Category: Economics

Econ 101: Price Caps

On June 6 this year, the average price of regular gasoline in Maryland was $4.85 per gallon. Two years earlier it was $1.94 per gallon. If we assume that the cost to the gasoline producers and sellers was the same in the two periods, gas suppliers were reaping a huge profit in June. As I write this article, Maryland’s price is $3.91. Should the government impose a price cap of, say, $2.00 to take away Shell and Chevron’s excess profits?

The economics of this situation are very simple. At the $2.00 price cap people will demand more gas than they did at the $4.85 price but the supply will be the same. Thus, not everyone who wants to buy gas will be able to. How will the excess demand (supply shortage) be resolved?

If prices are not allowed to ration supply among demanders such that everyone willing to pay $4.85 gets all they want, an alternative rationing mechanism must be imposed. Ration coupons might be issued randomly, or by lottery, or by the first letter of your last name, or to friends and relatives of the government civil servants handing out the ration coupons. Unlike any of these formulas, price rationing provides the available supply to those with the most pressing need for it. Less important trips will be canceled or postponed.

The supply side of the market is important as well. Increasing the supply of most things incurs increasing costs per unit (per gallon). Suppliers of anything will produce up to the point that the cost plus normal profit of additional output matches the market’s demand price. The supply response to price increases for gasoline can be very long. At a higher price oil companies will invest more in searching for new sources and in developing them (drilling new wells, pumping and delivering the crude oil to refineries, etc.). A limited, quick response can be achieved by increasing the rate of extraction from existing wells, but this may reduce their long run capacity. At $4.85 per gallon, oil companies have a strong incentive to increase supply as rapidly as possible. At $2.00 per gallon oil companies have virtually no financial incentive to increase supply thus the unsatisfied demand will persist over time.

Price caps are a dumb idea.

Review of Thomas Sowell’s “Black Rednecks and White Liberals”

Thomas Sowell, a prolific and highly respected economist, wrote Black Rednecks and White Liberals in 2005, but I have only recently encountered and read it.  I wish I had read it earlier, but better late than never. The book is a collection of six essays on the role and dominance of culture over race in the experience of black Americans and other racial groups (Germans, Lebanese, Chinese, Jews, and other middlemen minorities). Like most good U of Chicago economists, he builds his arguments empirically. Digesting the book’s rich collection of data is worth the read.

Sowell documents that most slaves, who have existed from almost the beginning of humanity, have not been black, nor has being a slave, as unacceptable as it is in the modern world, necessarily impeded the futures of slaves once freed. Most interestingly, Sowell argues that the self-destructive behavior of America’s black ghetto culture is not genetic but rather the learned bad habits of the “Cracker culture” of the North Britons, Welsh, and Highland and Ulster Scots who immigrated to the American South and were its dominant slave owners. Sowell argues that the income and educational gaps between white and black Americans reflect the perpetuation by “ghetto” blacks of this culture and its remedy must come from blacks.

A review of the book by Neil Shenvi states that:

“Sowell’s first essay, which shares the book’s title, begins with this provocative quote:

‘These people are creating a terrible problem in our cities. They can’t or won’t hold a job, they flout the law constantly and neglect their children, they drink too much and their moral standards would shame an alley cat. For some reason or other, they absolutely refuse to accommodate themselves to any kind of decent, civilized life.

“Sowell continues: ‘This was said in 1956 in Indianapolis, not about blacks or other minorities, but about poor whites from the South… A 1951 survey in Detroit found that white Southerners living there were considered ‘undesirable’ by 21 percent of those surveyed, compared to 13 percent who ranked blacks the same way’.

“Sowell’s main thesis in this essay is that what we know today as ‘black culture’ is actually ‘white redneck culture’ or ‘cracker culture’ which ‘originated not in the South but in those parts of the British Isles from which white Southerners came. That culture long ago died out where it originated in Britain, while surviving in the American South. Then it largely died out among both white and black Southerners, while still surviving today in the poorest and worst of the urban black ghettos.’”

Shenvi’s review notes that: “[t]he 1970 census showed that black West Indian families in the New York metropolitan area had 28 percent higher incomes than the families of American blacks. The incomes of second-generation West Indian families living in the same area exceeded that of black families by 58 percent. Neither race or racism can explain such differences. Nor can slavery, since native-born blacks and West Indian blacks both had a history of slavery.”  “A review of Sowell’s Black Rednecks and White Liberals“

Sowell’s chapter on “Black Education: Achievements, Myths, and Tragedies” makes the exact same points and criticism of “modern” education made by my mother who was an elementary school teacher in the 1970s and 80s who believed in teaching basic skills and knowledge to a well-disciplined class. Any student who bullied a fellow student only had a chance to do it once while under the supervision of my mother’s strict disciplinary style. At her request she was assigned to classes with behavior problems and by the end of the year they loved her (as did I).

William Raspberry (1935-2012), one of my favorite Washington Post columnists, who like Sowell was black, wrote in a review of Black Rednecks… “[o]ne thing seems beyond dispute: Maybe we haven’t laid racism to rest, but we have reached the point where what we [i.e., blacks] do matters more than what is done to us. That’s great, good news.”

Econ 101:  Oil Price Cap

Among U.S. (and E.U. and some other primarily Northern countries) objectives in reacting to Russia’s invasion of Ukraine, is to diminish its capacity to continue this war, in part by reducing its export (largely oil and gas) income with minimum damage to the U.S. and other embargo supporters and to pressure it to the bargaining table sooner rather than later (we are trying to do that aren’t we??). As you can see from the previous sentence, this is not a particularly simple issue.

One measure being promoted by U.S. Treasury Secretary Janet Yellen is to cap the price at which we are willing to buy Russian oil.  If we just stop buying Russian oil all together (effectively a price of zero), global oil supply would presumably fall, and oil prices would rise. We know, of course that Russia will redirect its sales to countries not participating in the embargo, such as China and India, to the extent it can and the oil these countries would have purchased from Saudi Arabia and other suppliers would then be available to us and global oil supply would not fall as much as we might have expected nor would prices increase as much as otherwise. Much could be written about this (the limited potential of embargoes if not everyone participates), but I won’t.

The idea of Secretary Yellen’s cap is that rather than buying no Russia oil we (and all embargo participants) would continue to buy it but at an agreed price that is below normal market prices in normal time (the price cap). Thus, hopefully, Russia would still sell its oil to the West but would earn less foreign exchange from it and the West would have more oil than with a total blockage and thus avoid sharp market price increases.

“There are several outstanding issues to settle on the price-cap idea. Those include figuring out exactly how to enforce it, convincing other nations to subscribe to it and deciding the sales price at which Western countries would permit the purchase of Russian oil. Looming over the proposal is also the presumption that Russia would continue to sell oil at a price mandated by the U.S. and its allies.”  “WSJ: Janet Yellen begins Asia trip to win support for cap on Russian oil price”

“Some economists and oil industry experts are skeptical that the plan will work, either as a way to reduce revenues for the Kremlin or to push down prices at the pump. They warn the plan could mostly enrich oil refiners and could be ripe for evasion by Russia and its allies. Moscow could refuse to sell at the capped price…. 

“Mr. Biden… moved swiftly to ban imports of Russian oil to the United States and coordinate similar bans among allies. In some ways, the price-cap proposal is an acknowledgment that those penalties have not worked as intended: Russia has continued to sell oil at elevated prices — even accounting for the discounts it is giving to buyers like India and China, which did not join in the oil sanctions — while Western drivers pay a premium….

“The cap plan seeks to keep the Russian oil moving to market, but only if it is steeply discounted. Russia could still ship its oil with Western backing if that oil is sold for no more than a price set by the cap.”  “NYT Biden gas price cap Russia”

John Bolton, whose view I don’t generally share, said about Yellen’s oil price cap: “The proposal, academic and untried, faces multiple practical obstacles and uncertainties. Widespread sanctions violations by Russian maritime cargoes already exist, with no reason to think the oil-price cap is more enforceable.” “WP: Biden oil price cap-Russia Sanctions”

Such efforts to “hurt” Russia cannot avoid also hurting us. What other approaches might the Biden administration consider?

“The White House… has held off for months on backing a gas tax holiday, amid divisions within the Democratic Party and skepticism a roughly 18.4 cent-per-gallon discount would be passed on to consumers….  In private meetings with senior Energy Department officials to discuss ideas for boosting supply and lowering prices, some industry representatives have instead used the sessions to push for longer-term priorities like building pipelines and easing environmental restrictions.”  “Politico: White House-Biden-gas prices”

“Rep. Kim Schrier, D-Wash.,… called it “infuriating” that spikes in gas prices were “happening at the same time that gas and oil companies are making record profits and taking advantage of international crises to make a profit. This must stop.″ “PBS: House approves bill to combat gasoline price gouging”

When the supply of a product falls short of its demand, the gap can be closed in one of two ways. Both involve rationing a scarce commodity as is required for anything in limited supply which is virtually everything. The first approach—the market approach of price rationing—allocates the product to those who want it the most, i.e. those who are willing to pay the most for it. The second approach—the administrative allocation approach—allocates the product to those the government agency responsible for choosing who gets it, determine are most worthy or in most need of it based on the criteria the agency sets (which in practice invariably includes friends and relatives). History has clearly documented which of these methods of allocation works best.  Some of you will remember the long lines at gas stations when President Richard Nixon capped gasoline prices (another form of rationing).

That leaves measures that encourage increased supply from everywhere except Russia or that facilitate reducing demand. “Biden officials are openly pleading with Big Oil to pump more, not less. ‘We want them to get their rig counts up. We want them to increase production so that people are not hurting,’ [Energy Secretary Jennifer] Granholm said.”  “CNN: Gas prices-Biden-inflation” A higher price at the pump provides the market a strong incentive to increase supply, but that generally takes years to achieve much of an increase. In the interim profits of the suppliers will be higher than usual.

Some months back policy sought to reduce the consumption of carbon omitting products as part of our effort to slow global warming. For that objective an increase in gasoline prices would be a good thing, whether from a gas tax or restrictions on finding and pumping more oil out of the ground.

For the moment, encouraging more production by Saudi Arabia and other (non Russian) members of OPEC would be helpful. Finally rejoining the JCPOA (Iran deal), Trump’s withdrawal from which Max Boot called the “single worst diplomatic blunder in U.S. history” “WP: Trump-Biden Iran nuclear deal dead with no alternative”, would, among other important things, increase an important source of oil supply, as would dropping sanctions on Venezuela. If we can make deals with Saudi Arabia, given all it has done, deals with Iran and Venezuela should be no brainers.

Ending the war in Ukraine promptly is the most important measure for addressing the shortage of oil (and food more generally). “End the war in Ukraine”

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/