Month: May 2023

The Debt Deal

CNN reported today on the compromise bill to raise the Federal debt ceiling agreed between Biden and McCarty, saying that:” The Congressional Budget Office estimates the bill would reduce budget deficits by $1.5 trillion over the next 10 years, and reduce discretionary spending by a projected $1.3 trillion from 2024 to 2033.”

Language can be tricky. Debt and deficit are not the same.  Reducing projected spending need not mean a reduction in actual spending. In fact, the package agree to by Biden and McCarthy will continue to increase the Federal debt (though at a slower rate than was proposed initially by Biden) and all categories of spending will continue to grow.  Not only will they continue to grow, they will be growing from the abnormally high levels reached during the COVID pandemic.

If we really want all of these expenditures, we should, and will ultimately need to, raise taxes to pay for them.  But do all of them pass the cost benefit test? Do all of them contribute to American wellbeing?

One Republican blind spot is defense spending (which, by the way does not include foreign aid to, for example, Ukraine). The defense budget for 2023 is 9.8% higher than in 2022 and is projected in the Biden/McCarthy package to continue to grow over the next two years covered by that deal. Our huge defense budget has resulted from (or encouraged?) American military adventurism that does not contribute to our security.

The Dollar (again)

Any country selling its goods abroad could price and collect payment for them in its own currency. Foreign purchasers would have to buy the sellers currency in the foreign exchange market (a whole nether story) in order to make such payments.

To communicate with each other they could also learn each other’s language. To communicate with everyone in their own language would require learning 7,000 languages. The economy of everyone adding English as a second language to their own is self-evident.

Rather than each trader dealing with several hundred currencies, there is huge economy in everyone dealing in one intermediary (so called vehicle) currency for pricing and payments of their cross-border transactions. But what currency?

When an exporter gives up pricing its products in the currency it pays its workers, it takes on a valuation risk. The choice of its invoicing currency and currency of payment needs to be attractive to potential buyers and of minimal risk to itself. The currency needs to have a relatively stable value for a large number of goods. The U.S. economy is large, and its goods are priced in dollars, which has a relatively good track record of price stability.

But to pay for imports with someone else’s currency the importer must have some of it. He must either take the risk of buying it in the foreign exchange market at whatever its current exchange rate might be or keeping some in reserve. Keeping a reserve of the international pricing and payment currency requires having safe assets with stable values in that currency, with deep and liquid markets in which they can be bought and sold. Currently the US dollar wins hands down. The Empire and the Dollar – Warren’s space (wcoats.blog)

The militarization of the dollar to serve U.S. foreign policy objectives increases the risk to others of holding and using dollars. How much that potentially undermines the dollar’s reserve currency status depends on how broadly the foreign policy objectives of the U.S. are shared and how well alternative currencies measure up to the value and market advantages of the dollar.

Resolution of First Republic Bank

JPMorgan Chase’s purchase of First Republic Bank appears to be a standard purchase and assumption resolution of a failing bank. The Federal Deposit Insurance Corporation (FDIC) has organized hundreds of such bank resolutions there by painlessly purging bad banks for the banking system. The only mistake in my view was selling it to the country’s largest bank.

Purchase and assumption resolutions involve the simultaneous purchase of a failing bank’s good assets and the assumption of its deposit liabilities by a good bank and putting what’s left into bankruptcy (wiping out its shareholders and some or all of its corporate debt). Its the risk of loss to shareholders that provides the market scrutiny of bank risk taking. “Institutional and Legal Impediments to Efficient Insolvent Bank Resolution And Ways to Overcome Them”

Money (currency and demand deposits) should not be at risk of a bank failure. Depositors should not need to evaluate the safety and soundness of the bank they chose to hold their money in. So the FDIC insures deposits up to $250,000. But all deposits in the last three banks to fail were made whole whether insured or not and there is talk that all deposits should be explicitly (rather than just implicitly) insured. Central Bank Digital Currency (CBDCs) would provide such total protection to those holding it (retail CBDCs would be issued/administered by commercial banks and fully backed by an equivalent amount at the central bank).

Public “runs” on banks in order to move vulnerable deposits to cash or a safer bank, result from the fact that banks can fund long term loans with callable deposits. They can lend your deposit to someone buying a house with a 30-year mortgage. This works as long as banks keep enough cash or quickly liquidated assets on hand to cover any deposit withdrawals their depositors might want to make. An alternative to deposit insurance for all deposits is to isolate demand deposits from bank lendable resources by requiring that they be 100% back at the central bank (as with CBDCs) and not available to cover any losses on other bank activities.

It is time to take so called narrow banking (or The Chicago Plan) seriously. CBDCs are the natural vehicle for this restructuring of our money and credit systems.  “Protecting bank deposits”