Alex Jones

Alex Jones and his Infowars website have been removed and banned from YouTube, Facebook, Apple, and Spotify among the most popular social media platforms.  As of this moment, Twitter claims to be reviewing CNN claims that Jones and Infowars violate Twitter’s standards.  What should we think about this?

Jones has made many ridiculously false claims, such as the belief that Sept. 11 was an inside job, that the Sandy Hook massacre never happened and that Michelle Obama is a transgendered person with male genitalia.  “An InfoWars video posted in July 2018 falsely declared that the ‘CIA admits transgenderism is a plot to depopulate humanity.’” Twitter-Infowars-Alex Jones But accuracy and honesty haven’t been criteria for banning posts or President Trump’s tweeter account would have been closed long ago. Who is to decide whose lies can be tweeted and whose can’t?

Hate speech, which violates Twitter’s rules, is another matter, as is the promotion of violence.  Twitter’s rules state that it does “not tolerate” content “that degrades someone.”  President Trump violates this rule as well on a regular bases.

What should we do about the lies and hate that are regularly posted on the Internet?  I agree with Kimberly Ross who said that: “It is imperative that we don’t view those like Alex Jones, who peddle in fear-mongering and lies, as harmless. In fact, we should actively call out such appalling behavior….  We should never wait around for the Left to come in and clean up our side.  We should do that ourselves.  Individuals like Jones who manufacture outrage and spread falsehoods should find that the market on the Right for their wares is minuscule.”  Dont-defend-Alex-Jones-but-dont-let-the-government-get-into-censorship-either

Several important policy issues arise from this.  We should challenge what we believe to be lies and hatred ourselves.  Our First Amendment protection of free speech rightly prevents the government from deciding what is true and what is hateful and banning it.  Few of us would be happy letting Stephen Miller, a nasty minded White House Adviser, determine what could be posted on Facebook about American experience with immigrants.  Jonathan Rauch has updated his wonderful book Kindly Inquisitors: The New Attacks on Free Thought,in which he argues that the best defense against fake news and hateful speech is to exercise our free speech to challenge it.  Kindly-Inquisitors-Attacks-Free-Thought. See also his short essay on this subject:  “Who-will-regulate-hate-speech”.

Facebook and Twitter are private companies and should be free to set whatever policies for access that they want.  On the other hand they come close to being public utilities like telephone companies and Internet access providers who should not be allow to block access to the Alex Joneses of the world because they lie and spread hate.  This deserves further thought.

Turning to government to protect us from every unpleasantry we might encounter weakens us and takes us in the wrong direction.  Those who defend protecting us from hate speech with “safe zones” and “trigger warnings” reflect a paternalistic attitude toward the responsibilities of our government and of ourselves as citizens of a free society.  Like the well-meaning, but ultimately harmful, helicopter moms, we risk creating a society of wimps dependent on government for far more than is healthy for a free society.  Part of our training as we grow up and encounter a sometimes nasty world should be to stand up and challenge falsehood and hate when we encounter it.  Safe zones deprive us of such training.  It’s our job to counter lies and hate, not the government’s.

Posted in Discrimination, immigration, Musings | Tagged , , , , , , , , , , , , | 1 Comment

Have we been taken advantage of?

For as long as I can remember I have purchased food and household items from Safeway, Giant, and Whole Foods without any of them buying anything from me. Was I taken advantage of? Of course not. I voluntarily gave up part of my hard earned income in exchange for something I wanted more. I gained and was made better off by being able to make these trades just as they profited from providing them. In fact, I don’t know and I don’t care what those stores did with the money I paid them. Much of it, of course, was used to buy the goods they put on their shelves for me to buy.

These trades (my income for their goods) would only become a problem if I spent more at Safeway, Giant, and Whole Foods than I earned selling my labor. To do so I would need to borrow money from someone and go into debt. That might be OK temporarily, but obviously not on a permanent basis. In the long run, my purchases (imports) can’t exceed my income (export of my labor).

If you change my name to the United States and the names of Safeway, Giant, and Whole Foods to China, Japan and Germany (not necessarily in that order) nothing in this story changes fundamentally. Americans benefit from our purchases of Chinese goods and it doesn’t matter what they do with the money we paid to them (net of what they purchased from us—i.e., their trade surplus and our trade deficit). As I have explained in the following article, what they (all of them collectively) are largely doing with our money (our net global trade deficit) is finance our profligate government. https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

For some reason President Trump has trouble understanding these simple facts. He is upset by our trade deficit with China and Germany and others that his profligate, indebted government has caused. If the federal government balanced its budget (actually being at the top of the current business cycle it should be running a surplus in order to balance over the cycle), what would China and Germany do with their surplus of dollars? Rather than buying U.S. treasury securities, they might invest in the U.S. economy contributing to faster economic growth in the U.S. They might also choose to buy more goods and services from the U.S. thus reducing their dollar surpluses. In all likelihood they would do some of each. Given the resulting adjustments in their demand for dollars, the exchange rates of the dollar for Euros and RMB would adjust to produce the desired reduction in their surpluses.

Attacking China with tariffs and demanding a reduction in their trade surplus with the U.S. is counterproductive and wrong headed. But it does not follow that China is playing by the rules (WTO rules that we should be trying to strengthen rather than weaken). The EU, Japan, Canada, Mexico and others share this assessment and Trump would be much smarter to seek their cooperation in pressuring China to behave better rather than attacking them with tariffs and tariff threats as well. With the recent agreement with Jean-Claude Juncker, head of the European Commission, to deescalate the trade war with the EU and resume the negotiations over further trade liberalization started a few years ago (TTIP), perhaps Trump is changing tactics in a more promising direction. This should include concluding the updating of NAFTA and rejoining the TPP now the CPATPP.  We should all hope so.

Richard Rahn makes similar arguments in his Washington Times article today: https://www.washingtontimes.com/news/2018/jul/30/the-united-states-is-doing-better-than-it-did-duri/

Posted in Economics, trade | Tagged , , , , , , , , , , , , | 2 Comments

Trump and interest rates

There seems to be no norm or conventional wisdom that President Trump is not willing to overturn. Following Fed Chairman Powell’s congressional testimony Tuesday in which he confirmed the Fed’s intention to continue its gradual increase in its policy interest rate, Trump said: “I don’t like all of this work that we’re putting into the economy and then I see rates going up.”  The statement is wrong on multiple accounts.

The economy is now fully employed and interest rates probably should have been returned to normal some time ago.  The alarming current and projected fiscal deficits of the federal government will force interest rates and trade deficits still higher.  This is Trump’s fault– not Powell’s.  “Who pays uncle Sam’s deficits?”  The major policies threatening to undermine the economic boost from tax and regulatory reforms are Trump’s trade policies (pulling out of the Trans Pacific Partnership, stalling and threatening U.S. withdrawal from NAFTA, Steel and Aluminum tariffs (taxes) on our friends in Canada, Mexico and the EU, and a deepening trade war with China).  Leaving the TPP  Resisting the interest rate increases needed to keep inflation at 2% would increase the most regressive tax around (inflation).

But Presidential interference in implementing monetary policy, as is now being undertaken by President Erdoğan in Turkey, violates a long established principle and practice of central bank independence.  Historically, inflation, which falls heaviest on the poor and undermines economic efficiency and growth, has resulted primarily from governments turning to their central banks for financing in misguided and ultimately futile efforts to keep interest rates (government borrowing costs) low.

President Trump can save the economic benefits of his tax and regulatory reforms by rejoining the TPP, rapidly concluding amendments to NAFTA that improve productive efficiency and fairness, dropping the steel and aluminum tariffs, ending the trade war with China, joining with the EU, Canada, Japan and others to bring China into compliance with the rules of a strengthened WTO, and establishing a fiscal budget surplus primarily through entitlement reform.

Posted in Economics, Money, taxes, trade | Tagged , , , , , , , , , , | 3 Comments

A proposal for the Fed’s balance sheet

By Warren Coats[1]

To save financial institutions from the collapse that threatened them after the bankruptcy of Lehman Brothers in September 2008, the Federal Reserve purchased government securities and Mortgage Backed Securities (MBS) sufficient to increase the size of its asset holdings from $0.9 trillion to $4.5 trillion by the end of 2014.  These large open market purchases were not meant to increase the money supply, the traditional purpose of such operations, which after a sharp drop followed by a sharp increase in the growth rate of broad money (M2) has grown at its historical average rate of around 6% per year. Rather they were to support the market prices of government debt and hard to price MBS in the face of market panic (at least initially).

The Fed accomplished this trick (large increase in the Fed’s asset holding with only modest increases in the money supply) by paying banks to keep the proceeds of their sales of securities to the Fed in deposits with the Fed, so called “reserves,” in excess of what is required, so called “excess reserves.”  Beginning in October 2008, the Fed began to pay interest on bank required and excess reserves deposited with Federal Reserve banks.  This kept broad money from growing in response to the huge increases in base money (the counterpart of the securities purchased by the Fed) and became the primary tool of monetary policy.

The Fed is now pondering what to do about its abnormally large balance sheet.  A year ago it announced its intention to gradually reduce the size of its asset portfolio in order to return to its traditional policy tools—regulating the growth in bank money and credit by targeting the overnight interbank lending rate (the Fed funds rate) via open market operations.  After having suspended the open market purchases that had inflated its balance sheet in recent years (QEs 1, 2, and 3), in October 2017 the Fed stopped replacing the maturing securities it held to the extend of about $20 billion per month.  As a result its asset holdings dropped about $150 billion in the nine months since then and by the end of June 2018 stood at $4,315 billion.  Its current intention is to reduce its asset holdings to $3 trillion by the end of 2022.

The reduction in the Fed’s holdings of these securities (Treasuries and MBSs) is an increase in the market’s holdings of them, other things equal.  But other things are not expected to be equal.  Our profligate government is expected to run a one trillion dollar deficit in 2019, adding that amount of government debt to the market on top of the Fed’s additions.  The Congressional Budget Office projects a worsening federal deficit every year over the next ten of its official forecast, worsening even as a percent of GDP. This will put pressure on the Fed to rain in or suspend its program to return its asset holdings to more traditional levels.

There is a better way to handle this difficult situation.  Bank reserves with the Fed are currently about $2 trillion (the rest of the Fed’s monetary liabilities is Currency in Circulation of $1.7 trillion) and banks’ checkable deposits are about the same amount (of which demand deposits are $1.5 trillion).  Requiring 100% reserve backing of checkable deposits was recommended in the 1930s by a group of University of Chicago economists as a way to protect our payment system from the loan default problems being experienced by many banks at the time.  This so called Chicago Plan would remove any risks to checkable deposits, a key part of our payment system, and thus eliminate the need for deposit insurance for such deposits.  Required reserves would continue to earn interest as they do now, but excess reserves would not.  But in addition to strengthening our payment system, adopting the Chicago Plan today would convert existing excess reserves into required reserves and end the debate over whether to further shrink the Fed’s balance sheet.

Adopting the Chicago Plan would prevent banks from on lending our checkable deposits.  At the moment they are not doing that anyway. This raises the question of where banks would get the funds (our savings) to on lend in their financial intermediary role?  In an extreme version of the Chicago Plan (100% required reserves against all deposits and deposit like bank liabilities) all bank lending would be finance by equity rather than debt.  Savers would hold claims on the value of a portfolio of loans as they now do with mutual fund investments and as in some Islamic banking instruments.  Equity rather than debt financed bank intermediation is a more stable structure as a result of shifting the risk of loses (loan defaults) from banks to the ultimate public investors.  The Federal Deposit Insurance Company would stop insuring 100% reserved deposits and its bank resolution functions would be moved to the Office of the Comptroller of the Currency (OCC) in the U.S. Department of the Treasury.

For purposes of requiring a 100% reserve and dropping deposit insurance, a more pragmatic boundary between all deposit liabilities and checkable deposits might include savings deposits (which can generally be shifted into checkable deposits almost automatically) and time deposits with a maturity of less than six months (or maybe three months).  This would add almost $10 trillion dollars to required reserves and would need to be phased in gradually.  The Fed would need to buy an equivalent amount of government securities in order to finance the increase in required reserves without contracting the money supply or bank credit.

It is very desirable to separate our payment system (checkable deposits of one definition or another) from the necessarily risky lending by banks and other financial institutions and make our money (currency and deposits) risk free.  Doing so would allow banks to take whatever risks with investor funds those investors are willing to finance.  This would enable a significant reduction in the government’s regulations of these activities.  “Changing Direction on Bank Regulation” Cayman Financial Review April 2015

[1]Dr. Coats retired from the International Monetary Fund in 2003 and is a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.

Posted in Banks, Money | Tagged , , , , , , , | 2 Comments

Who pays for Uncle Sam’s deficits?

Who pays for Uncle Sam’s deficits?

 

Posted in Debt, trade, Uncategorized | Tagged , , , , , , | 2 Comments

Free Banking in the Digital Age?

By Warren Coats[1]

Introduction

A number of central banks are considering issuing digital currency either in place of the paper currency they now issue or in parallel with it.  The advantages of central bank digital currency (CBDC) over paper currency for the issuer is the much lower cost of supplying and maintaining the currency (printing, storing, transporting, safekeeping and replacing old and damaged notes). For the users, there are the benefits of much greater speed and lower cost of making payments of currency across distances.  The use of paper currency (cash) in economies with proliferating electronic means of payment (Visa, PayPal, Zella, popmoney, etc.) has been and will continue to fall.  In addition, digital currencies can and do extend digital payment services to the unbanked.  This note explores some of the policy issues raised by CBDC, by which I mean digital claims on the currency issued by the official monetary authority, whether directly or indirectly.

Payment with digital currency involves transferring ownership of a claim on the issuer without needing to or providing any information about the payer, in particular without providing information about the payer’s bank account if she has one.  In this respect it mirrors the payment of traditional paper currency.  A primary issue for a central bank when considering issuing a digital currency is whether it should be offered wholesale or retail, i.e., offered only to banks and maybe other financial firms, or offered to the general public.  If a central bank offered CBDC directly to the general public it would transform and greatly expand the role of the central bank and could potentially end the role of commercial banks in the payment system.

Offering CBDC only to banks and other financial firms would offer little that is not already available via central banks’ acceptance of deposits from these entities, which of course are digital.  In fact the distinction between digital currency and traditional deposits is not always clear or important.[2]  Currently Fedwire settles payments between account holders, including government agencies, in domestic and foreign banks licensed in the U.S.  It does not settle USD payments between accounts in non-resident banks and resident banks.  Such payments could occur with CHIPS (Clearing House Interbank Payments System) correspondent banks, but could also potentially be made by the transfer of a central bank digital currency.

If a digital currency is issued to the general public by banks in the two-tier fashion of today’s bank money, in which banks maintain deposits of national money with their central bank to secure the deposits of national money held by banks for the general public, there is an issue of what assets banks should hold or be required to hold against their deposit or currency liabilities to the public.  Digital currency issued to the public by the central bank would have no default risk, whereas digital currency issued by banks or other entities, being a liability of the issuing bank, would have default risks.

It is also possible to permit non-banks to issue digital currency as has been done very successfully in Kenya by a phone company.[3]  Over half of Kenya’s population participates in this so-called mobile phone money service. Public acceptance of a digital currency requires that its claim on central bank money is credible.  Safaricom, the issuer of Kenya’s digital currency, M-Pesa, backs the deposits of participants 100% with Kenyan shilling deposits with banks.  While M-Pesa balances are generally paid from one person or firm to another, they can be withdrawn via an agent at their face value in shilling currency issued by the central bank at any time.

A study issued by the Bank of International Settlements explores issues raised by central bank digital currency (CBDC) more generally.[4]

Background

A review of the free banking era in the U.S. (1837 – 1913) provides a useful framework in which to analyze the options and implications of digital national currencies.  Banks in that period could issue their own U.S. dollar denominated banknotes.  Because banks lend some of the money deposited with them – so-called fractional reserve banking – issuing their own currency when their depositors wished to withdraw cash, was stabilizing as explained below.  The issue of whether CBDC should use block chain (DLT) or centrally administered ledgers will not be considered here as DLT is too expensive and inefficient to take seriously as an option at this time.[5] Project Jasper of the Bank of Canada concluded that: “the versions of distributed ledger currently available may not provide an overall net benefit when compared with existing centralized systems for interbank payments.  Core wholesale payment systems function quite efficiently.”[6]

The report does not exclude the possibility that future versions might overcome existing defects and have net advantages for some applications.

The feature of so called free banking that is relevant here was the ability of commercial banks to issue their own currency (banknotes).  These banknotes did not represent private currencies in the way bitcoin does.  In the case of the United States, all bank issued currency was denominated in US dollars and redeemable for gold (or silver) at its fixed price for the dollar.  Historicallybanknotes were originally created by goldsmiths in post Medieval England – first as warehouse receipts to depositors of cash – and then as a form of lending as an alternative to having the borrower’s account credited.  For an interesting account see the article by Benjamin Geva.[7]

Banks generate most of their income by lending at interest or investing the money deposited with them by the public.  As a result, not all of the money deposited is available to pay out to the depositors should they all want their money back (as cash or by transfer to another bank) at the same time (a so-called bank run).  Only a modest amount of depositors’ money (it is actually the bank’s money once it is deposited) is available in the bank in the form of cash or deposits at the central bank.  These so called reserves must be, and virtually always are, sufficient to satisfy the cyclical (monthly and seasonally) variations in the public’s preferences for cash over deposits.  This system is referred to as fractional reserve banking because the amount of bank “reserves” are less than the amount of their deposit liabilities.  The difference in the amount of deposits and of reserves consists of bank loans and investments in less liquid assets.

In today’s banking systems all banknotes (cash) are issued by a central bank.  Thus when a deposit is withdrawn for cash, the bank’s assets (cash) and deposit liabilities both fall by the same amount.  If a bank does not hold sufficient cash or deposits with the central bank to satisfy these periodic demands, the bank is said to be illiquid.  When banks were able to issue their own currencies (Citibank dollars and Chase dollars) only the mix of bank liabilities changed (from deposits to cash) with no change in their assets.  Their total liabilities and assets remained the same.  This was a very desirable feature of note issuing banks and eliminated the risk of illiquidity from cash withdrawals.  These banks might still suffer illiquidity from deposit transfers/payments to entities with deposits in other banks.

In the free banking era when the public came to doubt the solvency of their bank (loan and investment losses that exceeded a bank’s capital—i.e., when the value of a bank’s assets falls below the value of its deposit and other liabilities) it was pointless to withdraw deposits as the bank’s own banknotes because the bank did not have sufficient assets to redeem them.  Bank runs in such cases would take the form of converting deposit or cash claims on the bank into claims on another, hopefully sounder, bank.  Those who failed to do so before the insolvent bank was closed and liquidated would lose part of their claim, i.e. they would be forced to absorb their share of the bank’s asset shortfall (its negative capital).

Thus a ten dollar bill issued by Citibank and one issued by Chase, being claims on two different banks, could have different values (even if redeemable in theory for the same amount of gold) if the public lost confidence in the solvency of one or the other. Merchants needed to pay attention to whose banknotes they were accepting.

When you pay someone by transferring some of your bank balance to the payee’s bank account (e.g. by writing a check), your bank and the receiving bank must both participate in the same clearinghouse (or have an account with a correspondent bank that participates) enabling their obligations with each other to be settled in central bank money.[8]  This role is now generally performed by each country’s central bank and the deposits that banks keep there are called reserve deposits.  In some countries a minimum amount is required (a reserve requirement) and in others it is fully voluntary but needs to be sufficient for net payments between banks.

While this fractional reserve system worked well most of the time, banks were occasionally hit with unusually large or panic withdrawals that they were not able to satisfy even when they were fully solvent (had positive capital).  A key function of the central banks being established all over the world a century or more ago was to provide temporary liquidity to such illiquid but solvent banks (though it is difficult to evaluate the solvency of a bank in real time—i.e. the soundness of their loans and investments).  Thus central banks were so-called Lenders of Last Resort.

In 1933, in the midst of America’s Great Depression, a group of University of Chicago economists proposed, among other things, that banks be required to hold reserves (cash and deposits with the Federal Reserve) of at least 100% of their demand deposit liabilities (checking accounts).  This is often called “The Chicago Plan.”  If banks’ demand deposit liabilities and their reserve assets are segregated from the rest of their balance sheet it removed any default risk to the public of holding demand deposits at any bank.  Instead of the Chicago Plan, the U.S. Congress enacted deposit insurance to reduce the risk of bank runs.

To review:banknotes issued by banks in the free banking era eliminated the risk of a bank becoming illiquid when its depositors withdrew cash, but imposed on the public the need to judge the solvency of the note-issuing bank before accepting its currency.  The risk of losses on demand deposits remained.  While that risk could have been eliminated with a 100% reserve requirement (The Chicago Plan), it was eliminated for smaller deposits by deposit insurance.

Central banks around the world now have a monopoly on issuing legal tender currency.  This eliminates the default risk of accepting such currency but reintroduces a liquidity risk for banks that promise to convert customer deposits into (central bank issued) cash on demand.  This risk is substantially reduced by central banks’ lender of last resort function.

Structuring Digital Currency

The above considerations can help us evaluate options for central banks wishing to issue digital currencies.  So-called “digital currencies” can take different forms.  “Digital coins” are the closest digital counterpart to paper currency.  Both have unique serial numbers for each unit.  “Tokens” or “claim check centralized digital currency” pass from one owner to another P2P via block chain or central registry and can be redeemed for central bank base money at any time.  “Deposits” function the same as tokens without pretending that they are not deposits.  The distinctions between these are primarily technical and may be of little if any relevance to users.  Thus I will use “digital currency” to refer to any and all of them.

Our two-tiered system for supplying money to the public (central banks issue base money that is their own liability and commercial banks create deposit money fractionally backed by central bank base money) has the very considerable benefit of outsourcing the competitive creation and management of money to many banks.  Banks develop and service their own relationships with their customers from tens of thousands of offices around the country (speaking now of the U.S.).  However, this money creating and payment function performed by banks is also comingled with their lending activity intermediating between savers and borrowers. There are synergies as well as risks from providing both services under one roof.[9]

Should central bank digital currency be provided retail or wholesale?  A central bank could issue its digital currency to anyone who signed up (registered, i.e. opened an account directly with the central bank). As all uses of this digital currency would be between participants in the system, transfer would be simple and instantaneous.  It would be essentially the same as logging into your current bank account and transferring money to another depositor in the same bank.

In addition to the above advantages of speed and simplicity, this central bank retail approach carries the burden of an enormous expansion of central bank staff to interface with the general public in establishing and managing this new digital currency. Equally troublesome is the likelihood, if not certainty of a “digital run” from bank deposits to the central bank’s digital currency.  This would be a permanent shift from banks to the central bank, which would force banks to liquidate a significant share of their assets in order to finance the outflow of their demand deposits into the central bank’s payment system.  The transition would need to be carefully managed. The magnitude of the digital run could be limited by limiting the size of CBDC payments.  This could leave most business payments with the banking system.

There are advantages to a single, monopoly provider of digital currency because payments would take the form of transfers between accounts/participants within the same system (in effect intra-bank).  But there would be the usual disadvantages of monopolies as well (e.g. sluggish technical innovation).[10]  Central banks generally have a monopoly in printing paper currency, but their sale to the public is done by competitive commercial banks.

Central banks could leave the provision of digital cash to banks and other qualifying financial firms.  This would parallel the two-tier system now in place with central bank base money and commercial bank broad money (deposits of the public).  Digital currency would be supplied only by banks, as was the case during the free banking era when individual banks supplied their own currency notes.  Thus there would be many digital dollars (Citibank digital currency, Chase digital currency, etc.).  As with free banking banknotes, each digital currency would be the liability of the issuing bank.  The risk of default for each bank’s digital currency could be eliminated by requiring 100% reserves with the central bank against any digital currency issued and segregating these assets and liabilities from the rest of bank balance sheets. It would also be possible for commercial banks to sell and administer central bank digital currency on behalf of the central bank.  Adoption of a full Chicago Plan (100% reserves for both currency and demand deposits and legal segregation from the rest of the bank’s activities) would fully protect all payment system assets (money) from bank failures. Policies would also be needed with regard to close substitutes for demand deposits such as time and savings deposits.[11] Alternatively the risk could be limited via the equivalent of deposit insurance.

Non Central Bank Digital Currency

Digital currencies issued by commercial banks would eliminate the risk of “digital runs” on bank deposits to the central bank’s digital currency flagged by the BIS in its report cited above.  Non-national digital currencies (or deposits) fixed in value to a foreign currency, to SDRs, or to gold, for example, issued by an entity playing the role of a central bank for that currency (e.g. the BIS) would also minimize the risk of a “digital run” from bank deposits in national currencies.  Such digital currencies could also adopt a traditional two-tier model by which commercial banks issue the digital currency to the retail public. In all cases of multiple, individual bank issued digital currencies, arrangements would be needed (as now) to settle payments from holders of digital currency issue by one bank to holders of digital currency issued by a different bank.  The transfer of deposits from one issuing bank to another on the books of a common institution (the traditional central bank) is the most likely mechanism for settling such payments as is now the case for deposit payments.

In the digital world the distinction between a digital deposit and a digital currency is notional. Both are liabilities of and claims on the bank or other entity that issued them.  Distinctions blur.  In addition, digital currency need not necessarily be issued by a deposit-taking bank. M-Pesa is the digital mobile phone currency version of the Kenyan shilling issued by a trust operated by the Kenyan mobile phone operator Safaricom.[12]  The trust is not licensed as a bank as it does not lend any of the money deposited with it.  One hundred percent of the money deposited with M-Pesa is placed with commercial banks. If these deposits were with the central bank, they would be risk free—an example of the Chicago Plan.

Conclusion

My conclusion from the above considerations is that digital currency should be issued by banks or by entities adhering to the Chicago Plan if and when they prove superior to existing electronic means of payment.  Commercial bank digital currency liabilities should be insured or should adhere to the Chicago Plan segregated from the rest of the bank and thus from any losses the bank’s other activities might suffer.  If bank demand deposits were also 100% reserved, bank digital currency would feature the same stability benefit as was enjoyed in the free banking era by bank note issuing banks without the default risk of that era.  Such digital currency can extend the benefits of digital payments to the non-banked as it has in Kenya and a growing number of other countries.  It is a model also well suited to the issue of global, non-national currencies such as market SDRs or gold backed currency.

[1]Dr. Coats is retired from the International Monetary Fund, where he was Assistant Director of the Monetary and Capital Markets Department.

[2]Michael D. Bordo and Andrew T. Levin, “Central Bank Digital Currency  and the Future of Monetary Policy” Economics Working Paper 17104, Hoover Institution, August 2017. https://www.hoover.org/sites/default/files/research/docs/17104-bordo-levin_updated.pdf

[3]Warren Coats, “The Technology of Money”Cayman Financial Review,January 18, 2012.

[4]“Central Bank Digital Currency,” Bank for International Settlements, March, 2018. https://www.bis.org/cpmi/publ/d174.pdf.

[5]Warren Coats, “Bitcoin, Cybercurrencies, and Blockchain” March 12, 2018. https://wcoats.blog/2018/03/12/bitcoin-cybercurrencies-and-blockchain/

[6]Project Jasper: Are Distributed Wholesale Payment Systems Feasible Yet?Bank Of Canada, Financial System Review, June 2017.  https://www.bankofcanada.ca/wp-content/uploads/2017/05/fsr-june-2017-chapman.pdf

[7]Benjamin Geva, “Banking In The Digital Age – Who is Afraid of Payment Disintermediation?”  EBI Working Paper Series, 2018 No 23, March 23, 2018.  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3153760

[8]In the “good ol days” representatives of all local banks would meet in a room and exchange the physical checks that their customers had written to each other and settling the net differences between each bank via a common correspondent bank.

[9]Warren Coats, “Changing direction on bank regulation”Cayman Financial Review, April 2015.

[10]For an elaboration see Geva, op.cit.

[11]Warren Coats, “The Money Problem-Rethinking Financial Regulation” by Morgan Ricks, Cayman Financial Review April 26, 2017.

[12]op. cit. Coats, 2012

Posted in Economics, Money | Tagged , , , , , , , , , , , , , , | 4 Comments

Review of John Tamny’s attack on Jack Kemp Foundation article

By Dr. Warren Coats

Dr. Coats is retired from the International Monetary Fund, where he was Assistant Director of the Monetary and Capital Markets Department.

In an article titled, “When the Ideas of Thinkers and Great Statesmen Are Perverted,” John Tamny offers what he calls “a semi-brief response” to a Wall Street Journal op-ed by Sean Rushton from the Jack Kemp Foundation, “Monetary reform would rebalance trade.”

Mr. Tamny wastes no time in launching his attack with the following: “Worse were the myriad factual inaccuracies, including a Bretton Woods monetary agreement that took place after World War II. Except that it took place in 1944.”  This is his only valid criticism in his not so brief discussion. As we all know, the Bretton Woods conference was in anticipation of the end of WWII and did not actually take place “after” the war.  Devastating, right?

Mr. Tamny launches his more substantive critic by noting that, “To be clear, all trade balances. Always.” Whether that balance is healthy or not, however, depends on its composition. Mr. Rushton’s article is about that composition. He discusses the implications of the fact that one of the ways in which we pay for what we import is by exporting U.S. dollars. The others are exporting U.S. debt (largely government) and the ownership of American firms and other private assets. Many countries wish to hold our dollars (it is the primary international reserve asset held by central banks) because so much of world trade is priced in and paid for with USDs.

Given all the many factors that determine what we import and export, the global demand for USD as a reserve asset makes our trade deficits larger than they would otherwise be in order to supply (export) those dollars. Tamny correctly notes that “the U.S. has run ‘trade deficits’ for longer than it’s been the United States.” Obviously such deficits were not the result of the world’s demand for U.S. currency. “The U.S. always ran trade deficits precisely because it’s long been an attractive destination for investment.”  In other words, other countries sold us more than they purchased in goods and services (our trade deficit) in order to earn the dollars to invest in the U.S.

But times have changed. Today, and since the U.S. left the gold standard in early 1970, most of the dollars earn abroad from our trade deficits (their surpluses) are invested in U.S. treasury securities. In short, dollars earn abroad via our trade deficits (in addition to accumulating dollars in foreign exchange reserves) are now largely invested in financing our government’s deficit spending. Even Mr. Tamny would not argue that this inflow of investment in the U.S. is contributing to our increased growth and productivity.

On the contrary, Tamny seems to be arguing exactly that. He says that: “we have a so-called “trade deficit” as a country precisely because the U.S. is a magnet for investors the world over. When we “export” shares in American companies that are routinely the most valuable in the world.” He seems to applaud selling our firms to foreigners when our government crowds out the domestic financing of our industries in order to finance our irresponsible government deficits.

Mr. Tamny is not content to label Mr. Rushton’s analysis false. He calls it “obnoxiously false” and “comically false.” Unfortunately these labels apply more accurately to Mr. Tamny.

Rushton claims and provides evidence that U.S. fiscal discipline weakened when Nixon closed the gold window. “No longer bound by fixed exchange rates and dollar convertibility, the U.S. government’s fiscal discipline broke down.” Obviously other political and demographic factors have also contributed to the alarming increases in U.S. deficits, but no longer needed to defend the dollars exchange rate removed an important constraint. To rebut Rushton’s claim and data, Tamny notes that our deficits were even higher during WWII. Truly. I am not making this up.

Turning to the dollar’s role as an international reserve asset, Mr. Tamny notes that Mr. Rushton “argues that thanks to ’high global demand,’ the ’dollar’s international position is always stronger and U.S. interest rates are lower than they would be otherwise.’” Added to all of the other factors influencing the composition of our external financial flows (our balance of payments), the world’s demand for dollars in their foreign exchange reserve holdings must increase their trade surplus (our trade deficits) or their investments in the U.S., either of which will appreciate the dollar’s exchange rate and lower interest rates in the U.S. relative to what they would other wise be. Mr. Tamny doesn’t get this. He says that Mr. Rushton “wants us to believe that a devaluation of the income streams paid out by the U.S. Treasury actually made them more attractive to investors.” I don’t really know what he means by that either.

Another of Mr. Tamny’s “obnoxiously and comically false,” or perhaps merely nonsensical statements is that: “if we ignore the obvious, that the sole purpose of production is to import as much as possible….” If he is relating production to imports, he presumably means producing for export. What we import must be paid for one way or another, i. e., by exports of goods and services, U.S. dollars for reserves, U.S. government debt, or ownership of U.S. firms.

I leave it to the reader to sort out what Mr. Tamny might mean by: “the path to a lower ’trade deficit’ is only possible if we’re willing to accept being much poorer.”

As a parting shot, Tamny mischaracterizes the views of the late Jack Kemp. Here’s what Kemp actually said, speaking in 1987:

“Why do we keep having these cycles? I believe it has to do with the burdens and privileges of the dollar’s unique international role. First, the extra demand for dollars puts a premium on their value that makes American exports less competitive. And on world markets, only a few cents means the difference between a sale and a loss. This increases our merchandise trade deficit.

“Second, the dollar’s role helps fuel Congress’s deficit spending. Foreign central banks buy U.S. Treasury securities to hold as reserves and to keep their currencies from rising—almost $100 billion in the last year and a half. This amounts to a special ‘line of credit’ that lets Congress spend resources that would otherwise be used to farm or manufacture for export. President Reagan used to say that to get Congress to spend less you have to reduce its allowance. Well, we may have reduced its allowance but we haven’t taken away its charge card. That’s one reason why every tax dollar is spent without cutting the deficit.

“Trying to compete in world markets under these conditions is like trying to run a race with a ball and chain around your ankle. We face a constant choice between giving in to pressure to let the dollar fall at the risk of inflation, or keeping interest rates high at the expense of a trade deficit and growing pressure for protectionism. This dilemma will continue until we stabilize the dollar, end the inflation/deflation cycle, and bring down interest rates with the right kind of monetary reform.”

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