Category: Economics

What is appropriate to teach our kids?

Obviously, the knowledge and skills taught to kids should be appropriate to their age. At whatever age kids can meaningfully absorb the history and message of religions, for example (don’t ask me what age that is), the real question is what they should be taught about them. Given our constitutional separation of Church and State and our commitment to individual choice and the enriching benefits of a multiethnic population, public schools can not “teach Christianity”. But it is highly desirable to teach students about Christianity, Islam, Hinduism, Buddhism, and the other major religions—their histories and beliefs. Parents have a right to be satisfied that what is taught fairly represents their religion.

At an appropriate age kids need to learn about races—about why some kids in the room are black, white, brown, and yellow. At an appropriate, presumably older age, they need to learn the history of these races and especially slavery as it is particularly relevant in America, as are Chinese rail road workers and the internment of Japanese Americans during WWII.

At appropriate ages kids also need to learn about how their bodies function and how to keep them healthy. As they approach puberty, they will want to know all about what is going on in their bodies. If they are not given this information in the classroom, they will seek it elsewhere. Current controversies over teaching information about sexuality and sexual functions to kids at the age needing and wanting such information and over the availability of affinity clubs for young teenagers to discusses these pressing questions, reflects, in my view, two serious mistakes in confronting this issue. The first is to overlook or deny that kids will seek out what ever information they can about every aspect of sex whether presented in the classroom or not. The second serious mistake is the claim that teaching about homosexuality and providing clubs in which kids can discuss their questions about it with their piers will recruit heterosexual students to join up with the gays as if being gay is so desirable. We cannot chose our sexual orientation.

I want to focus on the second of these. We are born with our sexual attractions. We are not and cannot be recruited from it to its opposite. The survival of the species requires that most people are heterosexual and happy to procreate and so overwhelmingly most people are heterosexual. Those who are not are acutely aware that their attractions are not the norm. As they attempt to establish their goals for their lives, most homosexuals try to hide from, or deny to, themselves that they are different. Most would rather not be. But they cannot change the facts. Their goal should be to accept the facts and carry on building the most fulfilling lives possible. This is much easier today than earlier because of honest and factual classroom information and public role models of successful gay men and lesbian women.

Sixty-five years ago as I struggled to sort out my own attractions (yes I know that that was a rather long time ago and a different world) I did not know any, or of any, gay people as models or better still to talk to. There was no Will and Grace, or Peter Buttigieg, or Peter Thiel, or Lily Tomlin. I had only heard of child molesters—bad people who were run out of town. I hated what I felt. It threatened to destroy the life I hoped to have. So I buried it away for many year at the cost of considerable internal pain. What a relief it would have been to have learn in class that some people are just that way and can have otherwise normal lives.

Thus, it is quite distressing to me that some poorly informed parents are rising up against such instruction. While I assume that they mean well, I see their actions as child abuse. They mistakenly believe that homosexuality is a choice. They understandably don’t want their child to make that choice. But it is not a choice. We often say that God made us homosexual, and we chose to be gay.

All children need the facts about the various urges god gave us and help with their struggle to accept their own sexual orientation and to fit in with the rest of society. Clubs at which they can socialize and feel comfortable and discuss the fact of their homosexuality can be a helpful part of their development. Despite the enormous progress in public understanding, ignorance persists in some quarters on which the Washington Post gives an interesting report:

Flyers at school advertising Safe Place club meetings, “set off a wave of parent anger and rumors that Safe Place club advisers including Melissa Panico, a teacher who has LGBTQ children, would “indoctrinate” students.

“Spurred by these concerns, legislatures in at least 19 states have passed or are considering laws that bar discussion of sexual orientation and gender identity for younger children while limiting teaching on those topics for older students….

 “’Safe Space’ signs had to come down. The posters were ‘political in nature,’ he wrote, and might cause ‘disruption to the learning environment.’ The signs could run afoul of two legal considerations, he added: ‘One, will what is posted or worn be seen as indoctrinating our students to believe or think in a certain way. Two, would we allow anything that represents the opposite viewpoint?’” It is hard to believe that these were the words of an adult educator.  “Gay-straight alliance-indoctrination-school club”

Progress has been made but we still have a ways to go:

“When Sen. Barry Goldwater, dubbed “Mr. Conservative,” learned that his grandson and grandniece were gay, he worked for new laws that would protect their civil rights. When Newt Gingrich became speaker of the House, and his lesbian half-sister, Candace, became a gay activist, he took a more neutral stance. “It’s a free country,” he told the press. State Sen. William “Pete” Knight has been estranged from his son since learning four years ago he is gay.

“And now, Dick and Lynne Cheney are faced with their decision, how to handle in public what is essentially a private matter: the sexual orientation of their daughter, Mary.”  “The Cheney’s”

Econ 101:  The Price of Oil

Supply and demand.  Supply and demand.

Every economist of all political persuasions knows that the price of oil in a free market is determined by its supply and demand. The price of oil has risen a lot because its supply has been reduced by the Russian sanctions and the war in Ukraine and because with the easing of the covid pandemic restrictions demand has returned for people to travel on the road and by air. Before you decide what you think should be done about this, let’s be sure you understand how supply and demand works in this (and most every other) case.

The price of oil (let’s talk about gasoline) equates its supply with demand. Gas (short for gasoline in this note) refiners (and those who search for it and drill, pump it out of the ground and transport it to the refineries) and their retail gas stations that sell it to us, sell it for the highest price they can get away with.  But if they set their price too high their customers will buy from a cheaper gas station around the corner and or reduce their driving or will double up for the commute to the office, etc.  People cannot buy more than is available. Allowing the market to freely set the price means that those with a stronger demand get it and those with a more moderate need pass it up. The available supply goes to demanders whose demand is prioritized by those most willing to pay for it. Gas’s high price rations out those with weaker demand.

Suppliers will continue to explore and drill etc., as long as it is profitable to do so (i.e., as long as the pump price is higher than the cost of finding and refining it). Gas’s high price will encourage the production of more of it.

This helps us evaluate what to expect or what to propose in response to current high prices.  The supply side is much more complicated by government regulations and OPEC monopoly agreements among producers, so let’s start with the demand side.

Those of you my age will remember the gas price caps imposed by tricky Dick Nixon in 1971 as part of his wage and price controls to fight inflation. It was a wonderful economics lesson for almost everyone. At the lower price of gas at the pump, demand exceed supply and therefore there was not enough for everyone to buy it who wanted it at that price (demand exceeded supply). Thus, long lines formed as people waited hours for their turn at the pump. Some cities alternated days in which people with license plates ending in an odd number or even number could enter the city, and other crazy things.  If demand is not being rationed by price, government bureaucrats will decide who gets it; or the willingness to wait in line for hours will be added to the price as a rationing devise.

On the other side of the supply/demand equation, price caps reduce the incentives to find and produce more gas. Many factors influence the costs and thus profitability of increasing gas supplies. Environmental regulations, pipeline approvals or disapprovals, some well-considered and some less so, raise the cost of supplying gas. OPEC (Saudi Arabia, Russia, Venezuela, Iran) and geopolitical factors complicate the picture. For many years after Nixon’s wage and price controls most everyone understood that they were a very bad idea.

Hopefully we don’t have to learn that lesson again. The environmental and other regulations that increase the cost of supplying gas and thus reduce its supply need to be carefully considered and justified by honest cost benefit analysis.

Econ 101: The Value of Money

During a discussion of Bitcoin with friends, it became clear to me that it might be helpful if I explained some fundamentals of how the value of money is determined. Like most everything else, money’s value is ultimately determined by its supply and demand.

Demand for money reflects the public’s need to keep an inventory of it in order to use it for making payments.  Bitcoin are generally held as a speculative asset rather than for payments as almost no one will accept them in payment. “Cryptocurrencies-the bitcoin phenomena”

The supply of money is determined by those who created it, generally central banks. Generally central banks issue their currency, thus increasing its supply, by lending it (generally to banks) or by buying assets, generally their government’s debt.  When anyone holding that currency no longer wants it and has the right to redeem it, the central bank takes it back in exchange for the asset it purchased in the first place, thus reducing the money supply.  Under the gold standard, currency was redeemed for gold.  The rules governing a central bank’s issuing and redeeming its currency defines the nature of its monetary regime.  That is the topic of this econ 101 lesson.

As none of us has ever redeemed our currency, it is understandable that my friends confused spending their money with redeeming it.  Spending it transfers it to someone else without changing its supply, while redeeming it reduces its supply.  Cryptocurrencies add a new category to our discussion of money.  As noted by “a billionaire hedge-fund manager… cryptocurrencies are a ‘limited supply of nothing.’”  “Crypto skeptics growing”

As discussed further below, the supply of Bitcoin increases slowly and steadily over time as determined by an unchangeable formula and Bitcoin cannot be redeemed for anything.  The U.S. dollar and virtually every other national currency in the world grow at more erratic rates as determined by their issuing central banks.  So what makes the value of the dollar relatively stable over long periods of time?  The fall in its value by about 8% over the last month is nothing compared to bitcoin’s fall of 23% over the same period and over 50% over the last half year.  Over the past 15 years the dollar’s value has declined less than 2% each year.  Unlike Bitcoin, dollars are widely accepted for payments that are denominated in dollars, including our taxes, and thus held (demanded) to make such payments.  Almost no Bitcoins are held to make payments as almost no one will accept them for payments.  But I want to focus on a currency’s supply.

There are fundamentally three broad approaches to determining the supply of a currency.  Historically, the supply of most currencies were determined by fixing their price to what they could be redeemed for, such as gold or silver. I have called such a system for regulating money’s supply, a hard anchor. “Real SDR Currency Board”  The value of a currency can be fixed (the price set) to something real such as gold or a basket of goods.  A country with a strict gold standard, which the U.S. never really had, issues its currency (dollars) whenever anyone wants to pay the fixed gold price for more of them.  If the dollar price of gold in the market rises above its official price, there would be an arbitrage profit from buying gold from the central bank at its lower official price.  Such gold could be resold in the market at the higher price.  But the key point is that this mechanism (what I call currency board rules) of redeeming currency reduces its supply and thus reduces prices in this currency in the market (deflation).  Several of the monetary systems I helped establish, work in this way (Bulgaria and Bosnia and Herzegovina). “One Currency for Bosnia”

The most common system of monetary control today is for the central bank to determine its currency’s supply by buying or selling it in the market (the Federal Reserve can buy treasury bills, etc. to increase the supply of dollars).  Most central banks today adjust their money supplies in an effort to achieve an inflation target (a much more complicated subject). “Czech National Bank: Inflation Targeting in Transition Economies”  Generally they do so by setting an intermediate target for a short-term interest at which market participants (banks) can borrow from the central bank.  Such fiat currencies, such as the U.S. dollar, are not redeemable but are widely accepted in payment for goods, services and debts.

This brings us to Bitcoin.  The supply of Bitcoin is determined by a formula that predetermines its gradual growth to 21 million by 2140.  There are currently about 19 million in existence.  The supply is increased by giving them to successful miners for verifying the legitimacy of each transaction (another complicated subject).  Thus, the issuer (the formula) received services (protection against double spending the same coin) but no assets such as gold or treasury bills for creating and issuing new Bitcoins.  Once created, an issued bitcoin can never be redeemed (i.e. the outstanding supply can never be reduced).  When you spend or give away your Bitcoins you are circulating them to other holders, not redeeming them.

When my imaginary aunt Sally discusses Bitcoin and cryptocurrencies more generally, she tends to mix up the marvelous new payment technologies for paying my dollars all over the world with private money such as Bitcoin and Tether.  She also doesn’t seem to quite understand that most money has always been privately produced including the U.S. dollars that we spend in various ways (occasionally even by handing over cash).  “A shift in monetary regimes”

But these distinctions are critical when considering what role the government should play in our monetary system.  The truly amazing technical progress we have experienced and the dramatic increase in the standard of living of the average person it has delivered over the last century was made possible by a government that provided a general framework in which we, the consuming beneficiaries of this progress, could make informed choices.  Our government, wisely, generally did not make such decisions for us.

With that in mind consider “a letter addressed to Senate Majority Leader Charles E. Schumer (D-N.Y.), Senate Minority Leader Mitch McConnell (R-Ky.), House Speaker Nancy Pelosi (D-Calif.) and other congressional leaders, [from 26 influential technology personalities that] outlined what it described as potentially grave dangers of cryptocurrencies.” They are absolutely correct to expose and condemn the technical and economic weaknesses of blockchain technology—the distributed ledger with which Bitcoin claims to avoid the need for trusted third parties to record and document payment transaction (as happens on a centralized ledger when you pay from your bank deposit). 

But the fact that foolish people invest in Bitcoin and other cryptocurrencies does not justify our government prohibiting and restricting them from doing so.  The government requires the banks in which we put our money to publish properly audited financial statements of the assets backing our deposits and to set minimum capital requirements to protect against the possible loss of bank asset value (e.g., loan defaults).  Cryptocurrencies claiming redeemability at a stable value (so called stable coins) should similarly be required to disclose the rules by which they operate and the composition and value of the assets backing their digital coins.  In short, government regulations should help us decide what we want to buy and/or hold without restricting the ability of fintech pioneers to explore and innovate products to offer.

Overly restrictive regulations create incentives for incumbents to create barriers to competition.  Large and intrusive governments tend toward corruption.  The Federal Reserve System seems quite aware of these risks as it cautiously explores whether to compete with the private sector in developing a central bank digital currency.  “Econ 101-Central  Bank digital currency-CBDC”

So when considering the government’s role in money and payments be sure to clearly distinguish money from payment technology and limit government to setting the rules of the game that maximize the ability of private consumers to make wise choices. But perhaps the biggest policy decision of all is how the government should determine/regulate the supply of its currency, most of which is privately created.  I support a currency whose value is fixed to something real (a hard anchor) and whose supply is determined by the market via currency board rules.  “A libertarian money”  

Econ 101: Retail Central Bank Digital Currency (CBDC)

The history of money is long and fascinating. Even the currency most frequently used in the United States has a rich history. Money makes possible the specialization and trade upon which our great wealth depends. Through its long history of development and evolution, money has serviced two key functions. It provides the standard unit for pricing traded goods and services so that their values can be meaningfully compared (it’s the unit of account) and it is the common asset in which payments are made (it’s the medium of exchange or payment).

Medium of Payment–Money

When you hire the neighborhood boy to mow your lawn, you probably first agree on a price (the number of dollars) This is the unit of account function of money, which is indispensable for the functioning of markets.  You could agree to trade with the neighborhood boy a nice lunch with lemonade in exchange for his mowing your lawn. But paying him $15 in Federal Reserve Notes has the advantage that he can exchange it for your lunch, or he can buy his lunch at Wendy’s or anything else of his choice.

Obviously, markets can’t really function if each item or service is priced in a different money unit (dollars, Euro, rubles, bitcoin, etc.). The Continental Congress of the United States authorized the issuance of a new currency, the US dollar, on July 6, 1785. Following the ratification of the Constitution of the United States, the new Congress established the United States dollar as the official currency of the United States in the Coinage Act of 1792. The Act also established the United States Mint, which produced and circulated coins with a fix amount of gold or silver (later only gold). “History of the United States dollar”  

As the result of the changing relative price of silver for gold, the bimetal gold/silver standard was replaced with the single metal standard of gold. The dollar was redefined in 1900 as “twenty-five and eight-tenths grains of gold nine-tenths fine,… and all forms of money issued or coined by the United States shall be maintained at a parity of value with this standard.” Fast forwarding through WWI and WWII and the creation of the Bretton Woods Institutions and the failure of the US to adhere to the requirements of the gold standard, the US “closed its gold window” and proceeded with varying degrees of success to manage the supply of its currency so as to preserve its purchasing power.

Over this long history many private actors (banks) created dollars. There are in fact thousands of private producers of dollars (Chase dollars, B of A dollars, etc.) Glossing over the details, it was a one currency system–the US dollar–because each bank’s currency could be redeemed for gold at  fix price or, after the creation of our central bank in 1913, for a deposit at a Federal Reserve Bank. This is obvious when you pay with Federal Reserve Notes, which are direct obligations of our central bank. Originally each note was identified by the Federal Reserve Bank that issued it–there were twelve of them–but even that distinction has been eliminated. Few people even noticed the difference. But most of our dollar money supply (M1: Federal Reserve Notes in circulation plus demand deposits at banks) is privately produced by banks and exists in digital form as accounting records with each of our banks.

Means of Payment

Our money–US dollars (or Euros or bitcoin)–is quite distinct from the various ways in which you can pay it–payment technologies. Cash payments–the transfer of Federal Reserve Notes from me to you–are hand delivered. But most payments are made by digitally transferring an amount of dollars from my bank account to yours. Such digital payments have the obvious advantage of enabling you to pay someone across town, across the country or even across the world (if they accept your currency) plus the safety of keeping your money in the bank pending such payments.  It’s not recommended that you send cash in the mail. The key insight is to understand how my dollar balance in my bank gets to your account at your bank and why your bank is willing to accept it. The quick answer is that your bank will not generally accept a claim on my bank but will record my payment because it receives an increase in its deposits at a Federal Reserve Bank of that amount.

In the old days I wrote a check that authorized my bank (after the check was deposited by you at your bank, which sent it to my bank) to debit my balance with the indicated amount and to transfer that amount from its balance at the Fed to your bank’s account at the Fed. SWIFT performs this payment instruction/authorization function for cross border payments (i.e., those involving two central banks). Today I issue this instruction directly to my bank electronically on the internet or my smart phone. The “dollars” are one currency no matter who creates and issues them because whoever receives them can redeem them for balances at the central bank (or in the old days for gold).

Visa, Master Card and American Express credit cards provide payments on my behalf by lending me the money before I actually make the payment from my bank account to the credit provider at the end of the month. The loan to me involved in such payments, increases the cost of this type of payment.

The execution of the interbank portion of my payments have become increasingly efficient over time but can still take several days because the Federal Reserve Banks do not operate in the evening or on weekends. When our central bank launches FedNow next year it will allow the continuous processing of payments between banks 24/7.

The front end of the payment process, i.e., my initiation of a payment to you, for example, has also benefited from software improvements. Unlike bitcoin, Ethereum, or Ripple, which are currencies, Zelle, Venmo, PayPal, etc. are payment technologies rather than money. They are means for paying US dollars (or other currencies) from me to you. Venmo, for example can be thought of as the payment service part of a bank. It can hold money for you and can transfer it to others (who must also have a Venmo account) but Venmo cannot make loans with your money. Thus, people without bank accounts can use Venmo as if it were a bank account.

The Federal Reserve and other central banks are investigating whether they should also provide the service to the public of paying dollars with so called Central Bank Digital Currency (CBDC). The Federal Reserve defines a CBDC “as a digital liability of the Federal Reserve that is widely available to the general public.” “Money and payments–Fed report”  CBDCs would be a direct claim on the central bank like Federal Reserve notes (cash) but would be held and transferred digitally like your bank deposits. If the Fed goes forward with introducing CBDCs, they would almost certainly be what are called retail CBDCs. Rather than opening accounts at the Fed directly, we would each do so through a bank. We would sign up with and deal with a bank to hold the Fed’s CBDCs. The Fed has no existing capacity to deal directly with each of us in the way that our banks do. The balance of this note will explore how such CBDC would compare with, say, Venmo balances and payments and whether they are worth the trouble.

All digital money is recorded on electronic ledgers, either distributed as with a block chain used by bitcoin, or centrally maintained as with our bank accounts. As block chains are slow and expensive to verify, they would not be used for CBDCs. Just in case you didn’t know, when you walk into your bank and deposit cash, they don’t put it in the value for you. They record the value of the cash you delivered in our account with the bank, and they return the cash to the Fed for a credit to your bank’s Fed account or invest or lend it to someone else (after having converted it into a balance in their Fed account). It is both useful and interesting (to us economists at least) to walk through how my deposit at my bank is transferred to you (your account at your bank).

Taking Venmo as the example of existing digital payment technology, your deposit of dollars to your Venmo account would be digitally transferred from your bank account to your account on Venmo’s ledger. Your bank would transfer the same amount to Venmo’s deposit account with its bank (in the name of PayPal, which owns Venmo) in the usual interbank transfer manner. All (double entry) financial ledgers have a liability side (your deposit with the bank — what the bank owes you) and an asset side (the cash you deposited or the balance in your bank’s fed account for the money you had transferred to it). The ledger shows what the bank owes (liabilities) and the assets it holds with which to pay out what it owes (assets).

All digital money, whether your bank deposit or Venmo or bitcoin, must provide for an on ramp into and off ramp out of the digital system, i.e., for the process of paying cash in to acquire the digital money and of drawing it out as cash. Interestingly, Kenya has had a version of Venmo payments for several decades already. Kenya’s M-Pesa The ownership and use of cell phones (not necessarily smart phones) is very widespread in Kenya, while bank accounts are far more limited. Thus, people paid for phone airtime by the hour by paying cash to street venders selling such service. This became the on ramp for the unbanked to fund their M-Pesa mobile money accounts.

If you have money in your Venmo account (a positive balance), you can issue a payment instruction via your Venmo wallet directly to the friend you are paying. You can also instruct Venmo to take that the money simultaneously from your bank account. You can do all of this on your smart phone while waiting for your drink at a local bar. If your friend doesn’t have a Venmo account, Venmo will instruct her on how to set up one in order to receive your payment. If you give Venmo a day or two to complete the payment, it is free. If you want it delivered immediately (within a few minutes) there is a small fee. When the payment is complete, your balance at Venmo (or your bank) will have been reduced by the amount of the payment and your friend’s balance with Venmo will have been increased by the same amount. She can leave the money there or move it to her bank account (on her cell phone) if she has one. The money will “exist” as an accounting record somewhere. These “dollars” are accepted from wherever they come (from whoever produced them) because they are claims on, or are converted into deposits at, a Federal Reserve Bank.

How would this compare with a payment with central bank digital currency (CBDC)? While the Federal Reserve has not indicated the details of a possible CBDC, it would probably work something like this. I would ask my bank to sell me CBDCs by debiting my checking account by the indicated amount. These would be added to (credited to) my CBDC account at my bank.  My bank would transfer that amount from its general account at its Federal Reserve Bank to a segregated CBDC account at the Fed. My cell phone wallet would record (by accessing my CBDC account at my bank) this amount, and my bank would back it 100% with its CBDC account at the Fed.

Why does this matter? It matters because if my bank fails (goes into bankruptcy), the amount in the bank’s CBDC reserves at the Fed would be excluded from the bankruptcy process. They are exclusively and fully available to back my CBDC holdings. When I pay CBDC to my friend, her bank will receive them without regard for the condition of my bank.

Some of you will recognize this as the equivalent of the so-called Chicago Plan. The Chicago Plan required banks to back all checking account deposits 100% with central bank reserves. Our bank deposits today are largely backed by bank loans and investments plus a small deposit with the central bank. Such CBDC deposits would be totally free of default risk. While all CBDCs would exist on the books of the Federal Reserve, ownership by individuals would be reflected on the books of their respective banks and in their CBDC wallets.

Like the Chicago Plan, CBDCs have the potential to reduce the money multiplier (the ratio of broad money to base money–the Federal Reserve’s monetary liabilities). A shift from demand deposits to CBDC deposits at banks would reduce the funds available to banks for lending by increasing the reserves they must hold at the Fed. This could be easily compensated for by increasing base money (Federal Reserve monetary liabilities). Sudden shifts to the safer CBDCs in reaction to financial shocks, like traditional bank runs, would require central bank intervention. The Fed has also indicated that it would want any digital replacement of its currency notes to provide as much user privacy as possible (like cash) consistent with “affording the transparency necessary to deter criminal activity.”

How would this compare with a Venmo payment. From our perspective (the perspective of the payer and payee) a Venmo or CBDC payment would be executed in the same or very similar way. The difference is that the CBDC balances would be totally risk free (being relatively direct claims on the central bank) while the Venmo balances would be exposed to the risk of the failure of the bank in which Venmo keeps its assets that back our Venmo balances. It is not obvious that this is a big enough difference to make it worth undertaking.

Roe vs Wade

The debate for and against the legality of abortion has been around as long as I have, i.e., for a very long time. Quoting from Justice Alito’s leaked draft of a possible court decision: “For the first 185 years after the adoption of the Constitu­tion, each State was permitted to address this issue in ac­cordance with the views of its citizens. Then, in 1973, this Court decided Roe v. Wade, 410 U.S. 113. Even though the Constitution makes no mention of abortion, the Court held that it confers a broad right to obtain one.” “Alito draft annotated”

Should the Supreme Court rescind Roe vs Wade, it would not make abortions illegal or necessarily restrict when they would be allowed. The current standard is that an abortion is permissible before the fetus becomes viable (likely to live if delivered). What rescinding Roe vs Wade would do is return the determination of the rules on abortion to the elected representatives in each state.  I have always been “pro-choice”, but I also believe that policy in a democracy should be determined by voters and their representative. I am comfortable with either a state-by-state determination or a federal determination, but I would like to see the status quo preserved. By that I do not mean that Roe vs Wade should be upheld, as it is simply an incorrect interpretation of the Constitution as Alito correctly claims: “even abortion supporters have found it hard to defend Roe’s reasoning.”

As Alito has also explained: “The abortion right is also critically different from any other right that this Court has held to fall within the Fourteenth Amendment’s protection of ‘liberty.’ Roe’s defenders char­acterize the abortion right as similar to the rights recog­nized in past decisions involving matters such as intimate sexual relations, contraception, and marriage, but abortion is fundamentally different.”  The Fourteenth Amendment provided for the protection of equal rights for all people. What any two straight, white people can do, black and/or gay people have the right to do as well, such as marry.

The almost hysterical reaction to the possibility of overturning Roe vs Wade is unwarranted. It will not make abortions illegal. As Alito stated: “It is time to heed the Constitution and return the issue of abortion to the people’s elected representatives.”

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.

A Libertarian Money

The long history of money began to take its modern form with the development of national central banks. “The story of central banking goes back at least to the seventeenth century, to the founding of the first institution recognized as a central bank, the Swedish Riksbank. Established in 1668 as a joint stock bank, it was chartered to lend the government funds and to act as a clearing house for commerce. A few decades later (1694), the most famous central bank of the era, the Bank of England, was founded also as a joint stock company to purchase government debt.”[1] Over time central banks were given a monopoly over issuing their country’s currency and usually for regulating the country’s banks, which create most of each country’s money.

Generally, the currencies issued by central banks (or commercial banks) were claims on, and thus redeemable for, gold or silver. The gold standard oversaw a long period of trade expansion and economic flourishing. A currency’s fixed price for gold regulated the money supply both domestically and between other countries also on the gold standard, keeping its supply consistent with the fixed gold price. Countries, like individual families, cannot buy more that they sell over their live time (whatever the lifetime of a country might be). The gold standard, via the price-specie flow mechanism, preserved such balance of trade between gold standard countries.

Two countries on the gold standard, with fixed prices for gold for their currencies, have an unchangeably fixed exchange rate for their two currencies. But if the domestic purchasing power of each currency changes (inflation or deflation) the real value of the nominal exchange rate will appreciate or depreciate. The real exchange rate adjusts via changes in the domestic prices of one country relative to the other.  If a country buys more abroad than it sells abroad, the outflow of its money to pay for its trade deficit will reduce its money supply if gold standard rules are observed (gold flows out and the supply of currency backed by that gold contracts). The reduction in its money supply will reduce domestic (and thus foreign) prices in that money. This adjustment in domestic prices relative to foreign prices, which make foreign goods relatively more expensive domestically and domestic goods cheaper abroad, will reduce and eventually eliminated the trade deficit.

When the United States established the Federal Reserve System, its central bank, in 1913, it continued to fix the price of the currency it issued in gold. But it only adhered to gold stand rules loosely and in 1971 no longer had enough gold to honor its commitment to foreign central banks to redeem its currency for gold. Thus, on August 15, 1971, President Richard Nixon “closed the gold window.” The era of the value of currencies anchored by (fixed to) gold or some other hard anchor was over. The Federal Reserve and other central banks needed to develop other criteria for determining the supply of their currencies.

Following the inflationary experience in the U.S. in the 1960s and 70s, there were more and more demands for clear rules for the Fed’s regulation of is money supply, now that it was no longer constrained by a hard anchor (e.g., the price of gold). The objective of monetary policy was broadly accepted around the world to provide a stable value for the currency, though the Federal Reserve was shackled with the dual mandate of price stability and maximum employment. The short-term demand for money was not sufficiently stable for a Friedman rule (fixed growth rate for base, narrow, or broad money – M0, M1, or M2). Inflation forecast targeting (IFT) has evolved to become the state of the art of fiat money supply rules.

In IFT regimes, the central banks’ policy instruments (primarily the interest rate at which it lends to banks) are transparently set on the expectation (based on model forecasts and judgement) that in one to two years in the future they will produce (or maintain) the central bank’s target for inflation. While this approach has performed relatively well, its management of the money supply has been far from perfect and central banks are experiencing increasing government pressure to relax their price stability mandates. And then there are a few countries whose central banks have caved to fiscal dominance and behaved terribly.

Would some cryptocurrency, ala Hayek, provide a better monetary system? Some people claim that libertarians like cryptocurrencies like bitcoin because they do not rely in any way on government. Perhaps those people meant “anarchists” because libertarians accept the critical importance of government in defining and protecting property rights and personal safety. Cryptocurrency providers have been lobbying the U.S. congress (and others) to set out the rules for their legal operations. Are they money or speculative assets?  Bitcoin and most other cryptocurrencies do not satisfy the requirements for a good libertarian money because they do not satisfy the requirements for good money. This article explains why this is so and defines properties of a good libertarian money.

Are Cryptocurrencies the Answer?

Economists note the incredible power of markets and market prices in directing our scarce resources (our labor, capital, and technology) to their best uses. But prices are expressed in terms of money, the common unit of account that facilitates comparing relative values.

The presumption, and actual reality, is that within each market prices are expressed in terms of the same money. It would not facilitate our choices if apples were priced at $6 per bushel and oranges at 3 bitcoin per bag. Presently, virtually nothing is priced in bitcoin. In addition, sellers don’t generally accept payment in a currency other than the one in which the good’s price is expressed, thus very few sellers will accept bitcoin in payment. Moreover, you can only accept bitcoin in payment if you have a bitcoin account together with the software required (a bitcoin wallet).

None of these are insurmountable barriers to growth in the use of bitcoins or other cryptocurrencies, but they do require strong incentives for putting up with and/or overcoming them. I explained the basics of bitcoin’s value in the linked blog in 2014: “Cryptocurrencies-the bitcoin phenomena”[2] One incentive would be to replace the established currency in a market (a country’s legal tender) that has very unstable value (think Zimbabwe, Venezuela, Argentina, Brazil at various times in their histories). Another would be the need for anonymity (as is achieved with paper currency) that an illegal drug dealer or a political dissident in a repressive regime might require and find convenient.

Some mistook Fredrick Hayek’s “Competition in Currency” as an endorsement of what we now call cryptocurrencies. In the Preface to that book Arthur Seldon explained “The requirement is not to deprive government of the power to issue money but to deny it the exclusive right to do so and to force the citizenry to use it at the price it specifies. It is thus the government monopoly of money that is objectionable, and history is full of examples of governments that have attempted to enforce their power by extreme measures, including the ultimate sanction of death. The solution is therefore to allow people to use the money they find most convenient, whether the money issued by their own government or by other governments.”[3]

When the Zimbabwean dollar became worthless, reaching annual inflation rates of 10,000 percent in 2007 and exploding in 2008 with an estimated peaked rate in September 2008 of about 500 billion percent per annum, the Zimbabwean government legalized the use of foreign currencies and the country immediately dollarized (priced and paid in U.S. dollars flown in from South Africa). This was the remedy Hayek proposed and it ended inflation almost instantly.[4]

Later in 1976 Hayek followed up his Competition in Currency proposal with the more radical broadening to private currencies in his AEI pamphlet Denationalization of Money, An Analysis of the Theory and Practice of Concurrent Currencies.[5] Most money these days is privately produced by your and my banks (our deposits), but they are fixed in value to and ultimately exchangeable for the U.S. dollars created by our central bank. They are part of the U.S. dollar money supply. Bank deposits are not alternative, private units of account. In this second book Hayek was broadening his call for currency competition to the bitcoins of the world. Hayek was proposing that inflating central bank currencies should face competition from privately produced units of account and monetary assets (medium of exchange and payment).

Otmar Issing, Chief Economist of the ECB and member of its Executive Board from 1998 – 2006, concluded that adopting Hayek’s proposal “We would ‘discover’ that private currency competition – at least nowadays – would not work and would not serve the people affected.”[6] I made the same point to Hayek directly in a debate at the 1976 Mont Pelerin Society meetings in St. Andrews, Scotland. Competing private units of account would undermine an essential function of money in market economies (communicating the relative value of things). In high inflation countries, such as Venezuela, many things are priced in U.S. dollars. However, the Venezuelan government has made payments in dollars illegal. In such cases, Bitcoin and other cryptocurrencies are used to some extent to make dollar denominated payments. But as the value of Bitcoin is so unstable, holding on to then is very risky.

In El Salvador, which had successfully dealt with inflation by dollarizing a decade ago, President Nayib Bukele added Bitcoin as legal tender as of September 7, 2021. Though this legally obliges merchants to accept Bitcoin in payment, “few ordinary folk use…. Bitcoin, which has lost 70% of its value since November, is far too volatile to be a good store of value, especially in a country where GDP per person is $4,400.” according to a June 16, 2022, article in The Economist.[7] No one prices in Bitcoin.

Cryptocurrencies that use a Block Chain or Distributed Ledger Technology suffer from other problems as well. Bitcoin’s claim to eliminate the trusted third party (bank accounting systems) required by existing electronic (digital) payments with bank deposits, is particularly attractive to libertarians.  But this claim is a gross exaggeration. To prevent the double spending of the same bitcoin, each transaction must be verified by so called miners (third parties you don’t need to trust) which takes five to ten minutes and very large amounts of electricity to process as miners race to solve increasingly difficult mathematical puzzles. Also, all transactions are very public on block chains, though accounts may be held under pseudonyms and are thus described as pseudo-anonymous.

Though actual bitcoin transactions have been made easier via the development of software wallets, many assign their bitcoins to exchanges (trusted third parties).[8]  The loss of a bitcoin owner’s password to his account is fatal and final. Those bitcoins are lost forever. But more deadly to the use of bitcoin as money (unit of account and medium of payment) is the volatility of its value.  The price of a bitcoin has ranged from just under $30,000 to over $67,500 over the last year. It fell to $18,958 on June 18, 2022. Thus, payments of bitcoin generally involve temporarily purchasing them with dollars or some other stable currency and then exchanging them back to dollars as quickly as possible after receipt. The costs of these exchanges are often overlooked when claiming that bitcoin transfers are cheaper than traditional means of electronic payments. Of equal importance is that for an asset to function as money, it must be generally or at least broadly accepted for payments. Bitcoin fails this requirement miserably. Most buyers and sellers of bitcoin are indulging in a form of gambling rather seeking a “good” medium of payment.

Bloomberg exposes a false “libertarian” attraction to Cryptocurrencies on blockchains:

“An app running on, say, Ethereum, can’t easily be taken offline, since there’s no particular host or entity that can take it down.

“This architecture is inherently oppositional to governments and large corporations, and it’s for this reason that crypto has so much embedded politics. The whole space traces its roots back decades to hippies and hackers in Northern California, who anticipated that in an online world, pure cash-like peer-to-peer transactions would be impossible. When you pay a friend using Zelle or something, the payment goes through a series of intermediaries. You can get kicked off Venmo for buying a Cuban sandwich. Bitcoin can’t kick you off the network for anything.

“Take away the uncensorability of crypto, and all you’re left with is Ponzi schemes, dog coins, and drawings of monkeys. (Wait! That’s basically all that exists right now in the space, so ignore that thought.)”[9]

Unlike bitcoin, which are not redeemable for anything, so called stable coins have a fixed price for some other legal tender currency or even, potential, gold. The quality of the assurance of a stable price, and redemption at that price, vary considerably. Appropriate regulation that required transparency and external audit would be good. But the payment technology that has emerged in recent years such as PayPal, Venmo, or Zelle to transfer U.S. dollars (claims on bank accounts and ultimately on the Federal Reserve) have already introduced efficient, low cost, and fast payments of legal tender currency. The Federal Reserve is also modernizing its interbank settlement system. FedNow, which will operate real time 24/7 began testing in September and is expected to be operational in the summer of 2023. It is hard to see any further advantages introduced by so called stable coins.

The Libertarian Alternative

There are monetary regimes, however, that satisfy libertarian preferences for minimal government involvement and manipulation while satisfying truly valuable needs. The Constitution of the United States provides the authority for such a regime in Article I Section 8 “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;” The classical gold standard was such a system. However, its “rules” were diluted when taken over by central banks. Moreover, the practice of actually buying and storing gold distorted its market price and was costly, flaws that are avoided in the system I propose below.

In the U.S. today, as well as every other country in the world, there are thousands of private companies that create and offer their own currency. Most of them are banks. While that would seem to make libertarians happy, thousands of individual bank producers of money would not constitute an efficient monetary system without rules and mechanisms for linking them into what we think of as one currency–in our case the U.S. dollar.

While the dollars deposited in my bank are my bank’s liability, I am protected from the bank’s failure by deposit insurance. Your bank accepts my deposits in my bank because my bank credits your bank’s account with the Federal Reserve (by debiting its account with the Fed). In short, the deposits at thousands of different banks are accepted by every other bank because they are all ultimately claims on the Fed. This is similar to the gold standard in which the money created by thousands of banks were accepted everywhere because they were redeemable for a well-defined amount of gold.

Libertarians want a currency and monetary system that can’t be manipulated by the government (central bank).  The dollar is now a fiat currency, redeemable for a deposit with the Federal Reserve, and very importantly, acceptable by the government for the payment of taxes. Thus, its supply is determined by the Fed’s judgement of what is needed for “price stability and maximum sustainable employment.” We libertarians want a currency that we each individually control the supply of. In short, we want a currency with a hard anchor (which was the case for the gold standard) supplied according to currency board rules (which historically were violated by central banks nominally anchored by gold).

Currency board rules require the currency issuer to sell or repurchase its currency at its fixed price in response to public demand. Any number of private producers of dollars redeemable at an officially fixed price for a well-defined anchor (gold, aluminium, a basket of goods, etc.) would result in a money supply determined by the public that was consistent with and appropriate for its fixed price to the anchor and that was fully interchangeable. The central bank would be passive. It would have no monetary policy (beyond the fixed price for the anchor). This seems like libertarian heaven.

In addition to being anchored to a single commodity whose relative price could vary more than would the price of a basket (portfolio) of commodities, the gold standard was flawed by central banks actually buying and storing gold and thus distorting its market price. An ideal regime would use the anchor for setting the currency’s issue and redemption price but the anchor itself would not be purchased and stored by the central bank. Instead, the central bank would issue its currency for assets (such as treasury bills) of equivalent market value to the anchor. The arbitrage mechanism works just as well with this “indirect redeemability”[10]

I led the IMF teams that established the Central Bank of Bosnia and Herzegovina, which follows currency board rules. I have written a book about that experience.[11]  I also participated in Bulgaria’s central bank’s adoption of currency board rules. The currencies of both countries are anchored to the Euro and their currency experiences have been outstanding. Their money supplies are basically regulated by market arbitrage. If the market exchange rate of the Bulgarian lev to the Euro rises above its official rate, it would be cheaper for the banks that issue lev to buy Euros from the Bulgarian National Bank thus reducing the supply of lev in the market and lowering its market price for Euro. See my article on Bulgaria’s experience.[12]

A Libertarian International Reserve Currency

What about cross border payments? In brief, cross border transactors have found it economical to price and settle transactions in a vehicle currency, usually the US dollar. The increasingly frequent deployment of sanctions enforced by restricting the use of the dollar has intensified the search for alternatives. See my more detailed discussion in “The Empire and the Dollar”[13]  The search for alternatives to the dollar as proposed by Russia’s Sergey Glazyev[14] risks fragmenting the global market place.

The International Monetary Fund has already created such an alternative. An internationally established unit (anchor) is much less likely to be abused for national political purposes, but the IMF’s Special Drawing Right (SDR) suffers from some serious defects. However, these can be fixed.[15] [16]  

The SDR can be “fixed” in two stages. The first is to develop the private sector’s uses of the SDR unit of account (invoicing oil and other globally traded commodities in SDRs, borrowing and lending denominated in SDRs, SDR bonds and bills, and digital SDR deposits–eSDRs). See my more detailed discussion in “Proposal for an IMF Staff Executive Board Paper on Promoting Market SDRs.”[17] As with national currencies, where hundreds of individual producers of the national currency are made interchangeable by being claims on the central bank, the market SDRs of many competitive producers would be interchangeable as the result of being redeemable for the official SDR of the IMF.[18]

The second stage would require a reform of the IMF’s official SDR. Rather than allocating them from time to time to all IMF members, they should be issued according to currency board rules. In addition, the valuation of the official SDR should be changed from its current basket of five currencies to a small basket of homogeneous, globally traded commodities. The IMF’s existing rules for periodically adjusting the SDR’s valuation basket are transparent and appropriate and should continue to be used. In one sense, this would re-establish an improved international gold standard like system. It would be improved on the gold standard by replacing a single commodity anchor with a small portfolio of commodities and its supply would be improved by adopting the market driven rules of a currency board. Such a Real SDR issued by the IMF would bring to international payments the same hard anchor and currency board rules favored by libertarians for domestic currencies.[19]

[1] Michael D. Bordo, “A Brief History of Central Banks” Federal Reserve Bank of Cleveland, Dec 2007 https://core.ac.uk/download/pdf/6670255.pdf

[2] Warren Coats: “Cryptocurrencies—the Bitcoin Phenomena,” Feb 14, 2014, https://wcoats.blog/2014/01/25/cryptocurrencies-the-bitcoin-phenomena/

[3] F. A. Hayek: Competition in Currency, A way to stop inflation, The Institute of Economic Affairs, Feb 1976, London

[4] Warren Coats: “Hyperinflation in Zimbabwe” Jan 25, 2014, https://wcoats.blog/2009/05/29/hyperinflation-in-zimbabwe/

[5] F. A. Hayek: Denationalization of Money The Institute of Economic Affairs Oct 1968 London

[6] Otmar Issing: “Hayek’s Suggestion for Currency Competition: A Central Banker’s View,” Chapter 8 of Stephen F. Frowen (editor): Hayek: Economist and Social Philosopher, A Critical Retrospect, Macmillan Press, 1997, London

[7] The Economist, “El-Salvador’s Government is Gambling on Bitcoin” June 16, 2022. https://www.economist.com/the-americas/2022/06/16/el-salvadors-government-is-gambling-on-bitcoin

[8] Warren Coats: “The Future of Bitcoin Exchanges, March 3, 2014,
  https://wcoats.blog/2014/03/03/the-future-of-bitcoin-exchanges/

[9] Bloomberg: https://www.bloomberg.com/news/newsletters/2022-08-18/five-things-you-need-to-know-to-start-your day?cmpid=BBD081822_MKT&utm_medium=email&utm_source=newsletter&utm_term=220818&utm_campaign=markets  Aug 18, 2022

[10] R. L. Greenfield and L. B. Yeager, 1983, “A Laissez Faire Approach to Monetary Stability”, Journal of Money, Credit, and Banking 15: 302-15.

[11] Warren Coats, 2007: “One Currency for Bosnia – Creating the Central Bank of Bosnia and Herzegovina” Jameson Books, Chicago Ill.   https://wcoats.blog/2008/08/13/one-currency-for-bosnia-creating-the-central-bank-of-bosnia-and-herzegovina/ or  “Amazon– One Currency for Bosnia”

[12] Warren Coats: “Bulgaria and the Chicago Plan” Central Banking Vol. XXX Issue 3 (2020)
Available at: http://works.bepress.com/warren_coats/51/

[13] Warren Coats, “The Empire and the Dollar”, John Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise, Studies in Applied Economics, SAE./No.207/March, 2022, https://www.dropbox.com/s/7bnvejb5zhqzatj/The-Empire-and-the-Dollar-by-Warren-Coats.pdf?dl=0

[14] Pepe Escabar, “Exclusive: Russia’s Sergey Glazyev introduces the new global financial system” The Cradle April 14, 2022

[15] Warren Coats. “Time for a New Global Currency?” New Global Studies Vol. 3 Iss. 1 (2010)
Available at: http://works.bepress.com/warren_coats/1/

[16] Warren Coats, Dongsheng Di and Yuxuan Zhao. “Why the World needs a Reserve Asset with a Hard Anchor” Frontiers of Economics in China (2017)
Available at: http://works.bepress.com/warren_coats/34/

[17] Warren Coats: “Proposal for an IMF Staff Executive Board Paper on Promoting Market SDRs” The Bretton Woods Committee Feb 19, 2019 :  “Promoting Market SDRs”

[18] Warren Coats: “Real SDR Currency Board” Central Banking Journal Vol. XXII Iss. 2 (2011)
Available at: http://works.bepress.com/warren_coats/25/

[19] Warren Coats. “Free Banking in the Digital Age” Banking & Finance Law Review Vol. 33 Iss. 3 (2018) p. 415 – 421 ISSN: 0832-8722 Available at: http://works.bepress.com/warren_coats/45/

Why does Turbo Tax want our data?

The usually helpful Geoffrey A. Fowler’s article in today’s Washington Post reveals that Turbo Tax and H&R Block want our tax data “to target you with “offers” — or, as they’re more commonly known, advertisements.” For them to take and keep these data we must agree. Mr. Fowler asks, “did you know that by clicking ‘agree’ to some of their privacy prompts, you may be letting them use you?”  “Tax Prep Privacy”  

Wow. Econ Prof Coats was immediately aroused.

Turbo Tax, like any other company, is in business to make money. It makes money by developing products we like enough to pay for. We are presumably better off as a result. In looking for tax assistance software, we can search the web for what we think would be useful. Or, if Turbo Tax has developed something they anticipate we would like but might not know about, they can advertise it in the hopes that we will be interested and try their new product. Or if they have information from our earlier tax returns that enable them to refine their list of who might benefit from their product, they can target only those specific individuals with their “ad” while sparing millions of others from getting the ads they have no interest in. Like most economic transactions, this would be win-win.

I clicked “agree.”

The Empire and the Dollar

Committee for the Republic Salon

March 24, 2022

Warren Coats[1]

In our multicurrency world, the U.S. dollar is widely used for pricing internationally traded goods, for international payments, and for denominating the assets governments and companies hold as reserves. Why is that and what are its implications for U.S. behavior? What would a better system look like?

In a world of many different national currencies, the payment for international trade has found economy in using an intermediate, so-called vehicle currency to facilitate the exchange of the buyer’s currency into and delivery of the seller’s currency. Following the collapse in 1971 of the dollar-based gold exchange standard overseen by the International Monetary Fund, the dollar continues to dominate in this role. This role has given the United States important political power and financial benefits.

I will quickly review these benefits, and how they have come to encourage the U.S. to exploit them in exercising its international power, the forces that are building to seek an alternative, and the potential for the IMF’s Special Drawing Rights (SDRs) to provide an alternative.

The Dollar’s International Reserve Status

Cross border commerce and investments require a common currency to price and denominate them and the mechanisms for cross border payments. While modern technologies continue to increase the speed and ease and lower the cost of domestic payments of domestic currencies, cross border payments remain relatively slow and costly.

The payment and receipt of a currency is ultimately reflected/settled on the books of that currency’s issuer. If I pay you for something and your account is in a different bank than mine, the transfer of funds from my bank to your bank and to you will pass through a Federal Reserve Bank. My bank’s account at the Fed will be debited and yours will be credited.  A fundamental difference between national and international currencies is that the central bank issuers of national currencies only hold deposits for banks that are domestically licensed, while the issuers of international currencies, such as the Special Drawing Right (SDR) of the International Monetary Fund, hold deposits from banks almost anywhere in the world, enabling the settlement of their payments to enjoy the efficiencies of domestic payments in domestic currencies.

The older gold standard functioned more like an international central bank issuer of currencies but without such an international central bank. Instead, national currencies were tied to gold by virtue of the commitment of central banks on the gold standard to redeem their currency for gold at a fixed price. Thus, any net flow of payments from one country to another was ultimately settled by transferring the ownership of the gold it was fixed to from the deficit to the surplus country. This could occur by debiting the deficit country’s gold account at the New York Federal Reserve Bank and crediting the surplus country’s gold account at the same place or by physically shipping the gold.

In today’s world, cross border payments generally involve the need to exchange one currency for another at exchange rates that fluctuate. To facilitate the comparison of prices of globally traded goods (e.g., oil, gold, copper, and other commodities) they are generally priced in one common currency. The U.S. dollar is the currency most widely used for this purpose (79%). This contributes to the use of the dollar for cross boarder payments as well even when the buyer’s currency differs from the seller’s ultimate currency (the currency paid to its workers, etc.). https://www.federalreserve.gov/econres/notes/feds-notes/the-international-role-of-the-u-s-dollar-20211006.htm

Some economy is brought to the markets for foreign exchange needed for cross boarder payments by using a common so called vehicle currency as a common go between. The adoption by airlines of a hub and spoke model for connecting all airports in a country or the world illustrates the economy of a single or small number of vehicle currencies (hubs) to exchange currency X for currency Y. The U.S. dollar is the most widely used vehicle currency for this purpose. This is supported by and reflected in the dominance of the dollar in invoicing internationally traded goods and in the foreign exchange reserves of banks (central and commercial) around the world. The Euro is the second most used currency in these ways.

In 2021 40.5% of international payments were made in US dollars.  The use of Euros in international payments and in reserves has moved up to second place behind the dollar at 36.7% of payments.  The Pound sterling is a distant third at 5.9%. Having passed the Japanese yen a few years back for fourth place the Chinese RMB achieved 3.2% of international payments in January of this year from almost zero a decade ago. “China’s currency scores a win during the Olympics”  The Federal Reserve has constructed an “aggregate index of international currency usage.” The dollar has remained in the neighborhood of 70% for the last two decades. https://www.federalreserve.gov/econres/notes/feds-notes/the-international-role-of-the-u-s-dollar-20211006.htm

To pay for things with a currency, one must hold some amount of that currency. It is this demand for dollar reserves resulting from the widespread international invoicing and payments in dollars, that underlies foreign financing of US debt. For starters, about half of dollar currency (actual banknotes) are held abroad. That is the extent to which we pay for imports with cash and the sellers just hold the cash. Foreign central banks hold almost 13 trillion dollars in foreign exchange reserves of which over 7 trillion is in U.S. dollars (much of that is held in the form of US government debt). About 60% of the foreign currency claims of banks are dollar claims.

The dollar grew into its vehicle and reserve currency roles because of the size of the U.S. economy and its extensive trade with the rest of the world, the size and liquidity of financial assets denominated in dollars, public confidence in the stability of the dollar’s purchasing power, and in its trusted contract enforcement (rule of law).

U.S. Benefits from reserve currency status

The so-called exorbitant privilege of a reserve currency–the ability to borrow abroad in your own currency–makes it easier for the U.S. government to finance its military and other expenditures with debt. For countries to accumulate dollar reserves they must have a balance of payments surplus, i.e., they must sell more to the U.S. than they buy from the U.S.. As a result, American’s enjoy cheaper imports and the excess of dollars paid for such imports over those paid back for US exports are held in foreign reserves (generally in the form of US treasury debt).

As an aside, it is simply wrong to attribute much of the so-called offshoring of our manufacturing to the above phenomenon. The somewhat lower exchange rate for the dollar needed to generate the surplus China and other countries need for the trade surplus with which they buy American debt, does make imports somewhat cheaper. However, even if the dollar was totally replaced in foreign reserves and trade balanced, we would continue to be better off producing what we export and importing what China and the others produce and sell to us. Freely pursuing our comparative advantages increases our incomes and the incomes of the Chinese and others selling to us. Free trade is win-win. Contrary to the myth, U.S. manufacturing is at an all-time high. (Manufacturing employment is lower because of increased labor productivity). https://www.macrotrends.net/countries/USA/united-states/manufacturing-output

The U.S. dollar’s dominance in global trade and finance contributes to the existence of the American Empire in two ways. It attracts foreign financing of the U.S. government and its military industrial complex thus reducing the burden of the empire on the American taxpayer and it provides a tool by which the U.S. can impose its will on other countries or individuals in managing its empire. Borrowing to pay our government’s bills is politically easier than raising taxes and avoids (or delays) a debate over guns versus butter. 

Three factors now challenge the dollars reserve currency role. 1) Cumbersome payment technology: Existing arrangements for cross border payments via the Society for Worldwide Interbank Financial Telecommunication (SWIFT) are technically crude and outmoded. 2) Weaponization of the dollar: The U.S. has abused the importance of its currency for cross border payments to force compliance with its policy preferences not always shared by other countries, by threatening to block the use of the dollar. 3) Growing risk of a decline in the dollar’s value: The growing expectation of dollar inflation and the skyrocketing increase in the U.S. fiscal deficit are increasing the risk of holding and dealing in dollars.

The first factor–payment technology–is temporary. It is being modernized. While payment technology (ease, speed, security, and cost of making cross border payments) is important, it is not as important as the features of the currency being paid. As a currency, the dollar excels for the reasons given earlier.

The second factor–weaponization of the dollar–has been growing in importance as the U.S. has increasingly sanctioned trade and dollar payments without broad international support–Iran, etc.  The EU has sought work arounds in Euros. China and Russia are building alternative payment arrangement using China’s Renminbi. Even with the dramatic increase in coordinated sanctions against Russia, restricting the use of dollars is less effective than directly blocking trade. https://wcoats.blog/2022/03/04/how-to-stop-russia-in-ukraine/  The broad support for sanctions on Russia more likely increases support from the dollar as the dominant international currency rather than reducing it. On the other hand, those on the other side (e.g., Russia and China) will work harder to find alternatives. The balance of these contradictory forces is difficult to assess.

The third factor has never been taken very seriously until now. At the end of February (2022) the US national debt was over 30.1 trillion dollars or 125% of US output (GDP). Federal government interest payments on its net debt were $426 billion per annum. But with the increase in inflation, interest rates are rising. Uncle Sam’s debt service payments are likely to double or triple over the next five to ten years, rising to 15% to 20% of the Federal budget. The world still expects the US to regain control of its spending, but the risks of default are creeping up. Paul “Samuelson stated in 2005 that at some uncertain future period these pressures would precipitate a run against the U.S. dollar with serious global financial consequences.” https://en.wikipedia.org/wiki/International_use_of_the_U.S._dollar

It is the second factor, US abuse of its ability to sanction the use of the dollar that is most threatening to push the dollar over the cliff.

The Alternative to the dollar

An internationally defined and issued currency would have a number of advantages over the use of a national currency for cross border payments.

While the value of the dollar has been quite stable for many years, using a basket of major currencies for pricing internationally traded goods and financial instruments would be even more stable. This is what the International Monetary Fund’s unit of account–the Special Drawing Rights (SDR)– offers. The value of one SDR is equal to the current market value of fixed amounts of the US Dollar, Euro, British pound, Japanese yen, and Chinese yuan. Thus, its widespread use for pricing internationally traded goods and financial instruments would provide even greater stability than would any one of these currencies. Every morning when I check movements in the price of oil, I must ask myself whether it was really a change in the price of oil or in the exchange rate of the dollar. See my: “Why the World Needs a Reserve Asset with a Hard Anchor”

The IMF’s SDR can only be held and used by member central banks and a few international bodies. Thus, private SDRs–so called Market SDRs–are needed for payments by the private sector (perhaps issued by the IMF or the BIS). Being issued by an international body, such Market SDRs would have the equivalent of a central bank for settling cross boarder payments allowing the simplifications and economy increasingly available for domestic payments in the domestic currency. `

Moreover, as an internationally issued currency the SDR would be far better protected from the political abuse increasingly experienced with the US dollar and might be expected with the Chinese RMB or other national currencies.

Getting from here to there

But first things first. Before considering the reform of the international monetary system, let’s consider the reform of the dollar–the reform of U.S. monetary policy. The price of the dollar should be fixed to a hard anchor and issued according to currency board rules.

During the heydays of the gold standard (1820-1913) international trade flourished dramatically increasing global incomes and reducing poverty. According to Antoni Estevadeordal, Brian Frantz and Alan M. Taylor “Until 1913 the rise of the gold standard and the fall in transport costs were the main trade-creating forces.” https://www.jstor.org/stable/25053910  However, to cope with WWI, the Great Depression, and WWII, the gold standard failed and was abandoned because of weaknesses in banking systems and because the countries that fixed the value of their currencies to gold did not fully play by the gold standard’s rules.

Under a strict gold standard, the central bank would issue and redeem its currency whenever anyone bought it for gold at the official price of gold. In fact, however, by actively buying and selling (or lending) its currency for other assets whenever it thought appropriate, the Federal Reserve’s monetary liabilities (base money) were partially backed by U.S. treasury bills and other assets. In addition, the fractional reserve banking system allowed banks to create deposit money that was also not backed by gold. The market’s ability to redeem dollars for gold kept the market value of gold close to its official dollar value. However, the gap between the Fed’s monetary liabilities and its gold backing grew until the market (most conspicuously, France) lost confidence in the Fed’s ability to honor its redemption commitment and President Nixon closed the “gold window” in 1971 rather than tighten monetary policy.

Currency Board Rules

A reformed monetary system that returns to a hard anchor (firmly fixed price of the currency for gold or some other asset) should require the Fed to adhere strictly to currency board rules. Such rules oblige a central bank to buy and sell its currency at a set price in response to public demand. Under the Gold Standard, the price of the currency was set as an amount of gold (a gold anchor). For existing currency boards, the price is typically an amount of another currency or basket of currencies. See my book on the establishment of the Central Bank of Bosnia and Herzegovina (“One currency for Bosnia-creating the Central Bank of Bosnia and Herzegovina”).    The Fed would provide the amount of dollars demanded by the market by passively buying and selling them at the dollar’s officially fixed price for its anchor. All traditional open market operations by the Fed in the forms of active purchases and sales of T-bills or other assets would be forbidden.

The Anchor

Another weakness of the historical gold standard was that the price of the anchor, based on one single commodity, varied relative to other goods, services and wages. While the purchasing power of the gold dollar was relatively stable over long periods of time, gold did not prove a stable anchor over shorter periods relevant for investment.

Expanding the anchor from one commodity to a basket of 5 to 10 commodities with greater collective stability relative to the goods and services people actually buy (as measured by, e.g., the CPI index), would reduce this volatility. The basket would consist of fixed amounts of each of these commodities and their collective market value would define the value of one dollar.  There have been similar proposals in the past, but the high transaction and storage costs of dealing with all the goods in the valuation basket doomed them. However, with indirect redeemability discussed next, the valuation basket would not suffer from this problem.

Indirect redeemability

Historically, gold and silver standards obliged the monetary authority to buy and sell its currency for actual gold or silver. If the dollar price of gold in the market was higher than its official price, people would buy gold at the central bank increasing its market supply and reducing the money supply until the market price came down again. These precious metals had to be stored and guarded at considerable cost. More importantly, taking large amounts of gold and silver off the market distorted their price by creating an artificial demand for them. A new gold standard would see the relative price of gold rising over time due to the increasing cost of discovery and extraction. The fixed dollar price of gold means that the dollar prices of everything else would fall (deflation). While the predictability of the value of money is one of its most important qualities, stability of its value, such as approximately zero inflation, is also desirable.

Indirect redeemability eliminates these shortcomings of the traditional gold standard. Indirect redeemability means that currency is issued or redeemed for assets of equal market value rather than the actual anchor commodities.  Market actors would still have an arbitrage profit incentive to keep the supply of money appropriate for its official value.  As the economy grows and the demand for money increases, this mechanism would increase the money supply as people sell their T-bills to the Fed for additional dollars at its official (gold or whatever) price.

Towards a global anchor

The United States could easily amend its monetary policy to incorporate the above features – adopting a government defined value of the dollar as called for in Article 1 Section 8 of the U.S. Constitution and a market determined supply. The Federal Reserve would be restricted by law to passive currency board rules. Additional financial sector stability would be achieved by also adopting the Chicago Plan of 100% reserve requirements against demand deposits. This would be a natural byproduct of the Fed creating a two-tier Central Bank Digital Currency (CBCD) now under consideration.

The gold standard was an international system for regulating the supply of money and thus prices in each country and between countries and provided a single world currency (via fixed exchange rates). Balance of trade and payments between countries was maintained (when central banks played by the rules) because deficit countries lost money (gold) to surplus countries, reducing prices in the former and increasing them in the latter. This led to a flourishing of trade between countries. This was a highly desirable feature for liberal market economies.

The United States could adopt the hard anchor currency board system described above on its own and others might follow by fixing their currencies to the dollar as in the past. The amendments to the historic gold standard system proposed above would significantly tighten the rules under which it would operate and strengthen the prospects of its survival.

However, there would be significant benefits to developing such a standard internationally. One way or the other, replacing the fluctuating exchange rates between the dollar and other currencies with the equivalent of a single currency would be a significant boon to world trade and world prosperity.  Replacing the U.S. dollar as the world’s reserve currency with an international unit would have additional benefits for the smooth functioning of the global trading and payments system.  

In a small step to create an internationally issued currency the IMF created its Special Drawing Right (SDR) in 1969 in the expectation of supplementing the gold-based US dollar. But in today’s world of fiat currencies with floating exchange rates the SDR has several limitations as a reserve currency, most of which can be lived with for a while. The SDR allocated by the IMF can only be held and used by the central banks of IMF member countries and a few international organizations such as the World Bank and BIS. The SDR falls short as a challenger to the US dollar because of the absence of widespread private market use of the unit.

To become a serious supplement to, if not replacement for, the US dollar in the international monetary system the SDR would need to be usable for payments by private sector parties. This would require the creation of private or Market SDRs. This could be done in much the same way banks now create dollar deposits.

Digital SDR currency

As with national currencies, the internationally issued SDR needs a central issuer of the base money version of market SDRs (M-SDRs). The IMF should oversee the develop of a procedure for issuing M-SDRs following currency board rules and backed 100% by official SDRs or by an appropriate mix of sovereign debt of the five basket currencies.

The IMF might establish an IMF trust fund that would issue M-SDRs to AAA or AA international banks upon their request and payment of the equivalent value of one or more of the five basket currencies (and would redeem them under similar arrangements). As with other IMF trusts, the IMF might approach the BIS to operationally manage the issuance and redemption of M-SDRs and the maintenance of the official SDR asset backing (or its equivalent in the five currencies in the valuation basket).

Banks offering M-SDR deposits/currency to their customers would hold an M-SDR reserve backing with the IMF SDR trust fund. The base money M-SDRs issued by the IMF trust fund would perform the same payment settlement function as do central banks for the base money they issue, with the critical difference that its depositors/participants would be global rather than national. This would enable virtually instantaneous final settlement of M-SDR payments globally.

An M-SDR would facilitate and be facilitated by invoicing internationally traded goods and financial instruments in SDRs. More, if not most, internationally traded commodities could and should be priced in SDRs. Cross border borrowing can and should be denominated in SDR starting with bond issues and lending by international development institutions (as is now the case with the IMF, and to a very limited extent the World Bank).  https://www.brettonwoods.org/article/proposal-for-an-imf-staff-executive-board-paper-on-promoting-market-sdrs

To go all the way with SDRs, the IMF’s Articles of Agreement would need to be amended to replace the allocation of SDRs with issuing them according to currency board rules as discussed earlier. Furthermore, the valuation basket that now consists of key currencies would need to be replaced with a commodity basket as outlined in my Real SDR Currency Board proposal: (http://works.bepress.com/warren_coats/25/).

The shift from dollar to SDR international reserves, payments, and invoicing would give the world a more stable currency for all of these purposes. This would further promote trade because of more efficient cross boarder payments thus further lifting incomes around the world. Being an internationally issued and controlled currency, the potential for its political abuse by the U.S. would be greatly reduced. But eliminating the seigniorage that the U.S. now enjoys supplying its currency to the rest of the world, i.e., the foreign financing of some of its debt, would remain without further measures.

As central banks and foreign firms shifted from dollars to SDRs they might simply transfer the US treasury bills (and other US investments) that they now hold to the issuers of the M-SDRs. In that case the U.S. would continue to enjoy its exorbitant privilege of foreign financing in exchange for holding its currency. In this case M-SDRs rather than USD would also be backed by US debt. Thus, rules are need for what currency or assets must be paid to buy M-SDRs and/or what assets M-SDRs are backed by. This could take the form of buying M-SDRs with USD but the issuer exchanging the dollars for a more balanced portfolio of assets. While the SDR value continues to be defined by a basket of currencies, the assets backing issued SDR might reflect the same proportions of the same currencies.

The reduction in this way of the role of the dollar as a reserve currency would be win win. It would provide for more stable and more efficient international trade and payments. It would help demilitarize money and it would modestly increase the cost of US debt finance, hopefully encouraging more careful spending.

[1] Dr. Coats retired from the IMF after 26 years of service in May 2003 to join the Board of Directors of the Cayman Islands Monetary Authority. He was chief of the SDR division in the Finance Department of the IMF from 1982–88 and a visiting economist to the Board of Governors of the Federal Reserve in 1979.  In March 2019 Central Banking Journal awarded him for his “Outstanding Contribution for Capacity Building.”  His recent books are One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina; My Travels in the Former Soviet Union; My Travels to Afghanistan; My Travels to Jerusalem; and My Travels to Baghdad. He has a B.A. degree in Economics from U of California, Berkeley, and a Ph.D. in economics from the U of Chicago. He is a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.

Russia: How should we fight back?

Russia’s attack on Ukraine has rightly outraged most of us. Leaving aside the history that brought us to this present conflict, Russia’s attack is totally unjustified. Our natural instincts are to help Ukraine resist its aggressor. As we watch the destruction of lives and property, it is natural to want to send in our boys or planes to help. Surely, we can stop this by using the might of our military and advanced weapons. Wars tend to look like that in the beginning. Vietnam, Afghanistan, Iraq (I still can’t sort out what Bush/Cheney thought was America’s interest in attacking Iraq) looked like slam dunks going in. The realities were invariably very different by the end. How should we help Ukraine?

The U.S. and Ukraine’s NATO neighbors have been supplying Ukraine with weapons but left them to fight on their own. This was my assessment a month ago: “Ukraine-Russia-NATO”  As much as it strains against our impulse to help, President Biden is absolutely correct in ruling out our joining the war. For most of us, war, and the incredible pain it inflicts on those directly involved, is fought elsewhere by others. It is far too easy to say “sure, lets go to war.” “Ukraine-how should we help?”

But wars can be fought economically as well as militarily. Much of the West (the designation seems relevant again) has joined together to impose severe economic sanctions on Russia. But the objectives of these sanctions are not clear. They are too late to deter Russia from its invasion of Ukraine, though perhaps they provide an example of the potential cost to China if it decides to invade Taiwan. Are they meant to pressure Russia to come to the negotiating table? But it takes two to tango–Zelensky must be there as well. I have heard no statement of what Russia must do for the sanctions to be lifted.

The sanctions seem designed to cripple the Russian economy. Sadly, the pain will fall mainly on the Russia people rather than its government. Considerable pain will also fall on those imposing the sanctions. “The war in Ukraine and globalization”

Supply chains and financial channels will be disrupted for many years. But like military wars, the collateral damage an economic war is hard to predict. China and Russia and maybe India and much of Africa are being driven together to establish new trading relationships and non-dollar payment channels that don’t seem to serve American interests. If they are not explicitly linked to accelerating a negotiated peace, what are the sanctions for?  I don’t necessarily believe that our military industrial complex deliberately promotes the perpetuation of war, but as an economist I can’t ignore the fact that they have an economic incentive to do so.  

Missing from all of this seems to be the skillful deployment of diplomacy. The first priority, of course, is to end the fighting in Ukraine. But any peace agreement must look beyond the immediate war to the conditions that will promote peace and prosperity for Ukraine, Russia, Europe, and the world well into the future. As is often the case Chas Freeman says it best: https://www.youtube.com/watch?v=0vxufUeqnuc