Category: Banks

Should the State mandate or advise?

It depends of course. But in America, which was established to empower each individual to make their own decisions, the state should only regulate those individual activities that might harm others such as violating property rights. This attitude presumes that each of us cares more about our wellbeing than does anyone else and know better how to achieve it taking account of our differences in tastes, interests, and risk preferences. It has resulted in a society of more prosperous and happier members.

This can be contrasted with the view that the average person is not intelligent enough or self-motivated enough to maximize their potential and needs to be guided by smarter, wiser people.

A society in which each individual enjoys the maximum freedom of choice hardly means that the government has little or no role in our wellbeing. In addition to providing public safety, shared institutional and physical infrastructure development, and the adjudication and enforcement of contracts (the rule of law), government can contribute to the provision of the knowledge to help inform the individual choices we each make. I want to review two very different areas of government involvement that have reflected the above conflicting attitudes of the government’s best role—monetary policy and public health policy.

Section 8 of the US Constitution gives the federal government the power “To coin Money, regulate the Value thereof,…” Our twelve Federal Reserve Banks and the Board of Governors of the Federal Reserve System carry out that mandate via a system of market determined prices of goods and services and an inflation target of 2%. While I would prefer a monetary policy in which currency was issued or redeemed at a fix price for a hard anchor (traditionally gold) in response to market demand (currency board rules), the Fed has behaved very well within its inflation targeting regime over the past two years (after keeping its policy interest rate too low until two years ago).

A successful inflation targeting policy requires keeping inflation expectations anchored to the target (2% in the US) so that economic wage and price decisions are made in light of that expectation. But todays’ policy actions are only fully felt over the next year or two (what Milton Friedman called “long and variable lags” in the effects of policy). Federal Reserve policy is implemented largely by setting the rate at which it supplies the money it creates to the market. If it sets that rate below the so called neutral rate, it must supply money to keep the rate low. If it sets the Fed Funds (and related) rate above the neutral rate, it must absorb money from the market to keep the rate high. Setting its policy interest rate is the lever by which it controls the rate at which the money supply grows. Each Federal Reserve President and Governor must evaluate all available information about economic activity most likely over the next one to two years and determine in like of that what monetary growth is most likely to result in 2 percent inflation over that period. If market participants believe that the Fed’s choice is most likely to result in achieving the stated target in the future, their wage and price decisions will anticipate that inflation and thus bring it about.

It should be obvious that if Fed officials are honest it attempting to achieve their target and explain as fully as they themselves understand the prospects to the public and the public has confidence in the Fed’s commitment, this is the best that can be done. In fact, the Fed deserves high marks for such transparency in our uncertain and evolving world. Each person and firm make their own forward looking decisions in light of their best guesses of future conditions. The Fed’s guidance is the best and most the Fed can do to bring or keep inflation on target.  

When governments don’t trust “the people” to make their own decisions (they are not smart enough or are two lazy or whatever), they must mandate the “proper” behavior. Consider our approach to the public’s health during the Covid pandemic. Whether government should offer advice and provide information on what is known about a disease such as Covid-19 is complicated by the fact that we should not be free to expose others to communicable diseases. In the case of Covid the government’s understanding of its nature and best protection grew and evolved over time. But the US public heath agencies lost credibility from the beginning by telling well intentioned lies.

“In early March 2020, Dr. Fauci said ‘there’s no reason to be walking around with a mask.’ In the same interview he said people could wear masks if they liked, but they wouldn’t get perfect protection, and it would further pinch what at the time was a short supply of masks for doctors and nurses.” PolitiFact | Marco Rubio says Anthony Fauci lied about masks. Fauci didn’t.

But more to my point, CDC officials thought that their shut down and isolation mandates would be more effective than allowing individuals to determine how best to protect themselves and others. The subsequent evidence suggested that they were wrong. Any benefits were outweighed by very substantial costs. Read the following articles and studies for examples.

Scott Atlas on Lies

“I explore the association between the severity of lockdown policies in the first half of 2020 and mortality rates. Using two indices from the Blavatnik Centre’s COVID-19 policy measures and comparing weekly mortality rates from 24 European countries in the first halves of 2017–2020, addressing policy endogeneity in two different ways, and taking timing into account, I find no clear association between lockdown policies and mortality development.” https://academic.oup.com/cesifo/article/67/3/318/6199605?login=false  

“The most restrictive nonpharmaceutical interventions (NPIs) for controlling the spread of COVID-19 are mandatory stay-at-home and business closures. The most restrictive nonpharmaceutical interventions (NPIs) for controlling the spread of COVID-19 are mandatory stay-at-home and business closures. Given the consequences of these policies, it is important to assess their effects. We evaluate the effects on epidemic case growth of more restrictive NPIs (mrNPIs), above and beyond those of less-restrictive NPIs (lrNPIs)….

“After subtracting the epidemic and lrNPI effects, we find no clear, significant beneficial effect of mrNPIs on case growth in any country…. While small benefits cannot be excluded, we do not find significant benefits on case growth of more restrictive NPIs. Similar reductions in case growth may be achievable with less-restrictive interventions.”  January 2021 study

Worrying About Mandates and Lockdowns as Delta Variant Hits Unvaccinated Californians

FedNow

The Federal Reserve has launched FedNow, which executes instant payments 24/7. What does that mean? When I led IMF technical assistance missions to the former Soviet Union (Kazakhstan, Kyrgyzstan, and Moldova) and to post conflict countries (Afghanistan, Bosnia and Herzegovina, Iraq, Kosovo, Serbia), the payment experts on my teams referred to the Clearing and Settlement of payments. I never fully understood what that meant. “Federal Reserve FedNow Payments”

The key to understanding the meaning of “clearing and settlement” is to understand the deference between the authorization to make a payment and actually debiting and crediting bank accounts to execute the payment. When I pay from my bank account to yours, mine is debited and yours is credited. My bank executes the debt and credit if your account is also at my bank. If not, my bank debits my account and “sends” the money to you at your bank via an intermediary (usually the central bank) at which both my bank and yours have accounts that can be debited and credited. When my account has been debited and your credited, the payment has been “settled.”

The clearing part of clearing and settlement has to do with communicating the authorization to our banks to execute the debit and credit. It refers to the messaging systems that authorize the actual settlement of a payment. This is what FedNow is about (as is the well-known SWIFT messaging system for authorizing cross border payments). It will replace paper checks or electronic payments such as Venmo, Zelle, PayPal, etc. that now authorize our banks to debit our accounts and credit the accounts (somewhere) of the payees.  “Econ-101-Retail Central Bank Digital Currency-CBDC”

I haven’t mentioned what it is that is being paid. If it is from my bank account, it is US dollars (ultimately a claim on the Federal Reserve Banks of the U.S.). Every currency (dollars, Euros, bitcoin) has its system of clearing and settlement.  And of course, there are markets for exchanging one currency for another (FX markets).

FedNow is a messaging system that authorizes settlement in seconds 24/7 that replaces (or supplements) systems that now can take days.

My Travels to Kosovo

Post-World War II Yugoslavia consisted of the federation of Bosnia and Herzegovina, Croatia, Macedonia, Montenegro, Serbia, and Slovenia. Though its residents were predominantly Albanian, Kosovo was a province of Serbia. During part of its post-WWII history, Kosovo was relatively autonomous within Serbia, while part of the time it was ruled directly by Serbia. Frictions between Albanian and Serbian Kosovars escalated in the 1990s into armed conflict, which ended only with the North Atlantic Treaty Organization’s (NATO) bombing of Serbian Army forces in Kosovo and Serbia proper from March 24 to June 10, 1999.

Following the June 10 end to the fighting, the United Nations Mission in Kosovo (UNMIK) took over the governance of a ruined Kosovo. Among the normal needs to be restored most urgently (food, water, electricity, etc.), was the ability to pay for things. Kosovo’s banks were closed, and its financial and monetary connection with Belgrade and the rest of the world was not functioning. There was an urgent need to revive Kosovo’s ability to make payments while also determining what sort of financial systems to build for a future, more integrated with the rest of Europe.

If only by using it, Kosovars themselves had answered what currency they wished to use—the German mark (DM). But arrangements were urgently needed for how to acquire and maintain DM banknotes and coins (I remember well the tattered currencies in post-war Bosnia and Iraq), and to adjust the procedures of banks and other money handlers to the use and safekeeping of DM, rather than the Serbian dinars previously supplied by the National Bank of Serbia.

The International Monetary Fund (IMF) joined with the United Nations, the World Bank, the United States Agency for International Development (USAID), and other international organizations to provide the needed emergency humanitarian assistance and to help in the rebuilding of a potentially transformed economy. I led the IMF missions to address the money and banking aspects of this effort. The revival and/or restructuring of Kosovo’s monetary capacities needed to be achieved in days and weeks rather than months and years. This was a tall order.

My latest book documents our work to revive and transform Kosovo’s monetary system and some of the challenges and adventures we encountered in the process. Most of us only see the public face of our payment systems (currency, ATM machines, credit cards). In recounting our experiences in restoring and transforming Kosovo’s payment system, I will endeavor to pull back the curtain a bit to expose what is behind and generally out of sight.

If this interests you, you can buy the paperback or kindle versions here. https://www.amazon.com/s?k=Warren+Coats&i=stripbooks&crid=10ON15E99H8X6&sprefix=warren+coats%2Cstripbooks%2C63&ref=nb_sb_noss_1  This will also give you the opportunity to rate the book. I hope that you will enjoy it.

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”

Protecting bank deposits

Following the collapse of Silicon Valley Bank last week there has been considerable discussion about whether and how the regulatory regime might be strengthened (or actually more effectively implemented) to prevent such collapses (yet again) in the future. Raising deposit insurance coverage to 100% of all deposits is being suggested (and was provided ad hoc to SVB and Signature Bank this week). Econ 101: SVB and bank runs – Warren’s space (wcoats.blog)

Insuring all deposits and adopting the Chicago Plan represent two very different approaches to removing all risk of loss to depositors and thus any incentive to run from a bank. In the search for regulatory or market checks on excessive bank risk taking or poor management, the expectation that depositors would carefully monitor the behavior and condition of their banks was never realistic. Thus, removing any financial incentive for such due diligence by raising deposit insurance to cover all deposits would have little to no impact on bank behavior. Such scrutiny by bank shareholders and managers is much more realist and thus important. US bank bankruptcy procedures do not spare shareholders, who in the case of SVB have lost everything. However, more might be done to impose losses on managers of insolvent banks.

Following the bankruptcy of SVB considerable attention has rightly focused on the speed with which facts or rumors of a bank’s weakening financial condition can spread over the Internet. What might have taken weeks as depositors began to line up outside their banks to withdraw their deposits while the funds lasted, now takes minutes, dramatically accelerating the speed with which a bank must try to liquidate enough of its assets to fund the withdrawals.

Full deposit insurance and the Chicago Plan of 100% reserve banking (deposits at the central bank, which are always safe and instantly available) eliminate any incentive for bank runs. But the difference between them deserves more attention. The full deposit insurance approach puts the cost of bailing out the depositors of a failed bank on the rest of the banking system (on the “good” banks) who finance the insurance fund.  The cost of the Chicago Plan, if indeed it is a cost at all rather than a benefit, is the need for banks to fund their credit operations with equity or long-term debt, rather than with potentially volatile deposits. We should move to the Chicago Plan and fully separate money from credit.

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Econ 101: SVB and bank runs

What is a bank run and how can we prevent them? A bank run, as I am sure you all know, is a rush by depositors to withdraw their deposits for fear that the bank will not have the money to give them. But there is a lot to unpack there in order to understand what is going on and how runs might be prevented.

It is important to understand the difference between debt and equity—between lending a specific amount of money with specific terms and investing an amount of money in exchange for a share of the earnings (or losses) of the recipient. When you buy shares in a company, it has no obligation to return your money. If you no longer want to invest in that company, you can sell your shares to someone else or the company might, at its discretion, buy them back. Its failure to “return” your money cannot be the cause of a company’s bankruptcy (take over by creditors to collect what the company is no longer able to return).

The deposits that we make in our banks are a special case of debt finance of whatever the banks do with our money. As we know, they lend much of it to people and companies for one thing or another and invest some in hopefully safe assets like Treasury bills and keep a tiny bit on hand for when you need cash. But the deposit contract says that you have the right to withdraw (or pay to someone else) any or all of it whenever you want to. Thus, banks must keep sufficient liquid assets in order to satisfy such withdrawals by selling them in the market when you demand your money back. The Federal Reserve, our lender of last resort, also has facilities for lending to banks needing cash against the collateral of bank assets.

The difference between illiquidity and insolvency is critical as well. A bank is solvent when the value of its assets match or exceed the value of its liabilities (such as your deposits). But having sufficient good assets doesn’t mean that that bank can always honor your deposit withdrawal demand. That is a question of liquidity. Does the bank have enough of its assets backing your deposit in forms that it can pay out immediately (cash in its vault, deposits at the Federal Reserve that it can transfer to another bank or use to buy cash, or assets it can quickly sell such as t-bills, or credit lines with other banks or the Fed, etc.)?  “The difference between bank liquidity and capital” Thus, even a solvent bank (positive capital) might fail to honor your withdrawal demand if it doesn’t have sufficient liquid assets. “The big bailout-what next?”

Usually, a bank becomes insolvent when more of its loan assets default than the bank has capital to cover such losses. But as we will see in the case of Silicon Valley Bank, insolvency can also result from a decline in the current market value of a “good” asset.  When depositors suspect that their bank might be insolvent, they will withdraw their money while they still can. This tends to use up the bank’s liquid assets compounding the risk of default. As the word spreads the classical bank run takes off (electronically these days rather than long lines outside the bank as in the old days).

The SVB, which specialized in financial services to start-ups and technology companies, enjoyed a huge increase in its deposits over the last four years, increasing from $49 billion in 2018 to $189.2 billion in 2021 dropping back to $175.4 billion at the end of 2022. It invested most of those deposits in “safe” long term government and similar debt. While the default risk for these assets was negligible, the risk of a loss in current market value if market interest rates increased was high. No one will pay the face value of a 3% ten-year bond while current market rates for the same maturity are 4%. The rapid increase in interest rates as the Federal Reserve reversed money growth to fight inflation tanked the current market value of a large share of SVB’s assets making it impossible for it to come up with the cash depositors might demand if they “ran”. That is how runs work. On March 10 SVB was put into receivership.

The original sin of modern banking is financing long term loans/investments with money (demand and savings deposits). Islamic banking, what uses equity investing, is wiser in this regard. During the Savings and Loan crisis in the U.S. in the 1980s and early 90s (financing mortgages with deposits) more than 1000 S&Ls failed when interest rates increased. But in fact, the U.S. bank regulation regime has some good features. While bank risk taking is subject to many, often costly, regulations, the ultimate check on risk taking comes from the knowledge of bank owners that they will lose their entire stake if their bank becomes insolvent. The Federal Deposit Insurance Corporation (FDIC), which oversees America’s deposit insurance scheme, has developed effective bank bankruptcy and resolution procedures that allow it to take over and resolve insolvent banks with barely a ripple. A favorite tool is the so-called purchase and assumption transaction by which a healthy bank buys the assess of the insolvent one and assumes its liabilities (deposits), usually over a weekend. Thousands of insolvent banks have been resolved by the FDIC in the last fifty years.  See “Institutional and Legal Impediments to Efficient Insolvent Bank Resolution and Ways to Overcome Them” by Warren Coats and Arno Liuksilo “Warren Coats-17”

Most bank depositors pay no attention to the financial condition of their bank because their deposits are insured against losses, which until last week had been raised to $250,000. But the government has now implicitly extended such insurance to all deposits via accounting and other tricks, thus removing any remaining check on bank risk taking from all depositors. On Monday, President Biden announced that no depositors in SVB (and Signature Bank of New York) would lose any of their deposits.  Following the banking crisis of 2008, the Dodd-Frank law further strengthened financial sector regulations. The most important and helpful provisions of this 2,300 page law provided for significant increases and strengthening of bank capital requirements.  

The overuse of debt rather than equity financing is a more general weakness in our economy. The IRS should stop subsidizing it. Interest on borrowing is deductible from taxable income while dividends on equity financing are not. While increasing bank capital makes them less run prone, a simpler and easer to regulate approach is to remove the cause of runs all together by eliminating any risk that your bank can’t honor its obligation to return your money on demand. Another few thousand pages of laws and regulations might catch the last mistakes (though it is hard to see why regulators didn’t address the obvious duration risks taken by SVB), but there is an easier, less costly solution. Bank failures result from the mistakes of banks (their owners and managers) and the failure of depositors to more carefully evaluate the soundness of the bank in which they deposit their money. But depositors have little competence to evaluate bank soundness, and why should they be expected to?

Money (bank deposits) should be fully separated from credit. Deposits should not finance loans. Those financing investments should share in its risks (and rewards) via equity financing. “More than decade ago Professor Kotlikoff and [John Goodman] proposed “limited purpose banking” in The New Republic and in Investment News. The idea is that credit market institutions should be intermediaries between savers and investors and should not themselves use depositors’ money to make risky investments.”

When we deposit money in banks for safekeeping and making payments there should never be any doubt about the bank’s ability to return it on demand and thus no reason to “run” on the bank to protect our deposits. This is the essence of the Chicago Plan which would replace so call fractional reserve banking with 100% reserves (deposits at the central bank). When my bank deposit is backed totally by my bank’s deposits at the Fed, I would know with certainty that they were 100% safe and instantly available.  The “Chicago Plan” and New Deal Banking Reform | Levy Economics Institute (levyinstitute.org) Narrow banking schemes have a similar motivation. “A proposal for the feds balance sheet”

Econ 101: Moving money abroad

The Washington Post published an article this morning titled “THREE DOZEN TYCOONS MET PUTIN ON INVASION DAY. MOST HAD MOVED MONEY ABROAD.”“Offshore Putin Russia Oligarchs Pandora” It said things like “many of them had been moving their wealth out of the country for years,” and “The money often ends up offshore.” While where income is claimed is important for tax purposes, which is another interesting and complicated story, the abandon with which this story discusses moving wealth around drives us economists up the wall.

Wealth can be physical (factories, stores, etc.) or human (the knowledge or skills of people).  Financial wealth, such as money, is a claim on physical or human wealth. People can move abroad, and many skilled Russian’s are doing so. Moving physical capital abroad is more difficult if even possible. A yacht built in Russia can be sailed off to another country, but not a shopping mall. What this and similar articles generally mean by moving wealth abroad, is, as the headline states, moving money abroad. This is often done to minimize taxation, which is usually based on where income is recorded. “The corporate income tax” That is an interesting subject of its own but not my focus today.

How do people “move money abroad?” Money is rarely moved in suitcases anymore, and a bag full of rubles can’t be spent abroad in most places anyway.  So, let’s take a deeper look at what is really happening when Russian tycoons (or anyone else) “move money abroad.”

The easiest example is when Russian exporters are paid in foreign currency (generally US dollars). If the exporter has a dollar account in a bank abroad (in a US bank to keep it simple) the payment for his export can be deposited directly there by a debit to Shell Oil’s bank account and a credit to the Russian exporter’s US bank account via the normal interbank transfer process. He can hold it there or buy US treasures or other US financial assets. His money is moved abroad by moving (selling) his goods abroad and keeping the payment abroad. This helps explain why Russia is insisting that German and other buyers of its oil must pay in rubles.

To pay for oil or any other Russian export with rubles the foreign buyers must first buy rubles in the foreign exchange market. The increased demand for rubles increases its exchange rate (or keeps it from falling as Russian importers sell rubles for dollars to pay for imports). Russia has made the process of paying dollars then buying rubles simple and almost automatic, but critically the Russian exporter receives ruble. Normally Russian exporters would convert dollar payments into ruble with which to pay for their workers and local suppliers, etc. But by keeping the dollar payment abroad, they have effectively “moved money abroad” by shipping goods (and services) abroad.

If a tycoon’s income/wealth is local (in rubles), and he wants to move it abroad, he can’t just write a check (or SWIFT payment order) to deposit X amount of money in his account with the Bank of America. The funds in his local bank, which will be in rubles, will need to be exchanged for dollars in the foreign exchange market. He (his bank) will deposit his ruble in the ruble account of the seller of the dollars and will receive those dollars in his Bank of America account in the U.S. If the supply of dollars to the foreign exchange market are not being supplied as the result of Russian exports, the increased demand for dollars will depreciate the ruble (increase the ruble price of a dollar). With a balance of imports and exports the ruble/dollar exchange rate should be stable. But a net increase in the movement of money abroad would depreciate the ruble. In short, underlying the movement of money abroad, there is a net movement of goods (exports minus imports) abroad.

If there was a sudden increase in money being moved abroad from Russia (often called capital flight) the ruble’s exchange rate would depreciate and the cost of imports would thereby increase.

Econ 101:  How to help Afghans?

The world is rightly looking for ways to help Afghans without helping the Taliban (until or unless the Taliban forms a government the world is willing to recognize). Washington Post: “How to help Afghans without aiding Taliban”  In this Post article Anthony Faiola states that “The biggest problem isn’t a lack of food. Rather, it’s the disappearance of what had been the lifeblood of the Afghan economy — Western cash.” This mischaracterizes the problems of Afghans thus confusing our understanding. In this note I attempt to clarify the “cash” aspect of Afghanistan’s problems.

But first there is no escaping the fact that the cut back of foreign aid is reducing the income (and the goods that income buys) available to Afghans. Mention is often made of the approximately 10 billion US dollars of the Afghan government’s funds frozen in deposits abroad. These funds cannot be used until a new Afghan government is recognized with the authority to claim them. But these funds are not part of the lost revenue to the Afghan government. They are the wealth–the previous income saved–of the government (whoever that will turn out to be). The savings that we accumulate from our incomes for retirement or whatever is our wealth not our current income (though it can be drawn on to augment current income).

In recent years (prior to the Taliban take over) the Afghan government’s operating expenditures were 16 to 18% of Afghanistan’s GDP while its domestic revenue was 12 to 14% of GDP. The balance of its financing plus all development expenditures were from donors. The hope is that squeezing the Taliban “government” financially will add to the incentives for them to quickly form an inclusive government meeting international norms of human rights. Unfortunately, it is not possible to shut off the flow of funds to the government without also starving the Afghan people.

While the Ghani government has been replaced (temporarily) by Taliban leaders, the institutions (ministries and agencies) of government remain, but with new management. Of the government’s operating expenditures roughly 80% was for wages and salaries. Thus, the government could more or less finance its wage and salary expenses from its own domestic revenue without donor support. Indeed, all salaries have been and continue to be paid in the central bank (Da Afghanistan Bank — DAB) and presumably in the other government ministries as well, albeit with delays. However, the real value of these incomes is being reduced because of increased inflation (an indirect form of taxation). DAB and other government agencies have largely stopped providing economic and financial data since the Taliban take over.  IMF First-Review-Under-the-Under-the-Extended-Credit-Facility

None the less, freezing Afghanistan’s deposits abroad (DAB’s foreign exchange reserves held abroad) has created monetary problems within Afghanistan because of the inability to import the cash (dollar banknotes) on which the economy depends. Afghanistan remains a largely cash economy. Most payments are made in cash. Though inflation has been low in recent years (generally 2-4%), inflation in earlier decades was relatively high and thus Afghans held and transacted in US dollars quite extensively. Around 70% of bank deposits are in dollars. The availability of USD banknotes for local payments is thus very important. These were mostly supplied by the New York Federal Reserve Bank from the dollar deposits that DAB maintains there (and now frozen).

Prior to the Taliban takeover, the normal operation of DAB’s monetary policy consisted of receiving US dollars from the government (largely from donor grants) and depositing the equivalent value of Afghani in the government’s accounts. The government disbursed these Afghani to its employees in wage and salary payments (generally by electronic deposits to employee bank accounts). Without offset, the resulting creation and injection of these Afghani would be inflationary. DAB drains (buys back) this excess base money by auctioning some of the dollars it received from the government (sufficient to stabilize the dollar exchange rate) and capital notes of DAB. The government’s deposits of dollars with DAB took the form of credits to DAB’s dollar account with the New York Fed. From these deposits DAB pays the Federal Reserve to fly USD banknotes to Kabul as needed for DAB’s dollar auctions.

In mid-April 2021, when the U.S. announced its intention to withdraw the rest of its military personnel by September, an increased outflow of dollars by Afghans wanting to protect their wealth put the Afghani exchange rate under pressure. Acting DAB Governor Ajmal Ahmady (his appointment was never approved by Parliament) increased dollar auctions to stabilize the exchange rate. “Afghan central bank drained dollar stockpile before Kabul fell” As the amount of dollars in its vaults ran down, it used USD banknotes that it held on behalf of banks (approximately $700 million USD). The delivery of additional cash from New York expected in July never arrived and DAB’s balances at the New York Fed are now frozen until a new government is recognized so that no more dollar cash can be purchased from the Federal Reserve by DAB.

As an aside, I was surprised during a 2009 visit to Zimbabwe—as part of an IMF team following Zimbabwe’s dramatic hyperinflation during which it dollarized—to learn that there was an active private market in dollar banknotes supplying Zimbabwe from South Africa:  “Hyperinflation in Zimbabwe”

In the days just before and after the American evacuation in August 2021 public demands to withdraw dollar cash intensified but DAB had largely used up the dollars in its vaults (both its own and those held for banks). In response, on August 14 DAB imposed limits on the amounts that could be withdrawn each day. This fed public concern that their banks were running out of dollar banknotes and triggered runs on the banks. DAB was even running low on Afghani banknotes, which might have replaced dollars. Without access to its deposits abroad DAB is unable to purchase additional dollar cash nor pay for printing additional Afghani. For a largely cash and heavily dollarized economy this drying up of cash liquidity is very disruptive and the basis of the statement that people can’t buy the food that might be available.

In addition to the cash shortage, Afghans are also lining up to withdraw their deposits out of concern for a possible bank failure. Aid cut offs and civil strife have damaged many firms resulting in arrears on their bank loan payments. This threatens to push bank illiquidity into insolvency. Even if DAB had USD and AFN cash to lend or sell to banks with fully performing loans, DAB is currently unable to buy or lend against these illiquid bank assets. Moreover, the Office of Foreign Assets Control (OFAC) of the U.S. Treasury has sanctioned payments to many Afghan entities and activities blocking many payments to and from abroad by Afghan banks and uncertainly about the application of the sanctions regime has made banks overly cautious about executing payments for their customers.

UN and other aid organizations have experience in other countries with delivering wages and other payments to targeted recipiences (teachers, healthcare workers and potentially even government employees) without the funds passing through the government’s hands. This approach is needed and is being developed for use in Afghanistan. OFAC sanctions are being modestly relaxed and UN and other aid agencies have begun funding the importation of dollar cash for humanitarian assistance projects. The use of digital mobile phone payments, such as M-Paisa and HesabPay, should be promoted and exploitation to the extent possible.  “Use of mobile phone payments” The United States needs to and has been gradually relaxing its payment restrictions to make this possible.

The Taliban leadership needs to take urgent steps to establish a new inclusive government that can and will be recognized internationally thus unfreezing Afghanistan’s (and DAB’s) deposits abroad and eliminating its cash shortage and restoring development assistance. In the meantime, in addition to the urgent need for humanitarian assistance that bypasses the Taliban, the New York Federal Reserve, or any other doners, should consider a loan to DAB to finance immediate shipments of dollar banknotes to Kabul. Da Afghanistan Bank Law adequately protects the central bank from government interference in its conduct of monetary policy and bank supervision. As a condition for restoring USD currency shipments to DAB, the Federal Reserve (and the UN) should obtain an agreement from the Taliban government to fully respect that law and appoint qualified people to its Supreme Council and Executive Board.

Until Afghanistan has a proper government, and its economic development can resume, Afghans, many of whom are very poor to begin with, will suffer unnecessarily depressed incomes. The lack of cash is adding a further, tragic, and quite unnecessary disruption to the lives of a long-suffering people. This can be and should be fixed urgently. Any such assistance will somewhat reduce the financial pressure on the Taliban, but a total financial squeeze on the government will fall on the people of Afghanistan as well.

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I worked in Afghanistan as a member of the IMF program and technical assistant teams from January 2002 until mid 2015. I am grateful to Syed Ishaq Alavi for his insights and comments on this article. Mr. Alavi was Advisor to the governor of DAB from 2010 to early 2013, Director General Monetary Policy Department of DAB from early 2013 to mid 2018, and advisor to the Executive Director of the International Monetary Fund for Afghanistan, Algeria, Ghana, Iran, Libya, Morocco, Pakistan, and Tunisia from June 2018 to August 2020. For the sake of their security, I am not naming those who helped me with this article who remain in Afghanistan.

My Travels to Jerusalem

Palestine: The Oslo Accords before and after, My travels to Jerusalem By Warren L Coats (2021) Kindle and paperback versions available at: Oslo Accords: Before and After

An intimate account of the establishment of the Palestine Monetary Authority and related adventures by one of the International Monetary Fund’s post-conflict, transition economy monetary experts. From being stranded in the desert without a cell phone, to hearing the sound at breakfast of a suicide bomber, to meeting with Yasser Arafat, and Stanley Fischer of the Bank of Israel, the author shares his adventures in the land of Canaan over a sixteen year period.

The establishment of the State of Israel in 1948 in Israel’s ancestral homeland required dealing with Palestine’s existing residents. In the Six-Day War in 1967, Israel’s occupation of the territories given to the Palestinians when the United Nations first recognized the State of Israel (the West Bank and Gaza Strip) increased pressure to resolve that issue. The Oslo Accords offered a path to its resolution, based on an agreement between Yasser Arafat, representing the Palestinian people, and the government of Israel, to swap land for peace (the return of Palestinian lands in exchange for Palestinian recognition of the State of Israel and its right to exist in peace).

One of the elements of the Oslo Accords was the establishment of a central bank in the Occupied Territories. Between 1995 and 2011 Warren Coats lead or participated in the missions of the International Monetary Fund to assist the Palestinian Authority in establishing and developing the capacities of the Palestine Monetary Authority. This book recounts the highlights of his visits, which included meetings with Arafat, as well as Bank of Israel officials.

Previous Books

One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina by Warren Coats (2007)   Hard cover: One Currency for Bosnia

FSU: Building Market Economy Monetary Systems–My Travels in the Former Soviet Union By Warren L Coats (2020)  Kindle and paperback versions available at: FSU-Building-Economy-Monetary-Systems

Afghanistan: Rebuilding the Central Bank after 9/11 — My Travels to Kabul By Warren Coats (2020)  Kindle and paperback versions available at:  “Afghanistan-Rebuilding the Central Bank after 9/11”

Iraq: An American Tragedy, My Travels to Baghdad By Warren Coats (2020) Kindle and paperback versions available at: Iraq-American-Tragedy-My-Travels-Baghdad

Zimbabwe: Challenges and Policy Options after Hyperinflation by Warren L. Coats (Author), Geneviève Verdier (Author)  Format: Kindle Edition Zimbabwe-Challenges and Policy Options after Hyperinflation-ebook

Money and Monetary Policy in Less Developed Countries: A Survey of Issues and Evidence by Warren L. Coats (Author, Editor), Deena R. Khatkhate (Author, Editor)  Format: Kindle Edition Money and Monetary Policy in LDCs-ebook

Central Banking award

The Central Banking Journal annually awards central bankers (best governor, best central bank, and providers of services to central banks) for their performance.  This year’s ceremony was held in London on March 13 and I was awarded Outstanding Contribution for Capacity Building. Here is a video of my acceptance speech.