One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina

What follows is blatant self interested commercialism. Here is what my latest book (kind of makes it sound like I have a lot of them) is about and how to get it.

F O R  I M M E D I A T E   R E L E A S E

Book Launch:

Warren Coats’ One Currency for Bosnia:

Creating the Central Bank of Bosnia and Herzegovina.

349 pages


Jameson Books

August 3, 2007

Washington, DC – Bosnia and Herzegovina has arisen from war-torn ruins to relative national stability in just ten years – in compelling contrast to the chaos of nation-building efforts elsewhere in the world. The story of rebuilding the monetary and banking systems from these ashes and their contribution the country’s healing and rebirth is a story of national triumph and world hope.

An architect of this historic feat, Dr. Warren Coats of the International Monetary Fund, now offers a chronicle starting before the fighting had stopped — and concluding with reflections about the on-going challenges of establishing stable monetary systems in post conflict countries.

For those who know of Coats’ reputation, the especially good news is that Coats provides insights into human and practical aspects monetary systems, and he offers lessons for those who would undertake similar quests.

What people are saying about One Currency for Bosnia:

  • Michael Lind, Author of The American Way of Strategy: “Now that the challenges of rebuilding failed states and shattered societies are central to U.S. foreign policy, his [Coats] lively and fascinating account of one effort at national reconstruction is as timely as it is informative.”
  • Mario I. Blejer, Director of the Centre for Central Banking Studies at the Bank of England: “His book not only clarifies potentially obscure economic concepts for the laymen but also illuminates the important interconnections between the economic and political aspects of post conflict reconstruction.”

About the author: Warren Coats is currently an advisor to the central banks of Afghanistan, Iraq, and Kazakhstan and is a director of the Cayman Islands Monetary Authority. During his twenty-six years at the International Monetary Fund he has provided IMF technical assistance to central banks around the globe including in Croatia, Bangladesh, China, Egypt, Nigeria, Turkey, the West Bank and Gaza Strip. He lives in Bethesda, Maryland.

  • Monetary stability is a necessary precondition to a healthy economy. The author demonstrates in plain language the means to achieving this goal.
  • Bosnia remains in the world’s headlines as a flashpoint of ethnic and religious conflict, especially the suffering of its Muslim inhabitants.
  • Beneath the political rhetoric of peace, democracy and nation-building are the hard realities of economics. Policy writers and academics will find this book an invaluable guide.
  • For all academic library collections dealing with history, foreign policy, economics, banking, and the Balkans.
  • The Berkeley, Chicago, New York, Boston, and Washington, DC top bookstores should have this on their history, foreign policy and economics shelves.
  • Milton Friedman’s more than 2,000 economics PhDs, like Coats, are a formidable market for serious works of economics and are likely avid reviewers.


One Currency for Bosnia


Creating the Central Bank of Bosnia and Herzegovina


Warren Coats, Ph.D. of Bethesda, Maryland

Author Bio

Warren Coats received his undergraduate degree at U.C. Berkeley and his Ph.D. at the University of Chicago. Currently advisor to central banks in four countries, he has led technical assistance missions to more than twenty countries, including China, Israel, Egypt, Iraq and the Czech Republic. For 26 years he held various positions at the International Monetary Fund.

This is both a fascinating personal narrative of the often colorful warriors rebuilding a part of war-torn Yugoslavia, and a detailed inside look at how experts can stabilize a nation’s currency and banking system. Written by an American who has led International Monetary Fund advisory missions to the central banks of more than twenty countries, this book, crafted in layman’s language — but of immense value to specialists in monetary and foreign policy initiatives — is an account of the behind-the-headlines work American and other economists do to bring peace and prosperity to former failed states.
Coats was involved in the creation of the Central Bank of Bosnia from before the Dayton Peace Accords. His “currency board” rules for monetary policy, and the creation of the bank, have resulted in the most successful state institution in the country.
Marking the tenth anniversary of the bank, the technical world of economics comes alive as the book unfolds like a mystery novel full of colorful and determined people determined to escape the disaster of a bloody civil war.

Order from Amazon:

Bosnia book endorsements


Front cover:


“Warren Coats’ well told account of the establishment of a currency board in war torn Bosnia and Herzegovina is fascinating and insightful reading.”


Robert Mundell, Nobel Prize in Economics in 1999


Inside before the title page


Robert Mundell,    Nobel Prize in Economics in 1999, Professor of Economics, Columbia University


“Currency board systems have become more popular since the collapse of the Soviet Union and with good reason: they provide a good option for monetary policy formation in countries where a suitable anchor currency is available. Warren Coats’ well told account of the establishment of a currency board in war torn Bosnia and Herzegovina is fascinating and insightful reading. His mastery of detail and intimate knowledge of that unusual environment, both political and economic, challenge and deepen our understanding of monetary systems and policies.”


Richard Rahn, Director of Cayman Islands Monetary Authority, former Chief Economist of the U.S. Chamber of Commerce, and syndicated columnist and author.


“If you were going to build a monetary system that would heal the wounds of a civil war devastated country and help lay the foundation for economic recovery and development, what would you do? Warren Coats provides the answer given for Bosnia and Herzegovina in his well told story of the establishment of the Central Bank of Bosnia and Herzegovina. Readers of his book will follow the detective like uncovering of the workings of the unique Yugoslav banking and payment system and the challenges faced and overcome in replacing it with a modern, market based system.”


Mario I. Blejer,  Former Governor of the Central Bank of Argentina (2001 to 02) and Senior Advisor in the IMF (1980 to 2001). Currently Director of the Centre for Central Banking Studies at the Bank of England.


“Warren Coats describes and analyzes the very complicated and extremely relevant process of the establishment of Bosnia’s present monetary system in clear, highly readable prose. His book not only clarifies potentially obscure economic concepts for the laymen but also illuminates the important interconnections between the economic and political aspects of post conflict reconstruction.”


Back dusk jacket:


Carl Bildt, Former High Representative of the UN in Bosnia, Former Prime Minister of Sweden, Current Foreign Minister of Sweden


“The democratization process in Bosnia was one of the most exciting periods of my life. And in the lives of all the courageous people who were involved.  The history deserves to be told over and over again. I told parts of it in my own book. Now, Dr Coats has taken the trouble to recall his own fascinating experience with the establishment of the Central Bank of Bosnia and Herzegovina. His account is an invaluable contribution to the never ending story of the Balkans.”


Serge Robert, First Governor of the Central Bank of Bosnia and Herzegovina (Oct 1996 to October 1997)


“This excellent book written by Warren Coats about the creation of the new Central Bank of Bosnia and Herzegovina is well worth reading. The author meticulously relates various aspects of history, monetary policy and human behavior in a clear, lively, humorous and enthralling style. The book reports how, after a grueling war, some men – still impregnated with rancor and distrust – bridled their own resentment, working together to build a monetary institution vital to their common future. Warren, with a great IMF team, played a major role in encouraging mutual understanding and co-operation. Today, on the eve of its 10th anniversary, the Central Bank has proved to be a real success. Warren Coats’ book will be an appropriate gift to mark such an event.”


Michael Lind,  Whitehead Senior Fellow, The New America Foundation and Author of The American Way of Strategy (Oxford, 2006) and other history and policy books and articles.


“The mission of Warren Coats in Bosnia was as much diplomatic as economic.  Now that the challenges of rebuilding failed states and shattered societies are central to U.S. foreign policy, his lively and fascinating account of one effort at national reconstruction is as timely as it is informative.”


Steve Hanke, Professor of Applied Economics at Johns Hopkins U Baltimore MD and leading authority on currency boards.


“The newly independent Bosnia and Herzegovina emerged in shambles from a bloody civil war in late 1995.  Warren Coats, a premier emerging market monetary expert, was central to the design and implementation of the currency board system that restored Bosnia and Herzegovina’s economy.  His book represents a scholarly and comprehensive, yet readable, realistic, and insightful account of one of the world’s most successful modern currency reforms.  One Currency for Bosnia should be required reading for all those who are serious about stable money.”



Fannie and Freddie, More Good, Bad and Ugly

By Warren Coats[1]

Should Uncle Sam have bailed out Fannie Mae and Freddie Mac and what should he do now?

Fannie and Freddie were created by the government to promote home ownership by lowering the cost of home mortgages. Whether it is good public policy to subsidizes home ownership in this and other ways is a separate issue. Fannie, and later Freddie, lowered the cost of mortgages by raising mortgage financing in the market at lower interest rates than previously possible. They reduced borrowing costs to home owners because they were able to borrow in the market in their own names at the risk free interest rates paid by the government and to pass the savings on to the mortgagees. After Fannie was privatized in 1968, it began to raise funds in the market with minimal risk by selling claims to pools of mortgages that met clearly stated minimum underwriting standards.[2] It guaranteed (insured) that private investors would receive the expected principle and interest payments on the underlying mortgages in each pool. Not only did the pooling and guarantee reduce the risk to market investors in such mortgage backed securities (MBSs), but the market fully trusted Fannie’s and later Freddie’s guarantees because of the widely held view that the government would not let them fail (implicit—now explicit—government guarantees).

These low funding costs could be passed on to ultimate mortgagees with lower spreads (the difference between Fannie and Freddie’s cost of funds and the rate they charged home owners) because of F&Fs high leverage. Fannie and Freddie were granted much lower capital requirements than other financial intermediaries. Investors didn’t worry about F&F’s small capital because of the implicit government guarantee of F&F obligations. These advantages over the competition allowed Fannie and Freddie to deliver very large amounts of relatively low cost funds to home buyers.

Why should we care if this arrangement channels more and cheaper financing to homeowners? The history of state owned banks almost every where they have existed in the world has been bad. For obvious political reasons, they are usually greatly overstaffed (with friends of the ruling party) and hold higher levels of non performing loans than privately owned banks as a result of politically motivated loans and poor management. It is too easy and tempting for politicians to push off the costs of government programs, such as loans to subprime borrowers with low or even zero down payments, to such institutions (off-budget expenditures).

Thus the privatization of Fannie Mae in 1968 should have been welcomed. Unfortunately, however, what was privatized was Fannie’s profits but not its risks. The same mistake was repeated with the later creation, then privatization, of Freddie Mac to provide more competition when the more sensible policy would have been to remove Fannie Mae’s special privileges (especially its very low capital requirement). As privately owned companies, F&F have taken a significant amount of their income to pay high dividends to their private owners,[3] very high salaries to their management,[4] and large payments for lobbying services.[5] These payments reduced the extent to which they were able to lower the cost of home ownership. According to The Economist “it has been an awful deal for the tax payer – a Fed economist calculated the implicit debt-guarantee was worth a one-off sum of between $122 billion and $182 billion. Because Fannie and Freddie barely lowered the cost of borrowing, little of this subsidy went toward busting home ownership. Instead, just over half—about $79 billion—went straight to their share holders.”[6]

Worse yet, the “The Department of Housing and Urban Development sets ‘affordable’ housing goals for Fannie Mae and Freddie Mac to dedicate a given amount of credit to poorer homeowners. One way Fannie and Freddie fulfilled these goals was to buy subprime mortgage securities — many of which have now gone bad.”[7] In other words, congress has pushed the cost of one of its programs off the government’s budget onto F&F, backs which is now coming back to the taxpayers.

Between them Fannie and Freddie guarantee two fifth of America’s 12 trillion dollars in mortgages by either owning them or packaging and reselling them to the market as mortgage backed securities of one sort or another. Stated differently three fifths of American mortgages have been financed without Fannie and Freddie’s help.

Basically F&F now provide investment banking services and guarantees to investors in mortgage back securities. But their guarantee, which should be backed by the capital provided by their private shareholders and their due diligence in vetting compliance with the stated underwriting standards, are actually backed by American tax payers. They do nothing that the private market cannot and is not doing already. They do it somewhat cheaper because the tax payer bears the ultimate risk of losses. For many many years a long list of economists and public servants have recommended breaking them up and or getting rid of them[8] and congress has delayed taking action until the latest Fannie and Freddie crisis of this last week.

Congress’s housing bill, signed by President Bush July 30, 2008, strengthened emergency arrangements by the Federal Reserve and the U.S. Treasury to open credit lines to F&F after their share prices collapsed on July 7, following an analysis by Lehman Brothers that potential accounting changes could leave their capital $75 billion short.[9] The new law confirms the Treasury’s pledge to provide liquidity against mortgage collateral and even capital if needed. In other words, the government’s implicit guarantee of F&F liabilities has been made explicit. F&F’s share prices immediate recovered following the earlier Treasury and Fed announcements. These steps were necessary because a loss of confidence in the market in F&F’s mortgage guarantees would freeze trading of, and/or cause very large losses in the value of, the $5.2 trillion mortgages guaranteed by F&F. This could do irreparable damage to the mortgage market and financial markets more broadly. It is impossible to know at this point whether F&F really needs any of this money, which depends on whether mortgage defaults over the next few years are more or less serious than now assumed.

The new law also provides much needed strengthened supervision of Fannie and Frieddie, but there are worrying signs that the underlying problems are just being postponed for yet another bailout rather than being fixed. F&F, along with Ginnie Mae,[10] will continue to have social responsibilities that potentially put tax payers at risk. At the same time that the new law authorizes tax payer money to cover F&F losses, it also taps future income (starting in 2010) to fund a new National Housing Trust Fund. Rather than liquidating F&F, congress has provided for the financing of the new NHTF with yet another off balance sheet scheme that builds a political constituency for the perpetuation of Fannie and Freddie. David Broder declared this an example of “lawmaking as it should be.” [11]

What should be done?

The government should stand ready to provide whatever capital Fannie and Freddie need to honor their existing obligations (and to provide adequately collateralized liquidity). However, such capital injections should come only after all shareholder capital has been used up. The condition for tax payer funded capital should be the surrender of current owners’ shares (a nationalization ala Northern Rock in the UK). Shareholders would lose everything in this case but all other obligations would be met. Once back in government hands these institutions should be gradually liquidated in an orderly way over a number of years.[12] Though investors in F&F guaranteed mortgage backed securities would be bailed out, shareholders would not. This compromise would retain considerable market discipline and is essentially the approach taken with failing banks, which are taken over by the FDIC and often resold over the same weekend. It is the approach advocated by Alan Meltzer for investment banks now that they have access to Federal Reserve credit.[13]

Refusing to bail out shareholders while protecting depositors (in the case of banks) and other creditors (mortgage backed securities in the case of Fannie and Freddie) is a compromise. Market discipline of investors in F&F guaranteed mortgage backed securities from potential loss in bankruptcy of F or F would be reduced, though it would be gradually transferred to privately guaranteed mortgages after the liquidation of F & F. However, full market discipline would be retained for shareholders who are in the best position to control the behavior of these institutions anyway. This is generally as much market discipline publics around the world are willing to accept, but we should insist on nothing less.

[1] Warren Coats, Bethesda, MD, retired from the International Monetary Fund in 2003 as Assistant Director of the Monetary and Financial Systems Department, where he lead technical assistance missions to central banks in over twenty countries. Prior to that he served as visiting economist to the Board of Governors of the Federal Reserve System, and to the World Bank, and was Assistant Prof of Economics at UVa from 1970-75. He is currently a director of the Cayman Islands Monetary Authority, Senior Monetary Policy Advisor to the Central Bank of Iraq for BearingPoint, an IMF consultant to both the central bank of Afghanistan, and to the Palestine Monetary Authority, and an Asian Development Bank consultant to the National Bank of Kazakhstan on inflation targeting. In 1989 he coauthored the World Bank’s World Development Report on “Financial Systems and Development.” His most recent book, One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina, was published in November 2007. He has a BA from UC Berkeley and a PhD from the U. of Chicago in Economics.

[2] The Federal Home Loan Mortgage Corporation (Freddie Mac) was chartered by the government in 1970 and “privatized” in 1989.

[3] For the year ended December 31, 2005, before the beginning of the current housing and mortgage crisis, Fannie reported profits of almost $6 billion from $50 billion in revenues. According to the Economist (July 19-25, 2008) a Federal Reserve economist “calculated the implicit debt guarantee [of Fannie and Freddie by the government] was worth a one-off sum of between $122 billion and $182 billion.” With just over half going to shareholders rather than lower borrowing costs to home buyers.

[4] “CEO Daniel Mudd received $12.2 million in total compensation last year [2007], down 15 percent from 2006,” when he received $14.45 million. Reuters January 31, 2008. In 2004, 20 of Fannie Mae’s top executives “received more than $1 million each in total compensation in 2002. Twelve received more than $2 million. Nine received more than $3 million.” Washington Post October 11, 2004. Fannie’s chairman and chief executive at that time, Franklin D. Raines, was subsequently fired over accounting “irregularities” that bolstered his and other executives’ performance bonuses.

[5] Fannie and Freddie reported lobbying expenditures over the last ten years of $167 million. The power and effectiveness of their lobbying efforts are legend.

[6] The Economist, “Twin Twisters” July 19, 2008 p 15.

[7] Robert J. Samuelson, “The Homeownership Obsession”. The Washington Post, July 30, 2008 p A15

[8] Peter Wallison has been a particularly articulate and persistent critic of F&F. Also see the resent article by William Poole, "Too Big to Fail, or to Survive" , NY Times, July 27, 2008

[9] Catherine Clifford, “Fannie Mae and Freddie Mac Plunge,”, July 7, 2008: 6:36 PM EDT

[10] Government National Mortgage Association, guarantees with the full faith and credit of the Federal Government pools of mortgages collateralize with loans insured or guaranteed by the Federal Housing Administration (FHA) the Department of Veterans Affairs (VA) the Department of Agriculture’s Rural Housing Service (RHS) and the Department of Housing and Urban Development’s Office of Public and Indian Housing (PIH).

[11] David S. Broder, “When Congress Works,” The Washington Post, July 31, 2008, P A19

[12] An alternative would be the outright nationalization of F&F compensating the shareholders with the estimated value of their shares (which might be negative). If later recovers from liquidation are greater than expected, shareholder compensation could be increased at that time. The government would accept the risk that it was less.

[13] Allan H. Meltzer. “Keep the Fed Away From Investment Banks” The Wall Street Journal, July 16, 2008; Page A17

Should the U.S. adopt a Gold Standard?

The gold standard for the U.S. is not a serious issue in my view, but a few hundred people, including Ron Paul, think it is. FreedomFest staged a debate in Las Vegas July 10, 2008 on this subject. Gene Epstein, Economics Editor of Barron’s took the affirmative and I took the negative position.This is the paper I prepared for a debate.

July 10, 2008, FreedomFest, Las Vegas, Nevada

We live on here on earth with all of its marvels and challenges. Life on earth is full of opportunities and risks. All cultures and institutions are imperfect. Monetary arrangements are no different. There is no such thing as a perfect monetary system. The gold standard is one of the better ones with many virtues and many weaknesses. I will argue that it is not the best system for the United States today. I will begin by defining what a gold standard is then provide a quick review of its strengths and weaknesses.

The goal of the monetary regime or of the monetary policy of any country should be price stability with maximum economic growth and minimum fluctuations in output. In the long run, monetary policy can only determine the value of the central bank’s money (inflation). Economic growth (real GDP) is determined by real factors of technology, productivity, labor skills, and work effort. So monetary policy cannot increase real output in the long run other than through the benefits of providing money with stable value. However, it can affect output in the short run and this is where it tends to get into trouble. An important source of inflation results from central banks increasing the money supply to stimulate output in the short run. Historically, inflation of central bank money was generally the result of the central bank lending to government (printing money to finance government expenditures). All hyperinflations were of this sort.

What is a gold standard?

A gold standard is a monetary regime (policy) that fixes the price of currency to a physical quantity and purity of gold and supplies or redeems that currency at that price in response to market demand. Thus a gold standard is a monetary system or policy in which market demand determines the supply of money. The purchasing power of one dollar fixed to gold is determined by the purchasing power of gold, i.e. the price of things in general in gold.

Pros and Cons of a gold standard


  • A gold standard is transparent, simple to administer, and has produced very stable prices over long periods. It reflects a strong commitment of the government not to resort to monetary finance (printing money) and may help reinforce such a commitment.


  • It can produce more volatile prices in the short run.

“Between 1880 and 1914, the period when the United States was on the ‘classical gold standard,’ inflation averaged only 0.1 percent per year…. This compares with the post classical gold standard “period of 1946 to 1990 with an average of 4.2 percent.”[2] However, under the gold standard inflation has been quite volatile in the short run. “For the United States between 1879 and 1913, the coefficient [of variation of inflation] was 17.0, which is quite high. Between 1946 and 1990 it was only 0.8….[3]

  • It precludes a monetary policy to soften or counter economic shocks resulting in more volatile business cycles.

In the United State, “The coefficient of variation for real output was 3.5 between 1879 and 1913, and only 1.5 between 1946 and 1990. Not coincidentally, since the government could not have discretion over monetary policy, unemployment was higher during the gold standard. It averaged 6.8 percent in the United States between 1879 and 1913 versus 5.6 percent between 1946 and 1990.”[4]

  • The resource cost is very high (digging up and refining gold).

Milton Friedman estimated the cost for the U.S. at about 2.5% of GDP (or around $375 billion dollars per year today).

  • It precludes a lender of last result to prevent bank runs

(though J.P Morgan was able to provide some of this from the private sector before the establishment of the Federal Reserve Banks).

The example of the Great Depression:

What should have been a “normal” business cycle recession starting in 1929 turned into the worst depression in U.S. history when the Federal Reserve raised interest rates in 1931 as required by gold standard rules to stem the outflow of gold and failed to provide lender of last support to hundreds of banks in the face of wide spread bank runs. By 1933, almost half of the 25,000 banks in the U.S. had failed. With normal credit sources severely disrupted, production plummeted. The introduction of trade restrictions worsened the situation and along with the gold standard helped spread the depression world wide. By 1932, U.S. manufacturing output had fallen to 54 percent of its 1929 level, and unemployment had risen to over 25 percent of the work force.

Britain restored gold convertibility in 1925 after its suspension during WWI at the prewar price. This is widely seen as a mistake that forced wide spread deflation on the British empire to reverse the war time increase in the price of gold. Speculative pressure forced the U.K to abandon gold convertibility September 20, 1931. In response to the speculative pressure on gold prices, the Federal Reserve, which hung on to its $20 dollars per ounce price and convertibility until 1933, raised interest rates in 1931 in an effort to stem the outflow of gold. The results were disastrous.

“· Countries that were not on the gold standard in 1929–or that quickly abandoned the gold standard–by and large escaped the Great Depression

· Countries that abandoned the gold standard in 1930 and 1931 suffered from the Great Depression, but escaped its worst ravages.

· Countries that held to the gold standard through 1933 (like the United States) or 1936 (like France) suffered the worst from the Great Depression.”[5]

Federal Reserve Chairman Bernanke is well aware of the risks of monetary contraction and deflation on the banking system and the real economy. [6] “Bernanke and James’ data for the average growth rate of industrial production for the countries [that abandoned gold] was positive in every year from 1932 on. Countries that stayed on gold, by contrast, experienced an average output decline of 15% in 1932. The U.S. abandoned gold in 1933, after which its dramatic recovery immediately began. The same happened after Italy dropped the gold standard in 1934, and for Belgium when it went off in 1935. On the other hand, the three countries that stuck with gold through 1936 (France, Netherlands, and Poland) saw a 6% drop in industrial production in 1935, while the rest of the world was experiencing solid growth.”[7]

What are the alternatives?

Flexible gold standard, Dollarization or currency board

Monetary regimes that fix the price of their currency to gold, another commodity, a basket of commodities, another currency, or basket of currencies (e.g. the SDR) and passively buy or sell their currency at that price are gold standard like regimes. However, gold would not be the best thing to fix the price of the currency to. Larry White has argued for a flexible application of such regimes in order to permit lender of last resort help to solvent banks experiencing runs. This would require temporarily lending to banks and there by increasing the monetary base beyond its gold backing. This could have avoided the problems leading to the Great Depression[8]

Inflation targeting

The major advantage of a gold standard is the commitment to long run price stability that it reflects. Inflation targeting reflects the same or even stronger commitment to price stability without the negative rigidities of a commodity standard. Inflation targeting holds the central bank accountable for achieving an explicit inflation target (generally 2%) two to three years in the future while leaving the central bank with full discretion over its monetary tools and their use for achieving the inflation target. Experience to date has been very good, reducing the variance of inflation without increasing real output volatility.

Is the price of gold more stable than other things?

Alan Greenspan has put monetary policy in historical context: “Although the gold standard could hardly be portrayed as having produced a period of price tranquility, it was the case that the price level in 1929 was not much different, on net, from what it had been in 1800. But, in the two decades following the abandonment of the gold standard in 1933, the consumer price index (CPI) in the United States nearly doubled. And, in the four decades after that, prices quintupled. Monetary policy unleashed from the constraint of domestic gold convertibility, had allowed a persistent overissuance of money. As recently as a decade ago, central bankers, having witnessed more than a half-century of chronic inflation, appeared to confirm that a fiat currency was inherently subject to excess.”[9]

If the Central Bank of Bosnia and Herzegovina, the currency board I helped establish, had fixed the exchange rate of its currency to an ounce of gold rather than to the Euro, what would have been the result for the purchasing power of its currency (the convertible markka–KM)? From 1999 to 2007 the inflation rate (CPI) in Bosnia averaged 2.7% compared with 2.0% in the EU and 2.5% in the U.S. On average over this period, as would be expected, the Bosnian inflation rate was similar to the European inflation rate. But what if it had been fixed to gold rather than the Euro?

The Euro price of gold rose from 8 Euro’s per gold gram in 1999 to 18.8 Euros at the end of 2007. If the KM had been fix to gold rather than the Euro, its value relative to the Euro would have more than doubled from 2 KM per Euro to 0.85 per Euro. Put the other way around, in 1999 one KM would buy one half Euro, while if its price had been fixed to gold in would have been able to buy almost 1.2 Euros at the end of last year, a 10% appreciation in value each year. Deducting the European inflation rate of 2.0% per year over that period, Bosnia would have had an 8% deflation in KM on average over this nine year period. On the other hand if the KM had been fixed to gold in 1997 (about 10 Euros per gram)[10] two years later it would have depreciated against the Euro (about 8 Euros per gram), implying over those two years about a 13% per year inflation rate (after adding the underlying 2.0% European inflation rate). In fact, gold prices of the USD and the EURO have varied dramatically and would have provided a very unstable and unsatisfactory anchor for the KM.

As an aside, real GDP growth over the 1999-2007 period averaged 5.7% in Bosnia and 1.8% in the EU. The money supply (M2) grew at the explosive seeming rate of 41% per year over that period in Bosnia and only 7.4% in the EU, indicating the difficulty of monetary targeting in transition economies or post conflict economies like Bosnia.

The enormous volatility of gold prices over the last 40 years makes it a very unstable anchor for most countries’ monetary policies. Its price rose from 35 dollars an ounce in 1971 to over $800 in 1981 to below $300 from 1998 to 2003 to $926 per ounce at noon yesterday. However, these swings reflect speculative shifts in demand that would surely be greatly moderated if the United States and the world as a whole adopted a gold standard.

gold prices


The United States should not adopt a gold standard. Such a regime would have prevented the Federal Reserve from supplying the additional liquidity the banking system suddenly demanded this past year as part of the subprime mortgage crisis.[11] Without the injection of the additional liquidity, there would probably have been a financial sector meltdown and recession of hug proportions. Had the U.S. had a gold standard, it would not have survived such a financial crisis.

The United States should adopt inflation targeting. The Federal Reserve act should be amended to establish price stability as the primary objective of monetary policy, freeing the Fed from its statutory requirement to “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”[12]

[1] Warren Coats retired from the International Monetary Fund in 2003, where he led technical assistance missions to central banks in over twenty countries. He is currently Senior Monetary Policy Advisor to the Central Banks of Iraq and Afghanistan and a Director of the Cayman Islands Monetary Authority. His most recent book, One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina, was published in November 2007.

[2] Michael D Bordo, “Gold Standard” The Concise Encyclopedia of Economics

[3] Ibid.

[4] Ibid

[5] Brad DeLong, “Why Not the Gold Standard” 8/10/1996

[6] Ben Bernanke and Harold James, “The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison” NBER Working Paper No. 3488, Issued in October 1990.

[7] James D. Hamilton, Econbrowser blog December 12, 2005

[8] Lawrence H. White, “Is the Gold Standard Still the Gold Standard among Monetary Systems?” CATO Institute Briefing Papers, No.100, Feb 3, 2008

[9] Alan Greenspan, remarks before the Economic Club of New York, New York, December 19, 2002, p. 1.

[10] The Euro had not yet been introduced at that time and the KM was actually fixed one to one to the German mark, which in mid 1997 was 18.5 DM per gram of gold.

[11] Warren Coats, “The U.S. Mortgage Market: The Good, The Bad, and The Ugly,” Association of Banks in Jordan, June 22, 2008

[12] Federal Reserve Act, Section 2a.


Summary of my views on the ideal tax system

Government programs (expenditures, mandates, regulations) should be evaluated for their benefits and these compared with their costs. The resulting level of government expenditures politically prioritized and determined (hopefully on this basis) should be financed in the most economically neutral, equitable, and efficient (costs of compliance, collection and enforcement) ways possible. The following proposals are based on these assumptions and objectives. Stress is placed on the high compliance costs and enforcement difficulties of existing taxes in an increasingly globalized world.

Very simply stated, the ideal taxes in terms of neutrality (minimal distortion of relative prices) are either a comprehensive income or consumption tax. A comprehensive consumption tax is more neutral than an income tax, which distorts the choice between saving and consumption by taxing saving. For some, however, an income (the return for what you give society) tax is more equitable and for others a consumption (what you take from society) tax is more equitable. Use taxes (such as tolls or gasoline taxes for the use of highways), which are generally considered both neutral and equitable and thus desirable when feasible, are not otherwise considered here.

However, the ease of avoidance and costs of compliance are very different for income taxes (whether based on the residence of the tax payer or the territories in which the income is produced) than for a consumption tax, which necessarily applies to the territory in which consumption occurs.[1] U.S. efforts to prevent income tax evasion (both business and personal) by hiding income abroad have become increasingly costly, intrusive, and obnoxious to foreign governments. For these reasons, and the reasons of neutrality and equity, I favor a comprehensive consumption tax (VAT) combined with a rebate (negative income tax) to every man, woman, and child legally resident in the U.S. and the abolition of all income, wealth, and wage taxes.

Taxes on business income violate almost every standard of good taxation and contribute most to political controversy and to business costs aimed at reducing evasion. With increased globalization, efforts to define business income within the tax jurisdiction and to detect taxation evasion by moving income (as apposed to actual economic activity) abroad are becoming more difficult and invasive into the policies of other countries. The taxation of business income should be totally abolished.

Payroll (wage) taxes used to finance pensions might be thought of as a use tax. However, in the case of the payroll tax, which is nominally linked to the Social Security pension in the U.S, the pay-as-you-go financing of the Social Security pension makes the link weak. Furthermore, payroll taxes are very regressive.

The primary appeal of an income tax over a consumption tax rests on the public’s perception of fairness. Why should income from clipping bond coupons be taxed less than hard labor? A preference for an income tax may also reflect the desirability of limiting the accumulation of wealth and income inequality even potentially at the expense of less investment and thus lower incomes for everyone. An often overlooked drawback of income taxation is the relative ease with which the wealthiest can evade taxation via various off shore (or even on shore) vehicles for hiding it. IRS efforts to find all income earned or sheltered abroad raise similar problems for international cooperation and relations as do such efforts with regard to the corporate income tax. Defining and measuring properly net income subject to taxation can also be problematic as is the fairness of taxing U.S. citizens living and earning their income abroad. None the less, under the existing tax code those with incomes in the top 1 percent paid 40 percent of all income tax revenue in 2006 and earned only 22 percent of all income, the top 10 percent paid 71 percent and the bottom 50 percent less than 3 percent.[2]

I support a comprehensive consumption tax (Value Added Tax) for all residence in the U.S. When combined with cash rebates to all legal residents equivalent in value to the consumption tax paid on purchases of essential goods and services by every man, woman and child, the tax becomes modestly progressive and satisfies a sensible notion of fairness. As I also think a minimum level of retirement saving[3] and medical insurance should be mandatory as part of making our social safety net more efficient and equitable, the per person cash rebate should be large enough cover these mandatory minimums. To insure compliance with these mandatory payments, these amounts could be deducted from the cash payments and invested in a standard retirement fund or health insurance policy for anyone unable to document that they have satisfied these requirements.

Residents would support government services in proportion to what they take (consume) from the economy rather than on the basis of what they give (produce). By every calculation of actual tax collections, the wealthy would pay more than they do now with existing taxes. Its collection and enforcement would yield enormous simplifications and compliance cost savings. The IRS could stop chasing money around the world. A tax rate of 23 percent on after tax consumption (which makes the rate comparable to an income tax (i.e., 30 percent of pre tax consumption) is estimated to raise the same revenue as existing federal income taxes, including, personal, estate, gift, capital gains, alternative minimum, Social Security, Medicare, self-employment and corporate taxes.

[1] This is a simplification. A good may be purchased in another state or country and carried across borders to be consumed at home. Border tariffs for the difference in the foreign and the local consumption tax rates would be needed.

[2] Wall Street Journal, “Their Fair Share”, July 21, 2008 p A12

[3] Funding private pension plans attached to individuals rather than through companies in place of the existing, pay as you go social security system.