If we continue with this system, it will happen in the future.

The services provided to us by our bank are not free. Banks charge a monthly fee for our bank accounts. These fees are fixed regardless of the amount of money in the account. These fees depend on the services that you would want to avail.

Here is a simplified and generalized description of these account fees: Banks have three levels of accounts. Poorer people choose the cheapest accounts with the least amount of features and services. The middle class people choose the mid-level price accounts with moderate amounts of features and services. The rich people pick the accounts that have the highest costs with the highest level of features and services.

The money in these accounts still earns interest; the rich earn more because they have more money; the poor earn less because they have less money. Hopefully they are all earning at the same rate of interest; that is there is no discrimination in the rate of interest based on the amount of money in the account.

Most people are not happy about paying fees. So banks say "if you always keep a large enough amount of money in your account, then we will waive the fees for you". That is, these account fees are waived for those people who maintain the balance in their account above a certain minimum threshold. Rich people can maintain money above the specified thresholds and poor people cannot. Thus the poor end up paying for their bank accounts and the rich can have them for free.

To the extent that the bank's costs are funded using the fees charged to these account holders, those who pay the fees support the operations of the bank and those who can get their fees waived get free service. In effect, the poor subsidize the rich in their banking needs.

The safety deposit boxes that banks provide their customers contain things that the box's renter "owns". This is the only thing that is the safest in a bank. This is because when a bank fails, it does so with the improper management of money in our accounts; not by doing anything with the stuff in the safety deposit boxes. That stuff that we may place in safety deposit boxes can only be stolen; not misused by the bank itself. But as what we put in the safety deposit box is entirely up to us, banks do not "insure" the contents of these boxes in the unlikely event that they indeed get stolen. They cannot insure the contents because the contents of those safety deposit boxes are secret and hence the value of those contents cannot be known to the insurer and hence those contents cannot be insured.

Goods and Services

The point of earning money (through employment) and keeping it safe (in a bank) is to eventually use it to purchase the various things that we need and want. Many of our needs and wants cannot be satisfied by "things"; they are satisfied by "services".

The things (or goods or products) are usually produced (or manufactured) by some organization. Similarly many of the services that we avail are provided to us by some organization. Very few of the goods and services are provided to us by individuals (the self-employed individuals).

A significant part of our interaction with our financial system occurs when procuring these goods and services. The next few sections explore several aspects of goods and services.

Goods, Stores, Market-Places and Markets

Usually we procure the goods that we need by visiting a physical store, picking out what we desire from among the things that are offered, paying for those things at the checkout counter and carrying them off with us as we leave the store. These stores go by various names like grocery stores, department stores, convenience stores, etc.

More recently, we have started ordering things from online stores and those things that we buy are delivered to our doorsteps.

These physical stores or online stores are actually the most condensed form of a marketplace. A marketplace is where we can obtain products manufactured by various manufacturers from a single organization. There are many forms of marketplaces like a strip mall, an enclosed mall, a farmer's market, a flea market, etc. All these forms contain individual stores or individual vendors and each one of them may be offering products from multiple manufacturers or producers. A single store, whether physical or online, has almost all the characteristics of a marketplace.

Then there are concepts like individual garage sales, neighborhood garage sales, online avenues to find sellers of used items and arrange to pick the items we like from the seller at a mutually convenient location, online avenues to find sellers of used items and ask them to ship those items to us directly, etc.

Then there is the case of individual manufacturers and producers who sell us their goods directly or almost directly. For example, these days many manufacturers have online stores in which we can buy the products that they manufacture; this is an example of direct sale by the manufacturer to us. Another example of a direct sale is house builders selling the houses that they build; they have on-site offices that show us the house plans and to-be-built inventory of houses and we can purchase one of these houses; this is a case of direct sale. Examples of indirect sale are the car dealers who sell cars manufactured by some manufacturer; here the dealer is a little more than just a sales agent for the manufacturer.

Some car dealers sell used cars. These dealers buy used cars, fix them up and sell them. In this situation, they act like a marketplace for selling used items.

A house once built lasts a very long time and the original owner rarely lives in it for the entire useful life of the house. Thus houses get sold multiple times in their useful life. If we use an association of real estate agents to help us in finding a buyer for our house, then that association is a marketplace for selling "used houses".

Transactions

In all these instances of us buying goods and products, we part with our money in exchange for some product. Such a transaction changes the amount of wealth for both the buyer and the seller. The seller gets money which is a non-depreciating asset. The buyer gets the product and becomes its owner. Almost all goods and products are depreciating assets.

In conducting all these transactions, we routinely identify the transacting parties and these transacting parties authorize these transactions.

The identification of transacting parties is based on account numbers or card numbers.

In the past, authorizations used to be based on signatures. More recently, these authorizations are based on our ability to remember and provide PINs, passwords and pass-phrases to some application or device.

Should we still continue to rely on hand-made signatures? Can modern PINs and passwords be remembered by someone who has difficulty remembering?

Can we do identification and authorization much better than the current forms?

Record of Ownership

Some of the things that we buy and start owning have to be officially recorded.

For example, when we buy a car, the car first needs to be registered as owned by us with some government department that deals with ownership registration of vehicles. Similarly, when we buy a house or real estate, it needs to be registered as owned by us with some government department.

Some of the things that we buy come with warranties. Typically, we have to register those products with the manufacturers for those warranties to be activated; after all, if the manufacturer does not know who owns their product, how can they provide the warranty?

A vast majority of the things that we buy have no official record of ownership.

If someone steals something from us and if we find some person in possession of the kind of thing that got stolen from us, how do we know that the thing that this person possesses is actually ours?

If the thing that got stolen had a serial number, and if we knew the serial number of our thing, and if we could somehow prove that the serial number that we know was actually ours, then we may have a sound basis for claiming the thing that is in possession of someone else as actually belonging to us.

In our current system, we have no definite way of knowing the serial numbers of everything that we ever owned. In fact, we have no single place where we can find a list of all the things that we own. Besides, there are plenty of things that don't even have serial numbers (like almost every grocery item).

If we own something (that has a serial number) and we sell it to someone else, then how can the buyer of our thing prove that after the sale they own the thing? What distinguishes a rightful owner of a used thing from a thief?

While we value private ownership, so far, society has no proper way of proving ownership for all the things that can be owned.

In principle, we respect ownership; in practice, we don't know "who owns what". This is the fundamental problem that financial infrastructure will solve.

Product Standardization

If the society is very large, then the number of possible manufacturers and producers will be commensurately large and the total number of products that could be available for us to buy could easily be in a few millions of distinct products. This problem even exists today when we go to a grocery store and see several brands of essentially the same thing. The problem gets worse in a web-store because such a store can sell a much larger number of products than a physical store.

If we do nothing about it, we will be faced with an unmanageable choice of products that cannot be easily compared. For a long time we have been mandating standardization in various aspects of products like quality, packaging, quantity, nutrition, warnings about health-risks, etc.

Services

Here are some examples of services: getting a haircut, watching a movie in a movie theater, taking a taxi ride, getting our front or back yard mowed and maintained, etc.

Even when we avail services, we are engaging in an exchange of money for something that we value. Unlike a product, a service usually does not have a lasting monetary value that we take home and that becomes part of our wealth. Yet we desire services and we pay for them; that is we transfer some of our wealth to the service provider and we take nothing back with us which has some monetary value. This is quite natural because we value the increase in our well-being that those services provide to us. If those services were not beneficial, we would not have availed them.

For some services, we may be indeed taking something back with us. It could be intangible like "satisfaction guarantee or your money back" or it could be something real like a "takeout" from a restaurant. From a monetary perspective, do we take back anything of monetary value? Are all these availed services part of our wealth?

Then there are some services for which we pay with our time and attention - these are the "free services". Some of these services recover their cost by showing us advertisements and expect us to engage with those advertisements. All these service providers are deeply interested in knowing our identity, demographic characteristics, interests, needs, wants, etc. They want us to create a login and accept their "cookies" and their "terms and conditions". We are left with the headache of remembering all these logins and their passwords and all the security breaches caused because we just have to deal with too many logins. Some of these service providers also want permanent space on our phones and computers even when the actual service is web-based and could have been provided by a rudimentary web-site or a web-app.

Some of the providers of "free services" ask us to pay for something that they provide but not for free. Whenever we pay one of these service providers for something, we are engaging in a transaction with this service provider; this is just like any other service provider who at least does not entice us with free stuff.

Unlike goods, services usually are not bought from a marketplace or a store. We buy them from a service provider. That said, there are businesses that sell services on behalf of multiple service providers; some examples are: insurance broker/agent, travel agent, etc. These kinds of businesses are a "third-party" to the main transaction between a service provider and the consumer of the service. These broker or agent kind of businesses are paid by the service provider some percentage (called commission) of the monetary value of the main transaction. One can think of these commissions as a service charge that one pays to find the right service provider for our needs or wants. One can also think of these commissions as a "tax" that could easily be avoided if we knew which service provider to contact. With the advent of computers and the Internet, in general, these kinds of businesses are getting efficient and their service charges (that is commissions) are dropping.

A real estate agency and a stock brokerage firm may seem like a marketplace for services, but in fact they are more like a car dealership. They enable buyers and sellers of something (not some service) to find each other and conduct their transaction. These are the marketplaces for used houses and "used" ownership shares in organizations; they are not like a marketplace for buying insurance or making vacation reservations. These are similar to websites that enable us to buy and sell used stuff like books, tools, devices, etc.

Paying for Stuff

When we buy stuff, we have to pay for it. We got to consider the medium and mechanism of this payment. Currently, the predominant payment mediums are: cash, cheques, credit cards, debit cards and email transfer.

We also have the physical thing called a "wallet". It holds some of our money that we wish to carry around in the form of cash (paper bills and metal coins), numerous payment cards (debit and credit) and identification cards.

We could pay for the things that we buy using the money that we have by means of cash, cheques and debit cards. However, all these three mechanisms of paying for stuff, with the money that we have, seem to have some inconvenience or another.

It is risky to carry cash. Moreover, one does not ever know exactly how much cash to carry with us.

Cheques have to be carried in a cheque book. These usually are bulky enough that they don't fit in a wallet. Cheques are risky too. Someone can easily steal someone else's cheque book and forge a signature. Every time someone chooses to accept a payment by cheque and deposit it in one's bank account, somebody has to do something to attempt to discover a potential fraud.

Debit cards, since they are linked to our bank accounts, are deemed risky to use for mundane purchases. After all, if there is a substantial amount of money in our bank, then exposing that bank's debit card just exposes ourselves to some fraud that may impact a larger amount of money.

Credit cards of today solve all these kinds of problems by offering limits on spending using borrowed money that one pays later. The limits on spending using credit cards is large enough that can cover all normal spending; this makes it superior to carrying cash around. Spending using credit cards is protected by an electronic password (a PIN number as it is called); hence not as easily forged as a signature. Since a credit card is not the same as our debit card, it does not expose our bank accounts from our routine transactions and hence hopefully protects them.

So all these deficiencies in using our own money to buy stuff has led us to the use of credit cards and hence compelled us to borrow money even when we don't need to borrow. In solving one problem, we have created another.

Credit cards, debit cards are digital means of payments. The ability to transfer money to someone using their email address is also a digital mechanism. All these card numbers and email addresses are ways to identify individuals. The use of cash and cheques as a way to make payments is already in decline. As internet connectivity and digitization progresses, we will see further reduction in the use of cash and cheques.

Credit Card Costs

When we use credit cards to buy stuff, we incur costs. The cost is paid in many possible ways.

One is where the credit card company charges us some annual fee for having the "privilege" of paying by a credit card.

The second cost is the one charged by credit card companies to the vendors who accept these credit cards. Usually it is a small percentage of the amount of the transaction. Many large vendors are willing to pay this fee because they can just charge that fee in the price of whatever they are selling. Small vendors usually are uncomfortable with this situation and hence it is a common occurrence that a small business may only insist on being paid in cash or using a debit card or may ask the customer desiring to pay using a credit card to have a large enough transaction amount. Moreover, many of these credit cards even have a "feature" in which they give some cash back to the customer for spending using their credit card. Where does this cash come from? It comes from what they charge to the vendor.

The third cost is the enormously high interest rate that credit card companies charge to those people who do not pay the dues within a month. Thus, customers of credit cards get lured into spending beyond their means and then incur a very high interest burden. Who falls for this lure? What is the proportion of people who have had credit card debt for a long time?

The fourth cost is that it reduces our sense of our own afford-ability. Access to "easy money" has a cost. It allows us to fall prey to the temptations of instant gratification even when we cannot afford to pay for it.

The disparity in the interest rate that one can get if one places that money in a bank and that which one has to pay a credit card company is very large.

Renting

We also have this concept of "renting". We rent all kinds of things. Then things that we can rent may be of trivial value or very valuable.

The most prominent example of the things that we rent for a long time is our residence in the form of rented apartments and houses. We can also rent the furniture.

There are many things that we rent for a short time. For example, when we travel, we could rent cars and bicycles. Even clothing can be rented; especially clothing required for special and rare occasions.

The act of renting is using someone else's property and compensating that someone else by paying them some money; the money paid is called "rent".

The owner of the thing that can be rented is called a "renter". The user of the rented thing is called a "rentee". However, in colloquial English, the word "renter" is used when the intended original word is "rentee"; in this colloquial usage the "renter rents from a land-lord". In order to avoid this confusion, we will use the words "owner" and "tenant" instead of "renter" and "rentee".

Renting does not change ownership. Renting makes changes to the possession and usage rights of things from their owner to the tenant. Renting is for some duration after which the thing that is rented should be returned to the owner in pretty much the same condition that it was originally rented. Usually the period of rent and price of the rent is agreed to at the beginning of the owner-tenant relationship.

The point of renting is two-fold:

• It allows an owner to earn some money using the things that the owner owns.
• It allows a tenant the use of something that the tenant does not own by paying the rent.

There are terms like "leasing" which have a meaning similar to renting and for this discussion, we will not bother with all these slight variations in the terms. We will treat anything that is "using someone else's property by compensating them with some money" as renting.

Loans, Liens and Mortgages

If we can rent, then what is the need for a loan?

Renting allows an individual to borrow and use things owned by other people. The main requirement from the owner's perspective is that the thing that is being borrowed is returned in pretty much the same condition.

If the intended use is not for a short time, then the thing cannot be returned in pretty much the same condition. Examples of this are cars, household appliances and houses. Usually these things get worn out and have a far lower value than their original value. That is, these things depreciate. Even houses depreciate as they age and eventually they need to be torn down and rebuilt. Thus when an individual desires to use something for an extended period of time, then renting is not feasible.

When an individual does not have enough money to outright buy the thing that they want to use for an extended period of time, then that individual needs to use the concept of a "loan".

Instead of borrowing something, an individual (the borrower) borrows money from someone (the lender) and uses that money to buy the thing that they wish to own. Such borrowed money is called a loan.

Since the money is borrowed, one has to return the borrowed money at some agreed time (either gradually or in a single payment). The borrowed money is called the "principal". Moreover, the borrower pays some additional money, called "interest", to the lender for allowing the borrower the use of this money. The interest is paid at a certain "rate of interest" for a predetermined interval of time.

Usually, borrowers can fulfill the terms of repayment of their loans and pay the principal and interest on the agreed upon time (or schedule).

What happens when the borrower is unable to pay back the principal or the interest? What recourse does the lender have in such a situation?

The recourse is through the concept of "lien". A lien is for a specific loan and the specific thing bought using that loan. When there is a lien and if the borrower cannot repay, then the lender can take ownership of the specific thing, possess it and sell it off in order to recover the money that is owed to the lender. Any remaining money is returned to the borrower; usually the remaining money is not very much.

The need of a lender to exercise their right of lien is a consequence of the inability of the borrower to pay back the loan. It is usually not pleasant to the borrower and it is an unnecessary hassle for the lender. The concept of lien exists to protect the lender from a borrower's inability to repay. In such cases, if not the money, then the lender at least gets the thing.

Loans that are secured by a lien on something are said to be secured with a collateral. Once the loan is fully paid back, the lien is "released" and is no longer effective.

When an individual borrows money for owning a house, it is called a "mortgage". Associated with the loan, there is a lien on the house; the house is the collateral for the loan.

The borrower is required to repay the principal gradually and also make the interest payments on the remaining principal. All this repayment needs to be accomplished at a predetermined schedule.

If the borrower cannot fulfill the repayment obligations, the borrower risks losing the possession and ownership of their house.

Using Money to Earn Money

So far we have seen 4 examples of using money to earn money. They are:

• When we deposit our money in our bank accounts.
• When we pay interest on our credit cards. Someone else has lent us this money.
• When we borrow money. That is when we take a loan or mortgage.
• When we rent something.

The first three activities are that of lending money to earn money. One simply allows others to use the money that one has for some amount of time and in exchange charge them a fee (called interest).

The fourth activity, renting, needs an explanation. In order to rent something, one must first own it. In order to own it, one must first buy it. In order to buy something, one needs money. Thus, if one has money, then one can buy something that others want to rent from you, and actually rent it from you in exchange for their money. Essentially, renting is using money to earn money; it is just not as direct as loans or credit or even earning interest on one's money in one's bank accounts.

For most individuals, renting (as a means of earning money with the money that one has) is quite infeasible. That is because most individuals don't have a lot of money and even if they have it there is much work and uncertainty associated with buying something and renting it out.

Most citizens are more than willing to let their friends, family, neighbors and even acquaintances borrow some of the things that citizens own and are not currently using. Usually this is just borrowing with the borrower expressing gratitude with words or with other actions but usually not with money. A very few citizens who have sufficient money or resources may engage in some renting activity, but managing that renting activity does not constitute a major part of their daily work.

Most of the renting that goes on in our society is done by for-profit organizations. These organizations charge enough rent to recover the depreciation of the things being rented out plus the cost of running the business plus some more to make a profit for the owners of the business.

If lending money can earn money, then naturally we would want to compare multiple alternative ways of doing it and attempt to find which one is better.

For example, the money that we earn on our bank deposits is at a lower rate than a loan that we may want to take out for a house. That loan itself is at a lower rate of interest than the rate of interest charged by a credit card.

Banks offer to borrow our money at a higher rate of interest than the bank accounts. However, we have to commit to letting them have our money for a fixed and long duration. The terms "Fixed Deposits" and "Certificate of Deposits" represent this idea. This is an explicit loan that we give to our banks for a fixed amount of time at some fixed rate of interest which is higher than the one the bank pays us on our checking or savings account deposits.

Even after considering a higher rate of interest on fixed deposits, that rate of interest is still lower than the rate that we may have to pay for our home mortgage or our borrowing using our credit cards.

How can we get a higher rate of interest? Simply put, one earns at a higher rate of interest in riskier lending situations and lower rates in low risk situations. For example, governments currently are habituated to borrow money. We can lend our money to our government and the interest rate that our government pays us is low because there is hardly any risk of our government not being able to repay these loans; all they have to do is raise the money to be repaid through taxes. In fact, the risk to our lending when we lend to our government is so low that this rate is called a "risk-free rate of interest". For the exact same duration of lending, the rate of interest for lending to other parties should be higher than the government's rate.

What about unsecured loans?

When someone lends money to others for some time, the lenders are letting the borrowers use the money to overcome their temporary money inadequacies. Clearly the borrower did not have the money and hence needed to borrow it. If the lenders had something better (more useful) to do with their money, then they would have done that instead of lending it. Thus the activity of lending and borrowing is mutually beneficial to both the lenders and borrowers.

When we have a clear and present need to spend money and if we do not have money that we need for our immediate use, we can think about borrowing some money for either a short amount of time or for a longer amount of time.

When we have money that we do not have any immediate use for and we do nothing with it, then we are saving that money for a later use. Doing nothing with the money we have is "saving it". This money represents our "savings". Since we are doing nothing useful with this money, it is not being used to earn money.

When we have money that we do not want to use in the short-term or long-term future, we can and should think of using the money to do something useful so that we can earn some more money using the money we already have.

Lending is the easiest way to use our own money to earn some money.

Organizations

Organizations represent the most general way of using one's money to earn money.

The simplest of all organizations are the sole proprietary organizations. When an individual has some money and wants to conduct some business and make a profit doing that business, the individual can create a sole proprietary organization.

The individual transfers an adequate amount of money to the account books of this organization as its "capital". Then they run the business; the business could be producing something or manufacturing something or providing some services. Thus this organization provides goods and/or services to its customers and charges enough money for them so that the individual runs a profitable business. These charges, for the goods and services, should recover all costs of doing the business and then some more for the profit. The costs include the depreciation of the capital and all other operating costs of the business.

The business owner (that is the sole proprietor) can transfer whatever profit that remains to their own account as "dividend" or retain it with the business as "additional capital". The dividends are the individual's income (very similar to an employment income). The profits that are retained as additional capital increase the "book value" of the business and it can be thought of as an increase of the wealth of the business and hence the owner of the business, which in this case is the sole proprietor.

We have just described the model of a for-profit business. The model remains the same regardless of how many owners own the business.

Self-employed individuals can operate their sole proprietary business with very little capital and pay themselves any and all profits as dividends. These dividends are the equivalent of their salary as a self-employed individual.

Most individuals do not have enough money to start their own business and do something big. One step above a sole proprietorship business is a "partnership" business. A few people pool together their money in some proportion and divide the ownership of this partnership among themselves in some proportion (that could be different than the proportion of money they invested in the partnership). Such an organization could be owned by as few as just two individuals. Some partners provide money, some provide technical expertise, some provide management skill and some provide the labor and thus they conduct their business. As such, a partnership is a formal way for a few people doing something together and yet have plenty of flexibility in what kind of resources are being pooled together and how they distribute the ownership of the partnership organization.

While partnership may provide the organization money and resources larger than what a single individual can provide, it still is limited to the capital of a few individuals. One step above a partnership business is a "private enterprise". In this kind of business a few people pool together their money and create an organization called a "private enterprise". The people who create a private enterprise are the only ones who decide who all can be part owners of this enterprise. That is, part ownership in this enterprise is not open to all citizens and hence these are called "private enterprises". More than that, ownership share in the organization is strictly allocated based on the money contributed by the participant owners.

Other than the fact that a few people own the private enterprise, it works the same way as any for-profit business. It has the same concerns and challenges, it still has to provide something useful to its customers and charge enough to generate a profit after accounting for all expenses.

The next step above a private enterprise is a public enterprise. Anyone can be a part owner of such enterprises. All these owners own what are called "shares" of the enterprise. These owners have voting powers in taking the highest level decisions of who they should appoint for the "board of directors"; they have no other decision making power regarding how the business is conducted. The board of directors is indirectly responsible for the success or failure of the organization. They appoint the "management" of the organization and oversee their working and performance; this can even lead to the firing of some members of the management. This management includes such posts as the CEO, CFO, etc. The management is directly responsible for the success or failure of the organization.

Ownership shares of public enterprises are routinely traded on a stock exchange and usually there are some buyers and sellers. If a public enterprise is especially large, the number of shares traded each day could be in the millions.

When an individual decides that they want to invest and be part owner of such an organization, all they have to do is place an order to buy some number of shares of this organization through their brokerage account. If some other individual is willing to sell their shares at the price that this individual is willing to buy, then that trade can be made. Thus buying ownership shares in such an organization is easy. Similarly selling one's ownership shares in such organizations is equally easy.

Thus, it is trivial to invest one's money in a public enterprise or divest from a public enterprise.

There are an immense number of public organizations that one can be a part owner of. Most individuals don't have enough money to be part owners of all these public organizations using a non-insignificant amount of their own money for each of these organizations. Such individuals will have to limit their investments to only a few of these organizations and for that they will need some criteria to choose.

The way individuals can invest in a large number of organizations or all of the organizations with the money that they have is through "funds". These funds pool money of many individuals and then using this pooled money they invest in a large number of organizations or perhaps even all the organizations; it all depends on the purpose of existence of each one of these funds. There are many funds, each fund with some specific purpose.

Loosely speaking, a fund is almost like an organization whose sole business is owning other businesses using the capital it has.

Generally speaking, a fund is almost like an organization whose sole business is owning (or trading) some kind of financial instruments, using the capital that it has, with the understanding that doing so will generate either dividends or increase the value of the investments or both.

All these funds with their specific purposes can be neatly classified into just a few categories. There are also a few such categorization schemes. One such categorization scheme gives us hedge funds, mutual funds, exchange traded funds, fund of funds, etc. Another such categorization scheme gives us commodity funds, broad market stock funds, broad market bond funds, precious metal funds, etc. Yet another categorization scheme gives us passively managed funds and actively managed funds.

Bonds and Treasuries

Just like people may need to borrow money, organizations also have this need; but the underlying purpose could be different. When an organization needs lots of money for some long-term project, it has two alternatives: raise more capital from owners or borrow money from lenders. Raising more capital has a tendency to dilute the ownership of existing owners. This may not be palatable to all organizations and their owners. Instead they choose to borrow money from those who are willing to lend it to them. Hence, these debts are usually for the longer term. Similarly organizations may have short-term borrowing needs and raising capital for short-term needs is more problematic than raising it for the longer term. Thus, organizations can easily engage in borrowing money for both the short and long term. The financial instruments associated with such debts of organizations are usually called "corporate bonds" or just "bonds".

Not every organization is managed by a competent management team and even those organizations that are managed by competent management may face totally unexpected adversity. Thus some organizations may have difficulty in making the interest payments on time and some may even have difficulty in paying back the borrowed money. When either of these occurs, the organization is said to "default on its payment obligations" and this can easily lead to "bankruptcy" for the organization. Thus lending money to organizations has risks.

Currently governments also borrow. The financial instrument associated with such debts is generally called a "treasury bonds" or just "treasuries". Since it is the government and it can raise taxes to pay back the borrowed money, the concern that a government cannot pay back its debt or the interest payments on it are very small. Within a society that is also a monetary sovereign, this risk should be zero. Because this risk is zero, treasuries are considered to offer a "risk-free" rate of interest.

About Profit

Investment is necessary. Producing something or providing specialized services usually requires resources that are beyond the reach of average citizens. People can pool together their wealth and raise the capital that is required for doing things that require resources (like land, machines, etc.) that are well beyond the means of a single individual. This pooling together of wealth to do something productive is done through an organization that is collectively owned by the contributing individuals in the proportion of their contributions. These contributions of wealth to create the organization is called investing and the money thus contributed by an individual is called that individual's investment. Past investments by whoever did them are in part responsible for our current material well-being.

The argument for the necessity of investment implies that all individuals cannot be self-employed. Those who are self-employed either do not need a large amount of capital to do what they do, or they need a large amount of capital and have that amount of capital on their own. In fact, most of us will be employed by organizations who have a large amount of capital, pooled from many individuals, to do the specialized activities that produce the specialized products and deliver the specialized services.

Profit is necessary for organizations. For organizations, the profit is the monetary reward for the organization's investors for investing their money and creating an organization that provides something valuable to others.

Not-for-profit organizations run on donations and stewardship rather than investments and ownership. The donations could be of money or of time; those are acts of charity and volunteering. However, such organizations may not find volunteers to do all the work that needs to be done and they will have to employ people and pay them salary.

There is profit in employment too. When we work for others, we get paid in salary. We may incur some expense in doing the employment like: commute, work clothes, etc. If we pay for these expenses ourselves then our profit from the employment is the salary earned minus expenses incurred. If this profit was zero, then why would we work for the employer?

Even self-employed individuals need to generate a profit in order to satisfy their own needs and wants. The customers of self-employed individuals are like the employers. While employed people have one or two simultaneous employers, self-employed individuals may have several tens of employers in a single month.

Just because the organizations are not-for-profit, they cannot pay their employees any less for the kind of work that is expected from them; after all, the employees need to earn enough so that they can be independent and satisfy their needs and wants.

If even the not-for-profit organizations have an obligation to pay their employees fair wages, then for-profit organizations must pay their employees fair wages. Since employees typically only give their time to their employers, the fair wages ought to be on a per hour basis. This is the basis of minimum wage regulations. If employees, as part of their employment, give the use of their time and their equipment (like a delivery car) to their employers, then the "profit" that the employees derive from their employment ought to be at least at the rate of minimum wages.

Not-for-profit organizations are the source of earning money for some citizens when these citizens get employed by one of these organizations to do something useful. Those who donate money to the causes of these organizations are being helpful in supporting the cause and its employees.

If there is no investment, then there are no enterprises and hence there is no opportunity for employment for any one (except being self-employed) and that obviously is not good for the society.

While we may frown upon those who go for large profits, there is nothing wrong in doing so as long as it is done consistently. What we frown upon is demanding a much higher price in times of difficulty (e.g. price gouging for water bottles in situations of natural calamities) and hence the large profit. This is because it smacks of being selfishly opportunistic in other people's time of urgency or emergency. Most of our regulations about setting prices arise from these kinds of considerations.

This ability to choose our level of profit leads us to seeking out investment opportunities with higher profit potential. When the higher profit potential is actually realized, we get better returns on our investment. We are okay with people desiring larger profit margins as long as they are not engaging in ethically undesirable behavior.

Investment in an organization has several risks. Those risks may or may not materialize. Depending on which risks materialize, the profitability of the organization could suffer and invested capital could reduce. Thus, risks and their probabilities need to be considered when investing.

While employment is an activity of "earning money by using one's time", investing is an activity of "earning money by using one's money". That is money earns money. From that perspective, if someone wants to borrow our money and pay us some interest at some rate for the duration of the borrowing, then this activity of lending is also "earning money by using one's money". Just like in investing, lending has risks; though perhaps lower.

Since both investing and lending have risks, and doing nothing with the money does not have those risks, many times, people prefer to do nothing. This doing nothing with the money that one possesses is called "savings".

If this money could be lent without any risks, then people would gladly lend to earn some money without any risks. Currently when governments borrow from their citizens, from the citizens' perspective this lending is considered to be free of risks and the rate of interest that this kind of lending fetches is called the risk-free rate of interest.

In Building Utopia, we discussed that governments should not be borrowing money since they have the ability to levy taxes and the ability to create money. In the Utopian Financial Infrastructure, would we have a new mechanism for risk-free rate of interest?

Investments

Investing is the generic term describing the activity of "trying to earn money using the money that one has". When we invest money, that money is called an investment.

More specifically, an investment is a financial instrument that one owns and owning that instrument provides us with a potential for profit and no other practical use to ourselves. An investment is good to the extent that the potential for profit actually materializes.

Investing is the activity that involves the following:

• Evaluating the various choices of financial instruments for their profit potential and their potential risks.
• Doing the same evaluations for all the financial instruments that one already owns.
• Identifying a financial instrument that one owns that is inferior to a financial instrument that one does not own. All these pairs are potentials for swapping.
• Of the pairs that one has identified as potential for swapping, one has to choose to act upon.
• Finally, of all the swapping pairs that one has decided to act upon, one has to actually sell the instrument that one owns and buy the instrument that one does not own. These are two separate transactions. Conceptually, we are trading one financial instrument for another.

All these actions together are called investing. The term "investing" is used as an all-encompassing term to represent all kinds of activities of using money to earn money. Owning a part of an organization or owning a part of a fund that itself owns parts of many organizations or lending are all examples of using money to earn money. They are all examples of the general term "investing".

Since profit is the main motive in investing, there are many activities that appear like investing.

Some of these can be considered as investing; for example lending is investing with limits on profits (which is exactly the rate of interest) and with some risks.

Some of these are not truly investing. For example when we buy a house to live in and also call it an investment, we are really using the house to just live in it. If the house appreciates in value, it is an added bonus and not the true purpose of spending the money on buying the house. In present times, because the house prices are so high, most people cannot own their own home and also have enough money left over to invest in other things. Hence most people satisfy themselves by calling the home that they live in as an investment.

The most prevalent form of investing is owning a small part of large organizations. These organizations engage in producing something useful or providing some useful service and make a profit in doing that (after duly providing for the depreciation of infrastructure used).

Many of these organizations distribute these profits as "dividends". Some organizations do not give out dividends; they retain all their profit and attempt to use this profit as additional capital to do more things; thereby they increase their value and this added value is recognized by investors in the price they are willing to pay for one share of the organization.

Since there are many organizations and since the money that we have is usually limited, we cannot possibly buy a few shares of each one of these organizations. Thus we have to choose from among all these investment opportunities.

These choices can be made based on many things some of which are:

• Investment "tips" from someone we trust.
• Based on the idea of "diversification". This may take many forms.
• Diversification implemented using Mutual Funds and more recently ETFs.

Owning parts of organizations (either by directly owning shares of its "common stock" or indirectly through ETFs) is not the only way to invest. After all, making a profit is the primary criteria.

Ownership of an organization is just one kind of financial instrument. There are others like options, futures, etc. "Bonds" are financial instruments that represent lending to organizations. Lending to the government is yet another financial instrument commonly called a "treasury bond".

There are more kinds of financial instruments which deal with aspects other than just ownership of organizations (like leverage, volatility, etc.). All these are more challenging methods to investing and most individuals are already sufficiently challenged by investing using just the plain vanilla "common stock" which represents part ownership of organizations. Most individuals are "challenged" either because they don't have money to invest or they are worried about the next big crash and what to do about it.

Our current taxation rules significantly influence our investing decisions. There are too many special case rules and exemptions. Since we will be adopting wealth-based taxes, all these special cases and exemptions are obviously gone. From an investing perspective, taxation rules will cease to be a relevant factor in making investing decisions.

Financial Markets and Brokerage Accounts

Financial Markets are the places where we do the activity of "investing". There are many kinds of financial markets; a stock exchange is just one of these. We don't use all our money for investing, just a part of it; the other part is locked up in our personal belongings and in our home (if we own it).

We use a brokerage account (or some such account) to park the money that we wish to use for investing and then actually use that money to either buy shares of organizations or other financial instruments.

Most individuals, when thinking about investing, consider these brokerage firms as organizations that enable them to buy and sell "stock market kind of stuff". Most individuals don't concern themselves with how it is implemented; they trust that it is implemented correctly.

One of the quirks of the modern investment landscape is the recording and accounting of who owns how many shares of which organization. For instance, when we buy ownership shares in some organization, most likely, the shares are bought by the brokerage firm on our behalf. They own the actual shares (the name of the owner in whatever books of record show the brokerage firm as owning the shares) and they pass on the ownership rights and privileges (e.g. voting and dividends) to us.

Yet another quirk in the investment landscape is the settlement period. Settlement Period is the amount of time that it takes the current stock market related financial system to complete all aspects of a buy or sell transaction of a financial instrument. When selling, this implies that the money obtained from the sale is not immediately available to purchase something else. For someone with not much liquid money available, it results in the person having to wait to do the next transaction. During this period, the person cannot use the money that the person owns.

For most people, the financial markets and their brokerage accounts serve their respective purposes "just fine". Some people have concerns. We hear about high frequency traders and algorithmic trading. Recently machine learning and artificial intelligence got added to all that. Then there have been situations where some "parties" attempted and succeeded in gaining an advantage over other market participants by knowing what their order was even before that order was "known to the market"; this is called "front running"

In fact, there are many terms that crop up in the context of financial markets. Some of those terms are quite benign and others represent problems. Here are a few terms; see if you can distinguish between them: market orders, limit orders, stop loss orders, iceberg orders, bid-ask spread, order book, open interest, level 2 quotes, ticker, selling order flow, ECN, OTC, after-hours, pre-market, opening price, closing price, volume, market makers, indexes, market cap indexes, equal weighted indexes, best bid-offer, lot size, odd lot, etc.

Online and App Logins

We all access several websites. All these accesses are either to buy something from them or to avail of their free services. For most of us, some of these websites have something to do with our money and our wealth like: banks, stock brokerages, retirement savings, utilities, retailers, etc.

These websites have a desire and need to know who they are interacting with and hence most of these websites ask their users to log in. The activity of logging-in, at a bare minimum, consists of specifying a userid and a password. A website at a bare minimum has to store the userids and passwords for all its users and each time someone wants to login, ask for them and check if the entered userid and password matches. A matched userid and password is taken to be an indication that the person accessing the website is indeed who they say they are.

There are two distinct activities that occur in the activity of logging-in. The first is identification of the person (this is done by the userid) and the second is authentication of the person (this is done by the password).

Since there are many websites, we all tend to have many such logins. A login, in this context, is the combination of userid and password.

Experts tell us that we should have "strong" passwords and that we should change them frequently. The reason for such advice is that passwords can be guessed and hacked and that risks our online logins and whatever is in them. So, the advice is good for the current technological solution. Then there are concepts like one-time passwords, single signon, password managers, etc. that attempt to minimize the risks and also introduce other risks and inconveniences.

Now, if our userid is supposed to identify us, then why is it that we do not use our government issued identification number? Most of us will answer that question either with "because it is risky" or with "I don't know". Besides, our governments issue us more than one identification (like driver's license, passport, etc.), so which one to use? By the way, because some government issued identification documents contain our photo, they not only serve in identifying us with some identification number, but they also serve in providing the minimal proof of whether the holder of the identification card is indeed the person mentioned on the card. That is, these cards serve as tools of identification and authentication.

Next we have our payment cards and these have PINs. The card number on the card acts like our userid and the PIN acts like our password. So, when we have to buy something at a physical store, we may have to enter our PIN to both authenticate ourselves and authorize our transaction. But, there are many places where we use our payment cards without supplying our PIN. Which means that if the payment card is stolen, it can be used without authentication and authorization. This is the most obvious instance of the absence of security.

Thus we are required to possess, remember and keep secure too many userids, card numbers and identification numbers. If one ponders about all these situations and investigates them deeply, one will discover that there are numerous problems in this field of identification, authentication and authorization. The chapter, "Logins and Transactions", discusses all these problems at length and also provides the outline solution.