PALS Finance Explained

Part 1 of 2

"If all the economists were laid end to end, they'd never reach a conclusion."

George Bernard Shaw

Economics - pure perpetual motion machine fantasy

An often-neglected component of the Energy Seneca is its impact on economics and finance. The snowballing avalanche of energy, ecological and social issues is in the process of revealing the whole of economics and finance thinking as being no more than a perpetual motion machine fantasy, in full contradiction with the thermodynamics that form the basis of any durable society. These modes of thinking and decision making have become wholly unviable now that, once abundant, low cost energy is gone and that ecological disasters have begun to strike. It should be clear to all level-headed observers that by about 2030 all current financial systems are likely to have disintegrated and been replaced with “Something-else”. In short, new thinking concerning finance, wealth creation and preservation has become a necessity.

Recent years have seen a renewed wave of criticisms of “capitalism”, whatever this term may mean, and renewed efforts to create alternative currencies, notably cryptocurrencies. However, none of these criticisms and efforts are grounded in sound thermodynamics nor can they provide any resilience on the downside of the Energy Seneca. The very thermodynamics of the Energy Seneca dictate that the “next big things” that will engender some “new Business-As-Usual” (BAU) are of necessity closely linked: new energy systems and new financial/monetary systems.

In other words, due to the Energy Seneca presently obliterating all global future prosperity prospects, the next two decades will see a very substantial, very deep, re-engineering of all matters financial and monetary.  We stress it, this is sheer thermodynamic necessity and unescapable. The Covid-19 pandemic, responses to it, and impacts of both pandemic and responses have added considerable momentum to what already in train beforehand. We can expect rapid but also chaotic changes over the next few years. Of course, we do not know “what” specifically will happen “when”, however, whatever the detours and resistances, we know “it” will happen; and we know “it” will have to be soundly grounded in thermodynamics.

Suffice to say that energy is super abundant. Each year the Earth receives some 23,000TWyear from the sun while humankind presently requires less than 20TWyear per year.¹ Scarcity is something that specific modes of social organisation create. There is no “natural” fatality to it. The challenge that we face on the downside of the Energy Seneca is to access solar energy abundance through new thermodynamic means, new modes of social organisation and new modes of thinking. In this respect, it is important to recognise that, being the sole resource that cannot be replaced by anything else, energy is the sole, ultimate tangible anchor for economic value.² However, as such energy has no inherent, or very little, value per se; its value is derived from using human intelligence (sometimes referred to as “knowledge capital”) to develop power (in the thermodynamic sense of ability to generate energy flows per unit of time) – knowledge combined with energy is the sole source of value and wealth. In other words, new, sustainable monetary forms can only emerge at the interface between network innovation improving secure communications and exchanges between transacting parties, emerging technologies generating survival value, thermodynamics, and a fourth key notion that is also vital, that of actuarial domains of trust, already paramount in all matters related to credit cards, but also seen at play in the present flurry of business innovations related to people sharing their own facilities (homes, cars, etc.) such as airbnb.com.

Furthermore, on the downside of the Energy Seneca, presently most forms of wealth are de facto in limbo and are bound to evaporate briskly unless a paradigm shift establishes new sound thermodynamic foundations for wealth creation and preservation. Put in other words, in recent years, the risks affecting wealth have become enormous, but few have yet fathomed the extent of the dangers.

Still, notwithstanding the above necessities, it remains imperative that initiatives to establish new monetary and finance means retain compatibility with present BAU in its dominant form and navigate safely post-BAU developments concerning new ways of doing business as well as new financial and monetary forms. What follows is grounded in the above considerations.

Background

In recent years, a flurry of research, thinking and experiments have emerged concerning financing and financial instruments, including various forms of financialising, crowdfunding, cryptocurrencies, ICOs, ITOs and now IEOs.1 All present substantial drawbacks and/or regulatory issues. However, a new innovative financial product has attracted our attention for its potential to address creatively the issues summarised in introduction.

In French, it is called 4P – financement par le Principe du Partage des Profits et Pertes (financing via the principle of sharing profits and losses). In English we call it PALS™ (Profit And Loss Sharing). There is a bit of serendipity in the acronym in that it expresses what this is all about, a partnership where the contracting parties share risks and the outcomes of risk-taking for better or worse.

Initiatives like 4P are not just about creating a “new financial product”. Instead they are explicitly rooted in the challenges of our time. In this respect, considering their broader historical background may be helpful to understand their importance, their character and their potential.

4P

In France, 4P has been advocated by Bertrand du Marais, Conseiller d’Etat (something akin to QC, Queen’s Counsel in the UK) seconded as Professor in Public Law at Paris X University, and Stanislas Ordody, a finance executive.1 These two experts are not young mavericks. They present their initiative as explicitly motivated by the lessons to be learned from the last 40 years in the world of finance (often colloquially referred to as “Planet Finance”), its fantasies of low risk, high-returns, its speculative character and systemic risks, the myth of self-regulation of finance players, the consequences in the “real economy” re unemployment, struggling businesses, brakes on innovations, difficulties in funding new ventures, and so on. Their aim is to develop a new financing avenue suited to contemporary businesses and the new challenges that they face, one that does not fall into the traps of Planet Finance.

One of their foci is to structure finance in such a way that investors’ remuneration be disconnected from interest rates as the latter are often contributing to trap businesses (and States) into rigid and heavy loan repayments even when market conditions are difficult, “growth” is no longer there, while investments will return benefits only years later and so on.

Another focus concerns the present situation where, in 2008 and since, large numbers of investors have had their fingers burnt and have become weary of investing in many BAU financial avenues. Du Marais and Ordody seek to provide alternatives that investors can trust and that are not prone to speculation, attendant volatility, recessions, pandemics, the Climate Emergency, etc…

They see 4P as a tool contributing to forge new ways of financing and business development where all the partners in the “real economy”, investors and entrepreneurs alike, have access to means of achieving stable and durable growth and employment.

4P and the like, however, have historical roots that go back to the origins of capitalism in the Muslim sphere (notably from 8^th to 12^th centuries) and in European medieval times, origins that, it turns out, are becoming very relevant nowadays, i.e. in a new period of profound and rapid transformation.

Islamic antecedents

Although du Marais and Ordody do not refer to Islamic antecedents explicitly, others have noted the similarities of 4P with interesting aspects of Islamic banking and finance.¹ Key relevant notions include:

• Sukuk: through the Persian the word is cognate with the European check or cheque. The context is that Riba, the generation of money from money (e.g. usury, interest on cash loans, etc.) is forbidden as inherently unjust to one of the parties. Money is considered a tool to measure value and not an asset in itself and is not to be used on its own to grow wealth. In the broadest sense sukuk refers to legally binding contractual obligations involving financing of activities and/or goods where the parties share the risks entailed and there is no remuneration based on interest on any finance provided.

• Murabada: this is a contract where one party (investor) contributes finance and the other undertakes a business activity (entrepreneur/agent). Profits are shared but losses are born only by the capital provider.

• Musharaka: this is a form of contractual partnership where all parties share in both profit and losses.

Islamic banks, for example, may collect funds on a Murabada basis (where they act as agent for investors) and enter in Musharaka arrangements where they provide funds to entrepreneurs. Funds worth well over US $1 trillion are managed in such fashions globally.

European antecedents

While lessons can be learned from the Islamic experience, PALS’ prime focus is also concerned with the early stages of capital in Europe. Originally a “company” was a gathering of people sharing bread, i.e. sharing the produce of a common enterprise on a profit and loss sharing basis (co, with, together, pan, bread) and thus sharing the risks – bread also connotes energy; medieval societies were solar-based ones where energy flows were essentially happening through food for people and feed for their animals.

At the beginning of the capitalist era, moving away from medieval times and towards what was going to become the Industrial Revolution, we find the VOC, the Vereenigde Oostindische Compagnie (Dutch East India Company), created in 1602. It is recognised as the first multinational corporation and the first to have issued stock on a limited liability basis. At the time, it dwarfed all other similar ventures by its size and profit levels and relatively speaking, in regard of the means available in the 17^th century and now, it must still be regarded as unprecedented today.

Up to the VOC, companies lasted only the duration of a specific project, e.g. investors backing a merchant entrepreneur to send a ship or a fleet to collect and bring back goods such as spices. Risks were high. However, if the ship actually returned, profits could typically be over 400% of the amounts invested – some people could make a fair fortune on one successful trip. Inherently profit and losses were shared in proportion to the amounts contributed. Through Venice, Genoa, Portugal, and Spain, and, later on, the Dutch, aspects of such arrangements were partly inspired from the rather sophisticated Muslim commercial and financial practices that had developed between the 8^th and 12^th centuries and that are the antecedents of contemporary Islamic finance briefly reviewed above.

We are presently at a time of rapid transformation, probably much more profound and rapid than during the years that immediately preceded VOC or during the subsequent Industrial Revolution, at a time when it is necessary to innovate, a time of very high risk and thus a time where innovations concerning the handling of risk are paramount. In this latter respect, innovations like 4P or PALS™ re-link back directly to the early, very innovative days of capitalism and its very high-risk context.

Rizq Taking

Let’s recall that “risk” is derived, through the French risque, from the Italian risco expressing in merchant terminology a danger related to an enterprise and, in the military, the fortune or misfortune of a soldier; it is probably related to Byzantine Greek rizikon, the payment earned by chance by a soldier of fortune, borrowed from the Arabic rizq, the daily ration of a soldier.

In brief, fundamentally rizk equates with the “wages of fear” (“salaire de la peur”). When there is some risk, there is always some price, the rizq, for running that risk. Typically, a soldier of fortune or mercenary assesses the rizq, that is, the pay offered or the loot to be had against a combination of factors: the likely duration of the conflict, the dangers he or she will be exposed to daily, such as becoming handicapped (losing a leg, an arm, an eye or two) or dying, and the chances each day of any of this happening. For example, moderate chances of occurrence of high dangers (e.g. dying) over a long duration means a very high rizq will be demanded. Risks are taken, and even engineered, when the rizq that can be had is judged to be high enough.

Under Business As Usual (BAU), especially on Planet Finance, smart operators do their utter best to take the rizq first (or as soon as possible) and ensure that as much as possible the risks are born by others than them. Presently, on the downside of the Energy Seneca and its enormous threats, the consequences of BAU’s “Risky Business” become unbearable (to reuse the title of a 2014 report commissioned by Paulson, Bloomberg and Steyer).¹

As a kind of forerunner of much worse events that are likely to happen under the Energy Seneca, the Fukushima tragedy illustrate the relationships between risks and rizq-taking.

Villages in the foot hills overlooking the plain struck by the 2011 Tohoku tsunami had century old engraved stone steles marking the limit beyond which no one was supposed to build

houses because of the tsunami dangers. In the name of “growth”, BAU developers who thought they knew better ignored those warnings. In other words, historical data made it clear that over the lifetime of the Fukushima power plant site, including the period post operation for dismantling and sanitising the site, there was a high likelihood of tsunamis of small, moderate and high strengths, and that in the latter’s case the potential consequences were clearly unaffordable (not only locally but nationally re the impacts on the Japanese society and economy, and internationally). Other industrial and urban developments on that same plain bore the same risk; however, due to its nuclear nature Fukushima presented peak risks. The overall risk born by people living in the whole area was very obviously extremely high but was ignored by the rizq-takers, most of whom did not live in the affected areas. The Fukushima tragedy highlights strikingly the unsustainable character of the now terminal globalised industrial world and its rizq-taking practices.

Some people must pay the rizq. When the rizq is very high, generally this payment includes some sacrificial killings – some are sacrificed, usually at random, so that others benefit. This is what Fukushima and the Tohoku tsunami illustrate: over 28,000 deaths, an entire area devastated, hundreds of thousands lives ruined, a deep impact on the whole life of Japan, and economic and financial impacts globally. The devastation was not a “natural” catastrophe. It took place because some decision makers took the rizq to develop this area in this fashion (they took the rizq in all likelihood well before the event), and induced others to bear the risks.

On the downside of the Energy Seneca, the kind of approach to risk and business illustrated in the Tohoku/Fukushima tragedy is no longer bearable. In recent months millions of young ones have been marching and striking in opposition to this kind of risk, aware that they no longer have a future of their own and a life expectancy now known to be less than half that of their parents. The responses to the Covid-19 pandemic and their impacts (abrupt crash on oil demand, mass unemployment, drastic drop in world trade, steep increase in all forms of debt, homes, business and governmental) have highlighted further the necessity to innovate with new, viable financing approaches and strategies.

In fact, the Covid-19 pandemic and now the tragic war in Ukraine, are only the latest in the list of large-scale tragedies – a list that is getting rapidly longer. We only need to reminisce about the Katrina hurricane and New Orleans, Sandy and New York, and numerous super typhoons and hurricanes since then, the massive floods and storms in the UK, France, other parts of Europe, in Africa, India and Bangladesh, in recent years, the massive fires in the US west, in Australia, in Russia, the litany of massive blackouts in many countries, and more broadly the relentless increase in massive insurance costs routinely tallied every year by the likes of Munich Re or Swiss Re.

As global conditions keep deteriorating under the combined effect of the financial, monetary, energy and ecological crises, it is now obvious that most “players” stand to lose “big time”, including and especially BAU rizq-takers. At the time of the first warnings, proffered in the early 1970s, about what has become the Energy Seneca, it was understandable that most decision-makers would prefer to conservatively continue unabated along BAU. Nowadays BAU has become nonsensical – it is no longer in the best interest of even the most voracious financial predators.

In turn, a new breed of rizq-takers, scientists, engineers, and entrepreneurs is emerging who focus on the very high, non-sacrificial, rizq attached to fixing the messes made by BAU soldiers of fortune. The response time of BAU and the lack of intelligence of BAU issues that prevail within government as well as in business circles no longer fit within the time remaining for action and the knowledge required to deal with the massive non-BAU consequences of BAU. The only avenues left are those with extremely short response times that can be engineered by people of a rizq-taking entrepreneurial ilk who have an in-depth intelligence of the matters involved.

Extremely high "rizq" (i.e. reward) is there for the taking for those able to develop and produce technology, business and financial models aggressively opening up ways for a rapid transition out of this planetary mess and into sustainable living.  This is what the Fourth Transition is about, the rizq of intelligently fixing BAU messes, radically, now. In turn, finance initiatives like 4P or PALS™, aim to develop viable and sustainable alternatives to BAU risk, alternatives that balance risk and rizq-taking in fair and equitable ways.