Modern Monetary Theory—A Critique

So called Modern Monetary Theory (MMT) has become popular with Green New Dealers because it claims to remove or at least loosen traditional constraints on government spending.  MMT offers unconventional ideas about the origins of money, how money is created today, and the role of fiscal policy in the creation of money. It argues that government can spend more freely by borrowing or printing money than is claimed by conventional monetary theory. “The most provocative claim of the theory is that government deficits don’t matter in themselves for countries—such as the U.S.—that borrow in their own currencies….  The core tenets of MMT, and the closest it gets to a theory, are that the economy and inflation should be managed through fiscal policy, not monetary policy, and that government should put the unemployed to work.” James Mackintosh,  “What  Modern Monetary Theory Gets Right and Wrong’  WSJ April 2, 2019.

In fact, despite its efforts to change how we conceive and view monetary and fiscal policies, MMT abandons market based countercyclical monetary and fiscal policies for targeted central control over the allocation of resources. It would rely on specific interventions to address “road blocks” upon the foundation of a government guaranteed employment program.

MMT is an unsuccessful attempt to convince us that we can finance the Green New Deal and a federal job guarantee painlessly by printing money. But it remains true that shifting our limited resources from the private to the public sector should be judged by whether society is made better off by such shifts.  Printing money does not produce free lunches.

Where does money come from?

It has been almost 50 years since the U.S. dollar (or any other currency for that matter) has been redeemable for gold or any other commodity whose market value thus determined the value of money. It remains true, however, that money’s value depends on its supply given its demand. The supply of money these days reflects the decisions of the Federal Reserve and other central banks.

The traditional story for the fractional reserve banking world we live in is that a central bank issues base or high-powered money (its currency and reserve deposits of banks with the central bank) that is generally given the status of “legal tender.”  You must pay your taxes with this money.  We deposit some of that currency in a bank, which provides the bank with money it can lend. When the bank lends it, it deposits the loan in the borrower’s deposit account with her bank, thus creating more money for the bank to lend.  This famous money multiplier has resulted in a money supply much larger than the base money issued by the central bank. In July 2008, base money (M0) in the United States was $847 billion dollars while the currency component of that plus the public’s demand deposits in banks (M1) was almost twice that — $1,442 billion dollars. Including the public’s time and savings deposits and checkable money market mutual funds (M2) the amount was $7,730 billion.  [I am reporting data from just before the financial crisis in 2008 because after that the Federal Reserve began to pay interest on bank reserve deposits at the Fed in order to encourage them to keep the funds at the Fed rather than lending them and thus multiplying deposits. This greatly increased and distorted the ratio of base money to total money, i.e. reduced the multiplier. In October 2015 at the peak of base money M0 = $4,060 billion, of which only $1,322 billion was currency in circulation.]

The neo Chartalists, now known as MMTists, want us to look at this process differently.  In their view banks create deposits by lending rather than having to receive deposits before they can lend.  While a bank loan (an asset of the bank) is extended by crediting the borrower’s deposit account with the bank (a liability of the bank), the newly created deposit will almost immediately be withdrawn to pay for whatever it was borrowed for.  Thus, the willingness of banks to lend must depend on their expectations of being able to finance their loans from existing or new deposits, by borrowing in the interbank or money markets, or by the repayment of previous loans at an interest rate less than the rate on its loans.

The money multiplier version of this story assumes a reserve constraint, i.e., it assumes that the central bank fixes the supply of base money and bank lending and deposit creation adjust to that.  The MMT version reflects the fact that monetary policy these days targets interest rates leaving base money to be determined by the market.  Traditionally the Fed set a target for the over-night interbank lending rate—the so-called Fed Funds rate.  In order to maintain its target interest rate, the central bank lends or otherwise supplies to the market whatever amount of base money is needed to cover private bank funding needs at that rate.  The market determination of the money supply at a given central bank interest rate is, in fact, similar to the way in which the market determines the money supply under currency board rules under which the central bank passively supplies whatever amount of money the market wants at the fixed official price (exchange rate) of the currency.  With the Federal Reserve’s introduction of interest on bank reserve deposits at Federal Reserve Banks, including excess reserves (the so-called Interest On Excess Reserves – IOER), banks’ management of their funding needs for a given policy rate now involve drawing down or increasing their excess reserves.

According to MMT proponents, loans create deposits and repayment of loans destroys deposits.  This is a different description of the same process described by the money multiplier story, which focuses on the central bank’s control of reserves and base money rather than interest rates. It is wrong to insist that deposits are only created by bank lending and equally wrong to insist that banks can only lend after they receive deposits.

How is Base Money Produced?

MMT applies the same approach to the creation of base or high-powered money (HPM) by the government as it does to the creation of bank deposits by the private sector:

“It also has to be true that the State must spend or lend its HPM into existence before banks, firms, or households can get hold of coins, paper notes, or bank reserves…. The issuer of the currency must supply it first before the users of the currency (banks for clearing, households and firms for purchases and tax payments) have it. That makes it clear that government cannot sit and wait for tax receipts before it can spend—no more than the issuers of bank deposits (banks) can sit and wait for deposits before they lend.”[1]

This unnecessarily provocative way of presenting the fact that government spending injects its money into the economy and tax payments and t-bond sales withdraws it does not offer the free lunch for government spending that MMT wants us to believe is there. Central banks can finance government spending by purchasing government debt, but this does not give the Treasury carte blanche to spend without concern about taxes and deficit finance.  This is the core of MMT that we must examine carefully.

MMT claims that:

“(i) the government is not constrained in its spending by its ability to acquire HPM since the spending creates HPM….  Spending does not require previous tax revenues and indeed it is previous spending or loans to the private sector that provide the funds to pay taxes or purchase bonds….

“(iii) the government deficit did not crowd out the private sector’s financial resources but instead raised its net financial wealth.

“Regarding (iii), the private sector’s net financial wealth has been increased by the amount of the deficit. That is, the different sequencing of the Treasury’s debt operations does not change the fact that deficits add net financial assets rather than “crowding out” private sector financial resources.”[2]

MMT is correct that federal government spending does creates money. But what if the resulting increase in money exceeds the public’s demand (thus reducing interest rates), or the destruction of money resulting from tax payments or public purchases of government debt reduces money below the public’s demand (thus increasing interest rates)?  MMT claims to be aware of the risk of inflation and committed to stable prices (an inflation target) but ignore it most of the time.

If the central bank sets its policy interest rate below the market equilibrium rate, it will supply base money at a rate that stimulates aggregate demand. If it persists in holding short term interest rates below the equilibrium rate it will eventually fuel inflation, which will put upward pressure on nominal interest rates requiring ever increasing injections of base money until the value of money collapses (hyperinflation). If instead the central bank money’s price is fixed to a quantity of something (as it was under the gold standard, or better still a basket of commodities) and is issued according to currency board rules (the central bank will issue or redeem any amount demanded by the market at the fix price), arbitrage will adjust the supply so as to keep the market price and the official price approximately the same (for a detailed explanation see my: “Real SDR Currency Board”).  Unlike an interest rate target, a quantity price target is stable.

Does the Story Matter?

But does the MMT story of how money is created open the door for government to spend more freely and without taxation, either by borrowing in the market or directly from the central bank?  According to MMT, “One of the main contributions of Modern Money Theory (MMT) has been to explain why monetarily sovereign governments have a very flexible policy space that is unencumbered by hard financial constraints.  Not only can they issue their own currency to meet commitments denominated in their own unit of account, but also any self-imposed constraint on their budgetary operations can be by-passed by changing rules.”[3]

MMT maintains that: “Politicians need to reject the urge to ask ‘How are we going to pay for it?’…   We must give up our obsession with trying to ‘pay for’ everything with new revenue or spending cuts….  Once we understand that money is a legal and social tool, no longer beholden to the false scarcity of the gold standard, we can focus on what matters most: the best use of natural and human resources to meet current social needs and to sustainably increase our productive capacity to improve living standards for future generations.”[4]

MMT proclaims that a government that can borrow in its own currency “has an unlimited capacity to pay for the things it wishes to purchase and to fulfill promised future payments, and has an unlimited ability to provide funds to the other sectors. Thus, insolvency and bankruptcy of this government is not possible. It can always pay….  All these institutional and theoretical elements are summarized by saying that monetarily sovereign governments are always solvent, and can afford to buy anything for sale in their domestic unit of account even though they may face inflationary and political constraints.”[5] But inflating away the real value of obligations (government debt) is economically a default.  Moreover, debt cannot grow without limit without debt service costs absorbing the government’s entire budget and even the inflation tax has its hyperinflation limit (abandonment of a worthless currency).

MMT advocates do acknowledge that at some point idle resources will be used up and that this process would then become inflationary, but this caveat is generally ignored.  But if MMT is serious about an inflation constraint, we must wonder about their criticism of asking how government spending will be paid for.  In this regard MMT is a throwback to the old Keynesianism, which implicitly assumed a world of perpetual unemployment.

Is There a Free Lunch?

MMT states that when the government spends more than its income (and thus must borrow or print money) private sector wealth is increased “because spending to the private sector is greater than taxes drawn from the private sector, the private sector’s net financial wealth has increased.”  As explained below this deficit spending increases the private sector’s holdings of government securities, but not necessarily its net financial wealth.

Whether we take account of the future tax liabilities created by this debt in the public’s assessment of its net wealth (Ricardian equivalence) or not, we must ask where the public found the resources with which it bought the debt. Did it substitute T-bonds for corporate bonds, i.e. did the government’s debt (or monetary) financing of government spending crowd out private investment thus leaving private sector wealth unchanged, or did it come from reduced private consumption, i.e. increased private saving. Any impact on private consumption will depend on what government spent its money on.  MMT claims that “the government deficit did not crowd out the private sector’s financial resources but instead raised its net financial wealth,” is simply asserted and is unsupported.  Whether the shift in resources from the private sector to the public sector is beneficial depends on whether the value of the government’s resulting output is greater than is the reduced private sector output that financed it.

One way or another, government spending means that the government is commanding resources that were previously commanded by or could be commanded by the private sector.  If the government takes resources by spending newly created money that the central bank does not take back, prices will rise to lower its real value back to what the public wants to hold. This is the economic equivalent of the government defaulting on its debt, contrary to MMT’s claim that default is impossible.  This inflation tax is generally considered the worst of all taxes because it falls disproportionately on the poor.  In fact, MMT proponents rarely mention or acknowledge the distinction between real and nominal values that are, or should be, central to discussions of monetary policy. The exception to the inflationary impact of monetary finance is if the resources taken by the government were idle, i.e. unemployed, which, obviously, is the world MMT thinks it is in.

MMT claims to have exposed greater fiscal space than is suggested by conventional analysis. They claim that government can more freely spend to fight global warming or to fund guaranteed jobs or other such projects by printing (electronic) money. However, the market mechanism they offer for preventing such money from being inflationary (market response to an interest rate target that replaces unwanted money with government debt), implies that such spending must be paid for with tax revenue or borrowing from the public.  Both, in fact all three financing options (taxation, borrowing, and printing money), shift real resources from the private sector to the public sector and only make society better off if the value of the resulting output is greater than that of the reduced private sector output. There is nothing new here.

Fiscal Policy as Monetary Policy

Government spending increases M and the payment of taxes reduces it.  MMT wants to use taxation to manage the money supply rather than for government financing purposes.  MMT wants to shift the management of monetary policy from the central bank to the finance ministry (Treasury).  The relevant question is whether this way of thinking about and characterizing monetary and fiscal policy produces a more insightful and useful approach to formulating fiscal policy.  Does it justify shifting the responsibly for monetary policy from the central bank to the Finance Ministry?  Should taxes be levied so as to regulate the money supply rather than finance the government (though it would do that as well)?

In advocating this change, MMT ignores the traditional arguments that have favored the use of central bank monetary policy over fiscal policy (beyond automatic stabilizers) for stabilization purposes.  None of the challenges of the use of fiscal policy as a countercyclical tool (timing, what the money is spent for, etc.) established with traditional analysis have been neutralized by the MMT vision and claim of extra fiscal space.  In fact, as we will see below, despite their advocacy of fiscal over monetary policy for maintaining price stability, MMT supporters have little interest in and no clear approach to doing so as they prefer to centrally manage wages and prices in conjunction with a guaranteed employment program.

But the arguments against MMT are stronger than that. The existing arrangements around the globe (central banks that independently execute price stability mandates and governments that determine the nature and level of government spending and its financing) are designed to protect monetary stability from the inflation bias of politicians with shorter policy horizons (the time inconsistence problem). The universal separation of responsibilities for monetary policy and for fiscal policy to a central bank and a finance ministry are meant to align decision making with the authority responsible for the results of its decisions (price stability for monetary policy and welfare enhancing levels and distribution of government spending and its financing).  It is the sad historical experience of excessive reliance on monetary finance and the costly undermining of the value of currencies that resulted that have led to the world-wide movement to central bank independence.  MMT is silent on this history and its lessons.  As pointed out by Larry Summers in an oped highly critical of MMT, the world’s experience with monetary finance has not been good. Modern Monetary Theory-a-foolish-pursuit-for-democrats

The establishment of central bank operational independence in recent decades is rightly considered a major accomplishment.  MMT advocates bring great enthusiasm for more government spending—especially on their guaranteed employment and green projects, which will need to be justified on their own merits.  MMT’s way of viewing money and monetary policy adds nothing to the arguments for or against these policies.

The Bottom Line

To a large extent, most of the above arguments by MMT are a waste of our time as MMT advocates actually reject the macro fine tuning of traditional Keynesian analysis. “This approach of government intervention aims at avoiding direct intervention to achieve the goal (e.g. hiring to achieve full employment, or price controls to achieve low inflation), but rather using indirect “tools” while letting market participants push the economy toward desired goals by tweaking their incentives.  MMT does not agree with this approach. The government should be directly involved continuously over the cycle, by putting in place structural macroeconomic programs that directly manage the labor force, pricing mechanisms, and investment projects, and constantly monitoring financial developments….  But MMT goes beyond full employment policy as it also promotes capital controls for open economies, credit controls, and socialization of investment. Wage rates and interest rate management are also important.”[6]  No wonder Congresswomen Alexandria Ocasio-Cortez is excited by MMT.

MMT attempts, unsuccessfully in my opinion, to repackage and resurrect the empirically and theoretically discredited Keynesian policies of the 1960s and 70s.  A 2019 survey of leading economists showed a unanimous rejection of modern monetary theory’s assertions that “Countries that borrow in their own currency should not worry about government deficits because they can always create money to finance their debt” and “Countries that borrow in their own currency can finance as much real government spending as they want by creating money.” http://www.igmchicago.org/surveys/modern-monetary-theory  Both the excitement and motivation for MMT seem to reflect the desire to promote a political agenda, without the hard analysis of its pros and cons—its costs and benefits.

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[1] Fullwiler, Scott, Stephanie Kelton & L. Randall Wray (2012), ‘Modern Money Theory: A Response to Critics’, in Modern Monetary Theory: A Debate,  Modern Monetary Theory: A Debate, http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_251-300/WP279.pdf,  2012, page 19

[2] Ibid. page 22-23.

[3] Tymoigne and Wray, 2013 http://www.levyinstitute.org/publications/modern-money-theory-101

[4] Stephanie Kelton, Andres Bernal, and Greg Carlock, “We Can Pay For A Green New Deal” https://www.huffpost.com/entry/opinion-green-new-deal cost_n_5c0042b2e4b027f1097bda5b  11/30/2018

[5] Tymoigne and Wray, op cit. p. 2 and 5

[6] Ibid. pp. 44-45.

Econ 101: Trade Deficits, another Bite

Some years ago my friend Moritz Schularick and I were walking down a street in what is now called midtown Berlin (the former Eastern zone). Moritz asked me if I could explain why capital was flowing into the U.S. from developing countries when economic theory suggested it should flow in the other direction. At the time I didn’t have a very good answer. This note offers a better one.

We expect investors to put their money where the risk adjusted return is highest because that would maximize their profits. Wealthy countries like the United States have large capital stocks as a result of many decades of investment. Poor countries—especially the emerging economies—have much smaller capital stocks. Under those circumstances, the return to investing in more capital where it is relatively scarce is normally higher than where large investments have already been made. Economists call this the declining marginal return to capital. So the capital intensive, wealthier countries should have a lower return on investing in still more capital than would the poorer capital scarce countries. If the return to capital (interest rate) in emerging market economies is higher than in the U.S., capital should flow from the U.S. to promising developing countries.

I told Moritz that it must be that because of stronger institutions and property rights (rule of law) in the U.S. compared to many developing economies, investment in them was riskier to such an extent that the risk adjusted return was actually lower in developing economies. That may explain part of the reverse flow of capital into the U.S.

But two other factors might be even more important.

First we need to understand how capital flows from the U.S. to another economy. Consider American investments in Chile, a rapidly growing emerging economy with relatively good institutions and rule of law. American investors must buy Chilean pesos in the amounts to be invested. This will appreciate the peso some (one peso will be more dollars than before making American goods cheaper). Those pesos might be used to buy shares in a growing Chilean company. The purchase of these shares by an American might simply be a change in ownership (portfolio investment) or might finance new investment (Foreign direct investment—an actual increase in capital).

But what does the Chilean who sold her pesos for dollars do with those dollars? It simplifies without fundamentally changing the story to assume that the Chilean firm selling its share to an American acquired those dollars. The firm might buy U.S. treasury securities with these dollars (this is the simple swap of asset ownership of portfolio investments). But more likely it buys American machinery and equipment for its new investment. The U.S. “enjoys” a trade surplus as a result of these capital outflows. This is the traditional relationship assumed between the developed and undeveloped world. Capital flows from the U.S. to Chile.

Two additional very important factors have changed this story causing capital to flow backward from the Chiles of the world to the U.S. In my previous blog “Econ-101-trade-deficits” I explained the following relationship:

(M – X)   =   (I – S) +   (G – T),

which says that the trade deficit (imports-M- less exports-X) is equal to the savings deficit (investment-I- less saving-S) plus the government’s fiscal deficit (government spending-G- less its tax revenue-T). Uncle Sam has had a fiscal deficit every year since the Clinton administration surpluses (even currently when the economy is fully employed!) The rest of the world has helped finance our fiscal profligacy thus keeping US interest rates lower than they otherwise would have been and crowding out less of our private investment than such fiscal deficits would otherwise have caused. The rest of the world acquires the dollars to invest in the U.S. by selling more to us than they buy from us (i.e., via our trade deficit). So other things equal a smaller fiscal deficit or, god forbid, a fiscal surplus will reduce our trade deficit.

The other, often overlooked, cause of our trade deficits arises from the use of the U.S. dollar as the world’s primary reserve asset and thus the demand from foreign central banks to hold them in their foreign exchange reserves. They acquire these dollars via our trade deficit (and their trade surplus). Their demand for U.S. dollars appreciates the exchange rate of the dollar relative to foreign currencies making foreign goods cheaper in the U.S. and American exports more expensive abroad, thus creating our trade deficits and their surpluses (see my blog from last week linked above and/or this more extensive treatment; “Why the world needs a reserve asset with a hard anchor” Frontiers of Economics in China 2017, Vol 12 Issue 4, http://journal.hep.com.cn/fec/EN/10.3868/s060-006-017-0023-7).

It would be in our interest to replace the dollar’s use in foreign reserves with an internationally issued reserve currency, something I have been advocating for many years. The details for what this might look like and how it could be done are provided here: “Real SDR Currency Board”

 

 

My Political Platform for the Nation – 2017

For me, the ideal American government would deliver its important but limited functions efficiently and effectively and would raise the money to pay for these activities with efficient, minimally distorting (neutral), and fair taxes following a principle of maximum subsidiarity (decisions made and services performed at the most local levels possible). The government should do fewer things than it does now but should do them better and should fully pay for them with taxes and fees (cyclically balanced budgets).

My unrestrained, radical platform will be presented here at a high level of general principles. Details need to be refined by a political process involving public discussion and are likely to evolve somewhat over time. Links to earlier articles provide additional details. In the very broadest terms Americans should be self reliant and free to work and play as hard as they choose with the government supporting their choices by providing security, the legal foundation and framework of private property and contracts, and an efficient safety net when individual undertakings are not feasible or fail.

The limited functions of the Federal government are enumerated in Article 1 section 8 of the U.S. Constitution. Broadly these are to:

  1. Develop and maintain our relations with other countries and international bodies and to maintain an Army, Navy and Air Force for the purposes of defending and promoting the security of the United States;
  2. Establish and enforce the rights to property and contracts and to adjudicate related disputes;
  3. Provide for public safety;
  4. Provide an efficient and effective social safety net (welfare);
  5. “Regulate commerce with foreign Nations, and among the several States;”
  6. “Coin money, regulate the value thereof, and of foreign coin, and fix the Standard of Weights and Measures;”
  7. Arrange for the provision of roads and essential infrastructure; and
  8. Tax, borrow, and levy fees and tariffs to pay for these activities.

Our Social Contract

Sovereignty resides with each individual, who have collectively ceded limited powers to government for the general welfare. Each of us is free, within legal limits on doing harm to others, to lead our own lives and build or work at whatever we choose. Thus the government’s laws apply equally to each of us without regard to our race, religion, sex, or sexual orientation. From this environment of freedom and innovation, America has built the most successful economy in the world.

When building companies or developing products, many will fail and try again. The government provides the legal framework (bankruptcy) for resolving such failures. The implicit agreement between citizens and their government is that government will provide a floor—a safety net—whenever a person’s efforts fail or when, e.g., for health reasons, a person is unable to provide for him or herself. The level of the safety net should reflect the level of the country’s income and social consensus and should be designed to achieve its objective as efficiently as possible with careful consideration of the incentives it creates.

Income redistribution: taxation and a guaranteed minimum income

All income (personal and corporate) taxes should be replaced with a comprehensive, flat, consumption tax (Value Added Tax—VAT) and limited progressivity introduced by paying every legal man, woman and child resident a guaranteed minimum income. US federal tax policy, Cayman Financial Review July 2009 Each recipient of these monthly guaranteed income payments would be required to set aside a minimum amount for health insurance (chosen by each person or family in the competitive market place) and a minimum amount for retirement (invested in qualifying retirement funds in the competitive market place). Saving social security

As the guaranteed minimum income should be at a level sufficient to minimally support life’s basic needs, supplements such as unemployment or disability insurance would not be needed or provided. However, disabilities acquired from military or public safety service should receive additional income support.

Health care

Each person will be responsible for paying for at least part of routine medical care (the copay required by the insurance they have chosen) and will thus care about its cost. The cheapest insurance policies will be limited to major medical expenses (catastrophic health insurance). As everyone will be required to contribute monthly to a health savings account from their guaranteed minimum income, most people will chose to use such funds to buy health insurance, which would not be tied to employment or an employer.

Doctors and hospitals will be required to make medical service costs transparent. On that basis, patients, in consultation with their doctors, will decide the level of care and treatments to receive. These measures will introduce normal market competition into the provision of medical care that is currently absent, which will improve its quality and lower its cost.

Education

Equal access to quality education is a critical element in maximizing opportunity for all and the wealth of our society and each person in it. The public school system has often failed in this objective. While the wealthy can afford to put their children in private schools when the neighborhood school is of poor quality, lower income families generally cannot. Every K-12 aged child will receive a tuition voucher that covers the cost of state provided education. The amount will generally vary from state to state (or school district to school district). The voucher can be used to attend the local neighborhood public school with no additional cost, or any private school the family chooses, which might incur additional costs. Schools eligible to receive such vouchers must meet minimum education standards set by the state and must disclose the performance of their students on state administered achievement tests. This information must be available to the public. The learning progress of each child is more important than the average level of achievement of each school’s students as some schools might well specialize in slow or problem learners and performance data should reflect this distinction. The neighborhood school has the advantage of being easier to get to every day and will normally be chosen by families if it provides a good education. The argument for universal tuition vouchers goes beyond providing a level playing field to all. It also introduces the competition for students that is the basis for good quality, low cost goods and services in every other area of our economy.

Access to higher education raises different issues. Those with the aptitude and desire for a college or postgraduate degree can significantly increase their lifetime incomes as a result. It would hardly be fair to tax the general public to subsidize the higher education of those who will become wealthier as a result. However, the tuition loans that may be needed by those from lower income families to make this investment would be hard to get without insurance against default. Many states also provide community (or Jr.) colleges at public expense that provide training in various trade skills as well as four year college preparatory courses. These seem to have often been successful in leveling the playing field. The optimal structuring of higher education subsidies (e.g. between insurance guarantees and tuition subsidies) needs further examination.

Monetary and Financial Policies

Government policies that affect business should be as rule based and transparent as possible. Monetary policy stands out as a particularly important area in which clearer rules are needed. A currency with stable real value (purchasing power) is an important part of the foundation of efficient free markets. At the very minimum the Federal Reserve’s mandate should be tightened as provided in the very pragmatic Federal Reserve Accountability and Transparency Act of 2014. This act would require the Fed to chose an operational rule, from which it could depart only with an explanation to Congress of its reasons. A deeper review of options is proposed by the Centennial Monetary Commission Act of 2015. I have proposed a more radical reform in the spirit of the gold standard but with tighter rules and an anchor of a large number of goods rather than just gold. The supply of this currency, which ideally would become the global currency, would be regulated by the market using currency board rules and “indirect redeemability.” A hard anchor for the dollar.

The banking and financial sector are currently smothered with detailed regulations the compliance cost of which are driving smaller banks out of business. Under the Dodd Frank law adopted after the financial crisis of 2008, the largest five American banks have grown even larger (in absolute terms and as a share of the banking sector) than they were in 2008. Regulators, despite (or because of) their detailed banking regulations have failed to make banks safer and have slowed the competitive process of producing better and cheaper services. Bank owners and market preferences should regulate risk taking by banks.

Bank regulation by the government should focus on broad principles with strong owner accountability. Bank capital requirements should be raised and the no bail out rules strengthened. Bank owners and investors should absorb any bank losses. The payment services of banks should be isolated from the rest of its lending and investing business by adopting the Chicago Plan of one hundred percent reserve requirements against current account deposits, and virtually all other regulations (other than accounting and reporting standards) should be dropped. Larger banks will develop their own risk weighted capital requirements for their internal use, but the government’s capital requirements should state the minimum required leverage ratio (ratio of core capital to total assets) and set it at a high level. Changing direction on bank regulation, Cayman Financial Review April 2015. A bill now in congress moves in this direction: The Financial Choice Act

Business activities and regulation

The government should only provide services that that private sector can’t. It should provide the legal and regulatory framework for the private economy rather than compete with it. Though the approaches to providing “public goods” such as police, courts, prisons, firemen, parks, highways, airports, etc. have varied over time, they are almost always paid for by the government (i.e. collectively by tax payers) and should be provided efficiently at the level expected by the public. Publicly funded and privately produced goods and services are often sources of hard or soft corruption. Rather than over charging for services or paying bribes to win contracts (hard corruption), soft corruption exploits influence on government to obtain contract terms or regulations favorable to particular firms (“rent seeking”). The government’s purchases of goods and services from the private sector should be governed by transparent rules that promote competition among suppliers. This is easier said than done. Open the Books

While the government is involved in and trying to do far too many things, it doesn’t do many of them very well. Of those services the government needs to provide, states generally perform better than the federal government though performance varies across states. In Maryland, where I live, I was able to register my Limited Liability Company on line in about 30 minutes start to finish. Registering my car and updating my driver’s license is quick and easy. However, it took me months to obtain a statement of my residency from the U.S. Treasury and a personal trip to the State Department to have it certified to provide to the National Bank of Kazakhstan before they could pay me for my services. Getting a passport or green card is more complicated and takes longer than they should. The government should do much less and do it much better.

Those in the government who believe they can judge better than competitive private markets how best to allocate resources (what to invest in and produce) are generally wrong. Moreover, they establish an opportunity and thus incentive for corruption.

The government’s regulation of private businesses in the interest of public safety, environmental protection, and market competition should be limited and subject to very serious cost/benefit tests. Cost/benefit analysis unavoidably reflects subjective judgments but their role should be limited to the extent possible by full transparency of the basis of any assessment. Competitive capitalism vs. the other kinds.

Foreign policy and national security

The purpose of our foreign policy is to serve American security interests and the international rule of law under which American’s can explore the world and American businesses can compete globally on a level playing field. Our security requires a strong military, but it also requires the skillful use of diplomacy. Our military must be structured for defense, not offensive wars of our choosing. Our 2003 war in Iraq and subsequent developments in the Middle East have cost many lives (some American) and treasure, undermined our moral authority, and seriously damaged our security. Our foreign policy should be one of “restraint.”

Our relations with other countries should be based on shared interests consistent with our respect for individual dignity and the rule of law. We should support and, where appropriate, lead international bodies dedicated to developing, promoting, and overseeing compliance with the rule of law internationally. Our international leadership should rest, in addition to our economic and military strength, on our commitment to broadly shared values and standards of behavior. Just as we give up limited amounts of our individual sovereignty to our own government when it serves our individual and collective interests, so should we give up limited amounts of our national sovereignty to international bodies when it serves our national and international interests.

Our economic strength depends in part on providing for a sufficiently strong military in the most economical way possible. Money spent on tanks can be spent on building other businesses and producing goods that we enjoy. The very nature of the relationship between our military and the industries that supply it, what President Eisenhower called “the military industrial complex,” makes achieving this objective very difficult. As argued above, clear rules and transparency are important tools. Our unsupportable empire

Trade

Next to the right to personal property, nothing is as central to our liberty and well being as the right to trade. It is the basis of virtually all of our enormous increase in productivity and thus our standard of living. The government impedes our right to trade with a wide range of often unnecessary or excessive regulations. Restricting our freedom to trade across national borders is also a mistake that reduces our standard of living from its potential.

Trade has destroyed some jobs while creating others. “Since 1900, the portion of the U.S. workforce in agriculture has declined from 41 percent to less than 2 percent. Output per remaining farmer and per acre has soared since millions of agricultural workers made the modernization trek from farms to more productive employment in city factories…. Manufacturing’s postwar share of the labor force peaked at about 30 percent” in 1953 and has since declined to less than 9 percent while manufacturing output continued to climb. “Of the 5.6 million manufacturing jobs lost between 2000 and 2010, trade accounted for 13 percent of job losses and productivity improvements accounted for more than 85 percent.” George Will, Washington Post.

As with domestic, competitive trade, those out-performed in competitive markets suffer, at least temporarily. The safety net for “losers” in the competitive process discussed above is an important feature in our willingness to unleash the benefits of free trade. We must insure that they are adequate. We should support the World Trade Organization (WTO) as well as regional and bilateral agreements that reduce the barriers to trade and promote freer trade. Save trade. Globalization and nationalism-good and/or bad?. Trade and globalization

Conclusion

Our government should assume that each of us is capable of and has the right to make our own decisions and lead our own lives as we see fit. Its role is to protect those rights, in part by protecting us from others, foreign and domestic, who would violate them. We are, however, part of and best flourish within broader communities. Our government should develop legal frameworks to facilitate our interactions and relationships within and across societies both business and personal. Our successful flourishing will also depend greatly on a shared culture of mutual respect and comity.

Ukraine Monetary Regime Options

On March 12th I participated in the Emergency Economic Summit for Ukraine in Kyiv. The summit was organized by Tom Palmer (Atlas Foundation) and Dalibor Rohac (Cato Institute) and several Ukrainian free market think tanks. My charge was to evaluate monetary policy regime options. The following paper prepared for this meeting and published in the current issue of the Cayman Financial Review,  presents my assessment. If, like most people, you are not interested in monetary policy issues, you should skip this paper:  http://www.compasscayman.com/cfr/2014/04/07/The-future-of-Ukraine-%E2%80%93-and-the-role-of-sound-money/