Tag: technology

Goodbye 2019 (and good riddance)

As 2019 and the decade of the 20 teens comes to a close, the impeachment of Donald Trump, only the third President impeached in the history of the United States, dominates the headlines.  My hope (I am a crazy optimist) and wish for my country’s sake is for Trump’s trial in the US Senate to adopt rules that most everyone will see as fair. That means giving Trump every opportunity to state and defend his case and the opposition every opportunity to state theirs. Some Republicans have denied the evidence presented in the House investigation that Trump offered favors (White House visit and military aid) to Ukraine President Zelensky if he would investigate the activities of Trump’s political opponent’s son in Ukraine. Other Republicans, such as Congressman Will Hurd, accepted the evidence but argued that the offence was not sufficiently serious to justify impeachment. Congressman Hurd’s judgement reflects the fact, I suppose, that political standards have sunk so low that we now accept that every President lies to us and abuses his authority (see the Washington Post’s Afghanistan Papers https://www.washingtonpost.com/graphics/2019/investigations/afghanistan-papers/documents-database/).  I think it would be a mistake to accept and normalize such behavior.

Here are some of the key issues of this year (at least those I wrote about) and a few of my blogs/articles about them:

Health care insurance

Given medical costs must be paid by someone (the recipient of the care, the tax payers, insurance premiums, etc.). Insurance shares the cost (the lucky who are well help pay for the unlucky who are sick). But how services are paid for (what and how much is covered by insurance, etc.) will also influence the services provided and their cost.

https://wcoats.blog/2019/08/01/health-care-in-america-2/

Trade war and protectionism

President Trump has torn up the rule book for negotiating freer and freer trade. The result so far has left us worse off.  Fed economists Aaron Flaaen and Justin Pierce found “that tariff increases enacted in 2018 are associated with relative reductions in manufacturing employment and relative increases in producer prices.” https://www.federalreserve.gov/econres/feds/files/2019086pap.pdf

Trump pulled out of the progressive Trans Pacific Partnership (TPP), negotiated a “new” North American Free Trade Agreement (whatever he calls it) that is worse than the existing NAFTA except for the new parts taken from the TPP, worsened trade with China (so far–see Federal Reserve report above), alienated potential partners who would have happily joined us in negotiating with China, and angered the EU with whom he wants a new trade agreement. His potentially illegal uses of tariffs have introduced government protection of favored industries increasing crony capitalism. He continues to weaken the World Trade Organization (WTO), which has provided the bases of increasingly free rule-based trade since WWII. The growth in trade over the last 70 years has helped lift most peoples of the world out of dire poverty.  The number of people living in extreme poverty fell from 2.2 million in 1970 to 0.7 million in 2015.

https://wcoats.blog/2019/11/18/protecting-jobs/

https://wcoats.blog/2019/08/05/econ-101-currency-manipulation/

https://wcoats.blog/2019/06/07/the-sources-of-prosperity/

Foreign wars and policy

President Trump rightly condemned our forever wars and promised retrenchment. I agree with his assessment of our excessive military aggressions and deployments abroad, but for one reason or another he has failed to deliver. The New York Times reports that: “Under President Trump, there are now more troops in the Middle East than when he took office.” https://www.nytimes.com/2019/10/21/world/middleeast/us-troops-deployments.html

Trump seems to act on impulse without serious consultation with his National Security Council, State Department or Pentagon, decimating our diplomacy. His periodic insults to our foreign allies haven’t helped either.  Nor have his love affairs with Putin, Kim Jon-un, and Xi Jinping (do you see a pattern here?).  Diplomacy is the alternative to military adventures for serving our national interests abroad. Trump has failed to fill important State Department positions and seems to pay little attention to his NSC and State Department briefings. Having removed two ambassadors to Ukraine in one year (this year) because his personal lawyer, Rudy Giuliani, thought they were insufficiently loyal to Trump, the U.S. currently has no ambassador in Ukraine.  Trump’s stewardship of our international relations has been a disaster.

Then there was Trump’s intervention in Military justice: From the Military Times: “President Donald Trump’s decision to grant clemency in the cases of three military members tangled in war crimes cases raises questions about whether troops are being given a green light to disobey the rules of law…

Army 1st Lt. Clint Lorance, convicted of second degree murder in the death of three Afghans, was given a full pardon from president for the crimes. Army Maj. Mathew Golsteyn, who faced murder charges next year for a similar crime, was also given a full pardon for those alleged offenses.  Special Warfare Operator Chief Edward Gallagher, who earlier this fall was acquitted of a string of alleged war crimes while being convicted of posing with a dead Taliban member, had his rank restored to Chief Petty Officer by the president.”  “We-shouldnt-forget-what-whistleblower-seals-told-us-about-eddie-gallagher”  What is Trump thinking? What does he have in mind?

https://wcoats.blog/2019/12/14/nation-building-in-afghanistan/

https://wcoats.blog/2019/05/03/oslo-the-play/

https://wcoats.blog/2019/03/11/is-rep-ilhan-omar-anti-semitic/

Monetary policy and the international monetary system

While monetary policy has been relatively good for a floating exchange rate system, asset price bubbles and international currency flow imbalances persist and, in my view, are unavoidable. We need to adopt a hard anchor for the value of the dollar.  The shockingly large fiscal deficits (over one trillion dollars per annum in 2019) with a fully employed economy, when we should be running a budget surplus to provide room for deficits during the next downturn, are building serious risks for the not so distant future. Trump’s attacks on the Federal Reserve’s monetary policy will make managing those risks more difficult.

https://wcoats.blog/2019/01/25/central-banking-aware/

https://wcoats.blog/2019/03/24/central-banking-award/

https://wcoats.blog/2018/05/01/free-banking-in-the-digital-age/

https://wcoats.blog/2019/07/24/whither-libra/

https://wcoats.blog/2019/04/16/returning-to-currencies-with-hard-anchors/

Information and the Internet

The Internet has had a profound impact on how we live and do business. It is hard to imagine a day without our mobile phones. But like all new tools and technology it opens the door to new ways of doing harm as well. This is currently most conspicuous with the spreading of fake news and learning anew what news sources to trust and not trust.

https://wcoats.blog/2019/12/01/new-tools-require-new-rules/

Domestic politics and Trump

In my discussions of the Trump administration I have tried to focus on policies, some of which I like and some I don’t, rather than on Donald Trump himself, about whom I like nothing. The following focuses on Trump.

https://wcoats.blog/2019/12/27/a-letter-to-the-republican-party/

https://wcoats.blog/2019/11/20/to-whom-or-what-am-i-loyal/

My friend Jonathan Rauch explains the limitations of my efforts to focus on policies in an article well worth reading. “Believing is belonging,” https://www.nationalaffairs.com/publications/detail/rethinking-polarization

Modern Society and its challenges

If we move away from personalities and dig deeper into our human motivations that inform policy design and choices, we can’t escape the role of incentives at the center of much of the analysis of my profession–economics. I have and will continue to explore my thoughts on human nature and the role of incentives, institutions, and customs in our search for how best to live free with others seeking their own goals in our society.

https://wcoats.blog/2019/08/10/where-does-the-desire-to-explore-come-from/

https://wcoats.blog/2016/11/22/globalization-and-nationalism-good-andor-bad/

https://wcoats.blog/2016/12/31/my-political-platform-for-the-nation-2017/

Happy New Year

 

Protecting Jobs

Protecting jobs sounds like a good thing to do (if you don’t think very carefully about what it means). Free markets protect jobs that are performing desired tasks better than someone else can. President Trump’s protection of steel workers’ jobs by imposing tariffs on competing sources of steel (mainly Canada) is protecting a relatively inefficient industry and thus “protecting” a lower standard of living for our country at large. “Protectionism” protects us from innovation and exciting technical changes that we eagerly embrace when offered in the market.

This week’s Economist magazine has an interesting article on the latest economic disruption (known to economists as “creative destruction”).  “Today the latest bonanza is in full swing, but instead of steel and sand it involves scripts, sounds, screens and celebrities.” https://www.economist.com/leaders/2019/11/14/who-will-win-the-media-wars

Movies (cinema or film for the more sophisticated) were only available in movie theaters when I was a kid more than half a century ago and yes they were already talkies (don’t be a smart ass). Then there was TV and we could watch movies there if we could stay up late enough. Cable TV packages greatly broadened the choice of channels.  Then video players and cassettes meant that we could choose what movies we wanted to watch and when.  We used to get CDs from Netflix in the mail.  I think I still have an unreturned diskette somewhere.  Maybe I will frame it so that my grandchildren can marvel at such historic relics.  In 1985 Blockbuster Video opened and we could skip the mail and browse thousands of films for rent.  They filed for bankruptcy in 2010 and the last two stores (in Alaska) closed last year.

“This week Disney launched a streaming service which offers “Star Wars” and other hits from its vast catalogue for $6.99 a month, less than the cost of a DVD. As the business model pioneered by Netflix is copied by dozens of rivals, over 700m subscribers are now streaming video across the planet. Roughly as much cash—over $100bn this year—is being invested in content as it is in America’s oil industry…. This binge is the culmination of 20 years of creative destruction (see Briefing). New technologies and ideas have shaken up music, gaming and now television.” The Economist

We can look at these amazing technical and business innovations in several ways:  1. A lot of jobs were destroyed as newer technologies replaced older ones and the jobs associated with them.  2. Fortunately no one succeeded in “protecting” them and we, the consumers–the targets of greedy profit seeking capitalists, enjoyed the greater benefit of more entertainment, more conveniently delivered and costing less.  3. New jobs were created to provide these new services.

“Disruption has created an economic windfall. Consider consumers, first. They have more to choose from at lower prices and can pick from a variety of streaming services that cost less than $15 each compared with $80 or more for a cable bundle. Last year 496 new shows were made, double the number in 2010. Quality has also risen, judged by the crop of Oscar and Emmy nominations for streamed shows and by the rising diversity of storytelling. Workers have done reasonably. The number of entertainment, media, arts and sports jobs in America has risen by 8% since 2008 and wages are up by a fifth. Investors, meanwhile, no longer enjoy abnormally fat profits, but those who backed the right firms have done well. A dollar invested in Viacom shares a decade ago is worth 95 cents today. For Netflix the figure is $37.” The Economist

Such dramatic disruptions can be painful for some–those whose jobs were lost or whose investments lost value. We need to adopt policies that minimize that pain. But thank God we didn’t try to protect those jobs and share values and the older ways they reflected.

Free Banking in the Digital Age?

By Warren Coats[1]

Introduction

A number of central banks are considering issuing digital currency either in place of the paper currency they now issue or in parallel with it.  The advantages of central bank digital currency (CBDC) over paper currency for the issuer is the much lower cost of supplying and maintaining the currency (printing, storing, transporting, safekeeping and replacing old and damaged notes). For the users, there are the benefits of much greater speed and lower cost of making payments of currency across distances.  The use of paper currency (cash) in economies with proliferating electronic means of payment (Visa, PayPal, Zella, popmoney, etc.) has been and will continue to fall.  In addition, digital currencies can and do extend digital payment services to the unbanked.  This note explores some of the policy issues raised by CBDC, by which I mean digital claims on the currency issued by the official monetary authority, whether directly or indirectly.

Payment with digital currency involves transferring ownership of a claim on the issuer without needing to or providing any information about the payer, in particular without providing information about the payer’s bank account if she has one.  In this respect it mirrors the payment of traditional paper currency.  A primary issue for a central bank when considering issuing a digital currency is whether it should be offered wholesale or retail, i.e., offered only to banks and maybe other financial firms, or offered to the general public.  If a central bank offered CBDC directly to the general public it would transform and greatly expand the role of the central bank and could potentially end the role of commercial banks in the payment system.

Offering CBDC only to banks and other financial firms would offer little that is not already available via central banks’ acceptance of deposits from these entities, which of course are digital.  In fact the distinction between digital currency and traditional deposits is not always clear or important.[2]  Currently Fedwire settles payments between account holders, including government agencies, in domestic and foreign banks licensed in the U.S.  It does not settle USD payments between accounts in non-resident banks and resident banks.  Such payments could occur with CHIPS (Clearing House Interbank Payments System) correspondent banks, but could also potentially be made by the transfer of a central bank digital currency.

If a digital currency is issued to the general public by banks in the two-tier fashion of today’s bank money, in which banks maintain deposits of national money with their central bank to secure the deposits of national money held by banks for the general public, there is an issue of what assets banks should hold or be required to hold against their deposit or currency liabilities to the public.  Digital currency issued to the public by the central bank would have no default risk, whereas digital currency issued by banks or other entities, being a liability of the issuing bank, would have default risks.

It is also possible to permit non-banks to issue digital currency as has been done very successfully in Kenya by a phone company.[3]  Over half of Kenya’s population participates in this so-called mobile phone money service. Public acceptance of a digital currency requires that its claim on central bank money is credible.  Safaricom, the issuer of Kenya’s digital currency, M-Pesa, backs the deposits of participants 100% with Kenyan shilling deposits with banks.  While M-Pesa balances are generally paid from one person or firm to another, they can be withdrawn via an agent at their face value in shilling currency issued by the central bank at any time.

A study issued by the Bank of International Settlements explores issues raised by central bank digital currency (CBDC) more generally.[4]

Background

A review of the free banking era in the U.S. (1837 – 1913) provides a useful framework in which to analyze the options and implications of digital national currencies.  Banks in that period could issue their own U.S. dollar denominated banknotes.  Because banks lend some of the money deposited with them – so-called fractional reserve banking – issuing their own currency when their depositors wished to withdraw cash, was stabilizing as explained below.  The issue of whether CBDC should use block chain (DLT) or centrally administered ledgers will not be considered here as DLT is too expensive and inefficient to take seriously as an option at this time.[5] Project Jasper of the Bank of Canada concluded that: “the versions of distributed ledger currently available may not provide an overall net benefit when compared with existing centralized systems for interbank payments.  Core wholesale payment systems function quite efficiently.”[6]

The report does not exclude the possibility that future versions might overcome existing defects and have net advantages for some applications.

The feature of so called free banking that is relevant here was the ability of commercial banks to issue their own currency (banknotes).  These banknotes did not represent private currencies in the way bitcoin does.  In the case of the United States, all bank issued currency was denominated in US dollars and redeemable for gold (or silver) at its fixed price for the dollar.  Historicallybanknotes were originally created by goldsmiths in post Medieval England – first as warehouse receipts to depositors of cash – and then as a form of lending as an alternative to having the borrower’s account credited.  For an interesting account see the article by Benjamin Geva.[7]

Banks generate most of their income by lending at interest or investing the money deposited with them by the public.  As a result, not all of the money deposited is available to pay out to the depositors should they all want their money back (as cash or by transfer to another bank) at the same time (a so-called bank run).  Only a modest amount of depositors’ money (it is actually the bank’s money once it is deposited) is available in the bank in the form of cash or deposits at the central bank.  These so called reserves must be, and virtually always are, sufficient to satisfy the cyclical (monthly and seasonally) variations in the public’s preferences for cash over deposits.  This system is referred to as fractional reserve banking because the amount of bank “reserves” are less than the amount of their deposit liabilities.  The difference in the amount of deposits and of reserves consists of bank loans and investments in less liquid assets.

In today’s banking systems all banknotes (cash) are issued by a central bank.  Thus when a deposit is withdrawn for cash, the bank’s assets (cash) and deposit liabilities both fall by the same amount.  If a bank does not hold sufficient cash or deposits with the central bank to satisfy these periodic demands, the bank is said to be illiquid.  When banks were able to issue their own currencies (Citibank dollars and Chase dollars) only the mix of bank liabilities changed (from deposits to cash) with no change in their assets.  Their total liabilities and assets remained the same.  This was a very desirable feature of note issuing banks and eliminated the risk of illiquidity from cash withdrawals.  These banks might still suffer illiquidity from deposit transfers/payments to entities with deposits in other banks.

In the free banking era when the public came to doubt the solvency of their bank (loan and investment losses that exceeded a bank’s capital—i.e., when the value of a bank’s assets falls below the value of its deposit and other liabilities) it was pointless to withdraw deposits as the bank’s own banknotes because the bank did not have sufficient assets to redeem them.  Bank runs in such cases would take the form of converting deposit or cash claims on the bank into claims on another, hopefully sounder, bank.  Those who failed to do so before the insolvent bank was closed and liquidated would lose part of their claim, i.e. they would be forced to absorb their share of the bank’s asset shortfall (its negative capital).

Thus a ten dollar bill issued by Citibank and one issued by Chase, being claims on two different banks, could have different values (even if redeemable in theory for the same amount of gold) if the public lost confidence in the solvency of one or the other. Merchants needed to pay attention to whose banknotes they were accepting.

When you pay someone by transferring some of your bank balance to the payee’s bank account (e.g. by writing a check), your bank and the receiving bank must both participate in the same clearinghouse (or have an account with a correspondent bank that participates) enabling their obligations with each other to be settled in central bank money.[8]  This role is now generally performed by each country’s central bank and the deposits that banks keep there are called reserve deposits.  In some countries a minimum amount is required (a reserve requirement) and in others it is fully voluntary but needs to be sufficient for net payments between banks.

While this fractional reserve system worked well most of the time, banks were occasionally hit with unusually large or panic withdrawals that they were not able to satisfy even when they were fully solvent (had positive capital).  A key function of the central banks being established all over the world a century or more ago was to provide temporary liquidity to such illiquid but solvent banks (though it is difficult to evaluate the solvency of a bank in real time—i.e. the soundness of their loans and investments).  Thus central banks were so-called Lenders of Last Resort.

In 1933, in the midst of America’s Great Depression, a group of University of Chicago economists proposed, among other things, that banks be required to hold reserves (cash and deposits with the Federal Reserve) of at least 100% of their demand deposit liabilities (checking accounts).  This is often called “The Chicago Plan.”  If banks’ demand deposit liabilities and their reserve assets are segregated from the rest of their balance sheet it removed any default risk to the public of holding demand deposits at any bank.  Instead of the Chicago Plan, the U.S. Congress enacted deposit insurance to reduce the risk of bank runs.

To review:banknotes issued by banks in the free banking era eliminated the risk of a bank becoming illiquid when its depositors withdrew cash, but imposed on the public the need to judge the solvency of the note-issuing bank before accepting its currency.  The risk of losses on demand deposits remained.  While that risk could have been eliminated with a 100% reserve requirement (The Chicago Plan), it was eliminated for smaller deposits by deposit insurance.

Central banks around the world now have a monopoly on issuing legal tender currency.  This eliminates the default risk of accepting such currency but reintroduces a liquidity risk for banks that promise to convert customer deposits into (central bank issued) cash on demand.  This risk is substantially reduced by central banks’ lender of last resort function.

Structuring Digital Currency

The above considerations can help us evaluate options for central banks wishing to issue digital currencies.  So-called “digital currencies” can take different forms.  “Digital coins” are the closest digital counterpart to paper currency.  Both have unique serial numbers for each unit.  “Tokens” or “claim check centralized digital currency” pass from one owner to another P2P via block chain or central registry and can be redeemed for central bank base money at any time.  “Deposits” function the same as tokens without pretending that they are not deposits.  The distinctions between these are primarily technical and may be of little if any relevance to users.  Thus I will use “digital currency” to refer to any and all of them.

Our two-tiered system for supplying money to the public (central banks issue base money that is their own liability and commercial banks create deposit money fractionally backed by central bank base money) has the very considerable benefit of outsourcing the competitive creation and management of money to many banks.  Banks develop and service their own relationships with their customers from tens of thousands of offices around the country (speaking now of the U.S.).  However, this money creating and payment function performed by banks is also comingled with their lending activity intermediating between savers and borrowers. There are synergies as well as risks from providing both services under one roof.[9]

Should central bank digital currency be provided retail or wholesale?  A central bank could issue its digital currency to anyone who signed up (registered, i.e. opened an account directly with the central bank). As all uses of this digital currency would be between participants in the system, transfer would be simple and instantaneous.  It would be essentially the same as logging into your current bank account and transferring money to another depositor in the same bank.

In addition to the above advantages of speed and simplicity, this central bank retail approach carries the burden of an enormous expansion of central bank staff to interface with the general public in establishing and managing this new digital currency. Equally troublesome is the likelihood, if not certainty of a “digital run” from bank deposits to the central bank’s digital currency.  This would be a permanent shift from banks to the central bank, which would force banks to liquidate a significant share of their assets in order to finance the outflow of their demand deposits into the central bank’s payment system.  The transition would need to be carefully managed. The magnitude of the digital run could be limited by limiting the size of CBDC payments.  This could leave most business payments with the banking system.

There are advantages to a single, monopoly provider of digital currency because payments would take the form of transfers between accounts/participants within the same system (in effect intra-bank).  But there would be the usual disadvantages of monopolies as well (e.g. sluggish technical innovation).[10]  Central banks generally have a monopoly in printing paper currency, but their sale to the public is done by competitive commercial banks.

Central banks could leave the provision of digital cash to banks and other qualifying financial firms.  This would parallel the two-tier system now in place with central bank base money and commercial bank broad money (deposits of the public).  Digital currency would be supplied only by banks, as was the case during the free banking era when individual banks supplied their own currency notes.  Thus there would be many digital dollars (Citibank digital currency, Chase digital currency, etc.).  As with free banking banknotes, each digital currency would be the liability of the issuing bank.  The risk of default for each bank’s digital currency could be eliminated by requiring 100% reserves with the central bank against any digital currency issued and segregating these assets and liabilities from the rest of bank balance sheets. It would also be possible for commercial banks to sell and administer central bank digital currency on behalf of the central bank.  Adoption of a full Chicago Plan (100% reserves for both currency and demand deposits and legal segregation from the rest of the bank’s activities) would fully protect all payment system assets (money) from bank failures. Policies would also be needed with regard to close substitutes for demand deposits such as time and savings deposits.[11] Alternatively the risk could be limited via the equivalent of deposit insurance.

Non Central Bank Digital Currency

Digital currencies issued by commercial banks would eliminate the risk of “digital runs” on bank deposits to the central bank’s digital currency flagged by the BIS in its report cited above.  Non-national digital currencies (or deposits) fixed in value to a foreign currency, to SDRs, or to gold, for example, issued by an entity playing the role of a central bank for that currency (e.g. the BIS) would also minimize the risk of a “digital run” from bank deposits in national currencies.  Such digital currencies could also adopt a traditional two-tier model by which commercial banks issue the digital currency to the retail public. In all cases of multiple, individual bank issued digital currencies, arrangements would be needed (as now) to settle payments from holders of digital currency issue by one bank to holders of digital currency issued by a different bank.  The transfer of deposits from one issuing bank to another on the books of a common institution (the traditional central bank) is the most likely mechanism for settling such payments as is now the case for deposit payments.

In the digital world the distinction between a digital deposit and a digital currency is notional. Both are liabilities of and claims on the bank or other entity that issued them.  Distinctions blur.  In addition, digital currency need not necessarily be issued by a deposit-taking bank. M-Pesa is the digital mobile phone currency version of the Kenyan shilling issued by a trust operated by the Kenyan mobile phone operator Safaricom.[12]  The trust is not licensed as a bank as it does not lend any of the money deposited with it.  One hundred percent of the money deposited with M-Pesa is placed with commercial banks. If these deposits were with the central bank, they would be risk free—an example of the Chicago Plan.

Conclusion

My conclusion from the above considerations is that digital currency should be issued by banks or by entities adhering to the Chicago Plan if and when they prove superior to existing electronic means of payment.  Commercial bank digital currency liabilities should be insured or should adhere to the Chicago Plan segregated from the rest of the bank and thus from any losses the bank’s other activities might suffer.  If bank demand deposits were also 100% reserved, bank digital currency would feature the same stability benefit as was enjoyed in the free banking era by bank note issuing banks without the default risk of that era.  Such digital currency can extend the benefits of digital payments to the non-banked as it has in Kenya and a growing number of other countries.  It is a model also well suited to the issue of global, non-national currencies such as market SDRs or gold backed currency.

[1]Dr. Coats is retired from the International Monetary Fund, where he was Assistant Director of the Monetary and Capital Markets Department.

[2]Michael D. Bordo and Andrew T. Levin, “Central Bank Digital Currency  and the Future of Monetary Policy” Economics Working Paper 17104, Hoover Institution, August 2017. https://www.hoover.org/sites/default/files/research/docs/17104-bordo-levin_updated.pdf

[3]Warren Coats, “The Technology of Money”Cayman Financial Review,January 18, 2012.

[4]“Central Bank Digital Currency,” Bank for International Settlements, March, 2018. https://www.bis.org/cpmi/publ/d174.pdf.

[5]Warren Coats, “Bitcoin, Cybercurrencies, and Blockchain” March 12, 2018. https://wcoats.blog/2018/03/12/bitcoin-cybercurrencies-and-blockchain/

[6]Project Jasper: Are Distributed Wholesale Payment Systems Feasible Yet?Bank Of Canada, Financial System Review, June 2017.  https://www.bankofcanada.ca/wp-content/uploads/2017/05/fsr-june-2017-chapman.pdf

[7]Benjamin Geva, “Banking In The Digital Age – Who is Afraid of Payment Disintermediation?”  EBI Working Paper Series, 2018 No 23, March 23, 2018.  https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3153760

[8]In the “good ol days” representatives of all local banks would meet in a room and exchange the physical checks that their customers had written to each other and settling the net differences between each bank via a common correspondent bank.

[9]Warren Coats, “Changing direction on bank regulation”Cayman Financial Review, April 2015.

[10]For an elaboration see Geva, op.cit.

[11]Warren Coats, “The Money Problem-Rethinking Financial Regulation” by Morgan Ricks, Cayman Financial Review April 26, 2017.

[12]op. cit. Coats, 2012

Bitcoin, Cybercurrencies and Blockchain

What would we do without money/currency? Money is the unit in which we express prices (making it easer to compare the relative cost of things) and the asset with which we pay for our purchases and debts. A good currency has a stable value relative to goods and services (low or zero inflation) and is universally (or very widely) accepted in payment. The U.S. dollar receives high marks by these criteria. Bitcoin, however, fails miserably in all of these respects.

Why would anyone want to hold a highly volatile “currency” whose value one year ago was $1,230, then rose to $19,343 on December 16, 2017, dropped to $6,915 February 5 of this year and is now $9,364 (March 10, 2018). In addition, bitcoin is not accepted in payment almost anywhere? See my earlier explanation of bitcoin: “Cryptocurrencies-the bitcoin phenomena”

Bitcoin is better characterized as a security – an investment asset. It’s sort of like an option on a lottery, except that a lottery promises to pay something to the lucky person(s) holding the ticket. Bitcoin doesn’t promise to pay out anything to anyone. Its value is simply what you can get someone else to pay you for a bitcoin you want to sell. Buying bitcoin is a bet that its value will rise for some reason while you own it. Its ideological appeal for some is that it exists and functions totally independent of government; and its economic appeal is that it allows the transfer of funds (illegally gained or not) without much chance of being detected. For an excellent review of these points see Peter Morici’s: “Bitcoin-investors-have-reason-to-worry”.

Even if bitcoin had a well-behaved value and was widely accepted, the engine for maintaining and delivering it, a permissionless distributed public ledger of all bitcoin transactions linked together in blocks attached to an ever growing chain (blockchain), is deeply flawed. Records of who owns bitcoins and all transactions involving them are maintained in a database (ledger) copied to everyone with a bitcoin address (account). The system is open to everyone (permissionless) and not dependent on trusting any participants. Each bitcoin transaction is directly between the seller (or payer) and the buyer (payee) peer-to-peer without passing through a central registry such as would be maintained by a bank. Given the ease with which electronic data can be copied, preventing the spending of the same money multiple times when it openly exists in thousands of copies one as official as the other (the so-called double spending problem) in an environment where no one is trusted by design is the main challenge that blockchain ledgers need to overcome.

The majority of payments today are made by digitally transferring the ownership of digital records of money, i.e. electronic transfers of bank deposits. Our deposits of money with banks, which are a bit over half of so-called narrow money in the U.S. (M1= Currency outside of banks + demand deposits in banks), exist as digital records in each bank’s central deposit registry. Banks are so called trusted third parties responsible for insuring that our deposits are not touched and moved without our permission and are responsible for resolving any disputes or problems with regard to our deposits.

If we are paying money to someone who has their account in the same bank, we can go on line and transfer the money from our account to theirs in a millisecond without a service charge. These central registries are fortified with very robust protocols that insure their safety. The process is a bit more complicated if we are making a payment to someone whose account is in a different bank and there is scope for the speed, efficiency and cost of such interbank payments to be improved.

Blockchain’s claim to eliminate the need for trusted third parties by transferring ownership (e.g. of bank balances) directly peer to peer and publishing copies of the ledger containing the record of our transactions and resulting ownership in hundreds of nodes (our computers) around the world. The objective of a system that eliminates the need to trust anyone to safeguard your money from double spending necessitates some very complex and costly operations to substitute for a trusted third party.

For bitcoin, so called, miners are given increasingly difficult mathematical problems to solve to establish that the latest blockchain transaction is unique rather than a copy. The first miner to solve the problem cryptographically stamps the digital transaction record as genuine (in effect notarizes it) adding a new block of transactions to the chain and distributes it publically to all nodes. The winning miner is rewarded with new bitcoin (for as long as they continue to be created). Not only is the manpower and computer capacity required for this competition enormous, but the electricity consumed in bitcoin mining is now greater than is consumed in all of Ireland. https://powercompare.co.uk/bitcoin/

It takes around ten minutes to confirm the authenticity of a bitcoin transaction on average. Ten minutes standing at the check out counter waiting for your payment to be confirmed is an unacceptable eternity. “A familiar critique of Bitcoin is that “it does not scale” in the sense that, as it is currently implemented, the network is not capable of supporting a global payments system that requires many thousands of transactions per second. At the moment, this is true; Bitcoin can support up to 7 transactions per second as compared to the 2,000 transactions per second typically processed by Visa (with the potential to scale to an estimated 56,000 per second).” “The-bitcoin-scaling-debate”

Moreover, most bitcoin users don’t have the IT sophistication to operate and manage their own copy of the blockchain and thus deposit their bitcoins (or other cyptocurrencies) with exchanges that manage transactions for them. These trusted third parties in all but name are in effect banks (though they do not lend your bitcoins to others while waiting for you to use them). “Every-disadvantage-has-its-advantage-reviewing-blockchain”

To participate in the bitcoin system (to buy, use or sell bitcoin, to take the example of the best known cybercurrency) you must register to obtain an address (account). It is a closed system in that you can only deal in bitcoin with other registrants (account holders). If a central bank, for example, issued a digital version of its currency, it would also be a closed system in the same way. Participants would need to be registered with it (i.e. open accounts with it) in order to participate and could only use this Central Bank Digital Currency (CBDC) with other account holders.

When problems arise or views differ on whether and what changes might be desirable in the permissionless blockchain world, there is no one responsible to address it. There is no trusted third party to take responsibility. The bitter disputes among bitcoin “leaders” and its several hard forks (breaking off different versions of bitcoins) illustrate the seriousness of this problem.

The claim is often made that even if blockchain-DLT systems are fatally flawed as the vehicle for making payments, the blockchain technology may have revolutionizing uses for other public records such as property ownership and its transfers. However, the blockchain has so many serious disadvantages that even this more limited claim is very doubtful. “Blockchain Demystified”

To address or minimize these serious drawbacks of Distributed Ledger Technology, cryptocurrencies (there haven’t been any other applications of blockchain after ten years talking about it) have been rapidly moving away from the purer, permissionless, Proof of Work version used by bitcoin to more restricted and limited permissioned, Proof of Stake approaches. None of these to date are as efficient and secure as centralized ledges of the sort used by our banks. “What-if-blockchain-is-useless?”  “Ten-years-in-nobody-has-come-up-with-a-use-case-for-blockchain”

This is not to say that exciting things aren’t happening in the ownership registry area. Digitizing ownership records introduces dramatic economies in tracking ownership and transfers of ownership. Automating many or all of the steps involved in real estate sales with the use of digitized smart contracts can significantly shorten the time and cost of the many steps (mortgage loan agreement and disbursement, collateral confirmation, settlement, title transfer, etc.). “A-pioneer-in-real-estate-blockchain-emerges-in-Europe.” In addition, a number of central banks are considering issuing digital versions of their currencies. These will probably use central registries rather than blockchains. “Central Bank Digital Currency: Bordo-Levin.” But does blockchain technology have any advantages to outweigh the many disadvantages that can’t be achieved quicker, cheaper and more securely with central registries operated by trusted third parties. Probably not. Project Jasper of the Bank of Canada concluded that: “the versions of distributed ledger currently available may not provide an overall net benefit when compared with existing centralized systems for interbank payments.  Core wholesale payment systems function quite efficiently.”  https://www.bankofcanada.ca/wp-content/uploads/2017/05/fsr-june-2017-chapman.pdf    “SWIFT says blockchain not ready”

Immigrants from Hell

What immigration policies best serve the national interests of the United States?

Every country on the face of the earth has citizens whose intelligence, enterprise, and moral character range from 0 to 10. In poorly governed countries, we might call them “hell hole” countries, their best and brightest (the 8, 9, and 10s) often immigrate to more promising environments. The United States, with our constitution of liberty, has attracted a disproportionally large number of them. This is a dominant factor in the economic success of America and our spirit of individualism and enterprise. https://wcoats.blog/2010/06/10/a-nation-of-immigrants/

Just as individuals and companies compete in the market place to maximize the reward for their efforts (those who serve the public best, profit the most), so do the countries of which they are a part. When and if individuals and companies are given the chance to protect themselves from and restrict such competition they generally take it. Free (i.e. competitive) markets rarely offer such opportunities but governments often do. Governments claim to restrict competition to protect consumers or protect jobs from cheap foreign labor, etc. But more often than not government measures to interfere in the market are the result of political pressure to serve and protect special interests, what most of us would call corruption. Examples of government measures to protect companies or individuals from competition include: import tariffs, teachers’ unions that protect the jobs of bad teachers, excessive product safety standards that foreign competitors as well as domestic start-ups find hard to meet, and restrictive professional licensing through which medical doctors (to name just one profession) have limited who and what medical services can be provided.

The government’s regulation of who may immigrate temporarily or permanently is another area heavily influenced by individuals and companies seeking to protect themselves from competition. Subjecting American firms and workers to competition from foreign firms and workers (either from “cheap” foreign labor making it there and exporting to us, or immigrating and making it here), promotes long run economic growth.

Immigrants don’t take existing jobs from Americans; they create new jobs needed to pay for the consumption they add to the economy. While it is true that a firm can profit more with a monopoly by charging more by supplying less, the income of the nation as a whole suffers when supply is monopolized. Thus while worker and firm monopolies (e.g. the United Auto Workers, and uncompetitive steel manufacturers protected by import tariffs on potential competitors) will increase worker and firm incomes in the short run, the country would be poorer than otherwise in the long run. If we closed the border to trade all together, the country’s income would suffer considerably in the long run.

In this note I review a few immigration issues from the perspective of what policies best serve the national interest. By national interest I generally mean policies that best promote broadly shared economic growth. The self-selection of the best and brightest from around the world to immigrate to the U.S. in our earlier history clearly helped make us the prosperous nation that we are today. Our poorest citizens live better than the average citizen in many of the world’s poorer countries.

Attract the best and the brightest. To continue our past history of attracting the best and the brightest from around the world, our immigration policy should favor admitting the most talented and those with the work skills most needed. If we do not continue to attract and admit them they will go elsewhere boosting the economic fortunes of other (competitive) countries. “Immigration-is-practically-a-free-lunch-for-America”

Of the approximately one million foreigners given permanent residency each year about 70% are extended family members of existing permanent residents. These are the parents and grandparents and aunts and uncles of existing citizens or green card holders most of whom do not intent to work and/or do not have skills relevant to our labor markets. From a given total of immigrants the extended family preference crowds out workers. If we want to promote faster economic growth, we should pull the family preference back to the nuclear family (spouse and children) and keep or increase the total number of immigrants allowed each year thus increasing those coming to work.

Attract the best and the brightest. Similarly we should replace the existing green card lottery with merit based selection criteria (i.e. with H-1B visas, which are currently limited to 85,000 per year). The green card lottery, which provides 50,000 immigrant visas per year from countries with a low number of immigrants over the preceding five years, is meant to increase the diversity of countries from which people immigrate. Such country quotas, even if immigrants from each country are accepted on merit rather than luck, diminish the average skill levels from a global total without diversified country quota. A case might be made, however, that America’s interests are served by the good will gained when citizens of a large number of countries have a better chance of immigrating to the United States.

Help those displaced. While increased worker productivity increases our standard of living, it also causes some workers to loose their old jobs and to acquire the new skills needed for the evolving work place. While some of these dislocations come from the competition of global trade, most is the result of improving technologies that increase labor productivity and from changes in consumer tastes. These costs, which fall on a few for the benefit of many, must not be minimized or ignored.

Many of us are no longer such big risk takers as were our ambitious ancestors. We prefer a bit more security at the expense of increases in income. In any event we need to provide an effective and efficient safety net for those of us whose skills are no longer appropriate in the labor market while retraining for the new jobs that replaced the old ones. Very importantly, a public – private partnership should improve the targeting of training of new entrance into the labor force for today’s and tomorrow’s needs and to better support the retraining of those already in the labor force but in no longer needed occupations. This is a reasonable price to pay by the rest of us who benefit from the raising living standards of improving productivity.

Restore the rule of law. There are 11 to 12 million illegal immigrants living in the United States. It is not in our national interest to go on ignoring the law. But it would be devastating to our economy (to the firms that employ them) and to the personal lives and welfare of these people to expel them even if we had the military/police capacity to do so. So the laws defining their status must be changed. There is almost unanimous agreement that the Dreamers (those brought into the country illegally as minors) should be given legal status (permanent residency) but less agreement about citizenship. In my opinion, all illegal immigrants who have been here for more than say five years and have not been convicted of a felony should be granted permanent legal residency. However, to become citizens they should be required to go through the same process and procedures as anyone else applying for citizenship (though from their American residence). https://wcoats.blog/2017/02/12/illegal-aliens/

A Basic Human Right

Hunter-gatherers freely traded what they produced (gathered) for what they needed but did not produce. The story is well known (except by Peter Navarro, an energy and environmental policy analyst masquerading as Trump’s trade expert). By specializing in what they did best (hunting) and trading their bounty with those better at producing the other things hunters needed, total output was greater and every one was better off. The right to sell what we produce for what we need/want but don’t produce is, or should be, a pretty fundamental right. It is called free trade.

Historically governments have interfered with this right to protect the markets of special groups otherwise unable to compete. These trade restrictions and tariffs reduced total output making everyone (except those protected) worse off. Recognizing the general harm done by trade restrictions, most countries have negotiated mutual reductions in these restrictions. These have taken the form of bilateral and regional and global multilateral trade agreements.

The Trans-Pacific Partnership (TPP) was one of the most recent efforts to expand trade and its income rising benefits. It was negotiated over an eight year period among 13 Pacific Rim countries and in addition to expanding trade would have deepened U.S. leadership in setting trade standards in the region. Steve Bannon rejoiced when President Trump withdrew the United States from the agreement, claiming that all future agreements would be bilateral. President Trump thereby potentially gave standard setting leadership in the area to China. Not very smart.

Candidate Trump had also promised to scrap the North American Free Trade Agreement (NAFTA) with Canada and Mexico, calling it the worst trade deal of all times (a rather crowded category). President Trump wisely decided to renegotiate it instead. It has been updated several times since it was originally signed and another round can potentially make it better still. In fact, many of the good features of the now discarded TPP are being incorporated.

If we remove existing restrictions on purchasing Canadian lumber and millwork products, for example, fewer trees will be cut down in Washington and Oregon. In exchange Canada will reduce its tariffs and other restrictions on American cars, equipment, and food product sales to Canada. Production will be more efficient and incomes will rise both here and there.

As competitive advantages shift with freer trade and product and manufacturing innovations, some workers will need to shift to new areas of work and may need new skills. Public policy should facilitate and ease the adjustment burdens of these shifts, but it is important to recognize that these shifts arise mainly from improving productivity and not from increases in cross border trade. Most of us export our labor to a domestic company (our employer) and import everything we need (paid for by our labor export). But most of those imports are from domestic companies and service providers not from so called foreign trade. The era of the self sufficient farm families ended long, long ago. https://wcoats.wordpress.com/2017/07/23/the-balance-of-trade/

President Trump may well oversee the negotiation of a better NAFTA (better for all three countries involved). Unfortunately his style of leadership in this area—baseless claims of great harm to American workers from existing trade agreements—provides a very misleading message to the American worker and public in general. He creates a negative atmosphere around the right of each of us to sell what we make to whom ever we choose and to buy what we need from whomever we choose. The world has benefited enormously from freer trade and the increases in worker productivity it has made posible. This is a huge understatement. President Trump does us all a great disservice by characterizing trade in negative terms.

Net Neutrality

The issue of net neutrality is almost as complicated as the Internet (the network of networks) itself. As with so many topics, the debate over how best to maximize the development of and benefits from the Internet (email, World Wide Web, and all of the rest) broadly divides between those who support prescriptive rules to guide and govern its operations and those who support a more permissive role for the government stepping in only to correct actual problems. To overstate it a bit, it divides the statists from the free marketers.

The history of what we now call the Internet is quite amazing. History of the Internet. Though governments provided the seed money that got it going (in the U.S. it was the Department of Defense’s ARPANET and later the National Science Foundation’s CSNET and in the U.K. it was the National Physical Laboratory), the U.S. gradually stepped back and allowed the unregulated development of commercial and private uses of the connectivity that was developing and allowed private Internet Service Providers (ISPs) to develop the gateways (access) for almost all users (both content providers and consumers) to the Internet. This policy was imbedded in the Telecommunications Act of 1996 signed by President Clinton. That legislation, affirmed that the policy of the United States was: “to preserve the vibrant and competitive free market that presently exists for the Internet . . . unfettered by Federal or State regulation.”

From the beginning of its break away from its narrow military and scientific uses, all involved in the Internet’s development were committed to it being free and open. The Federal Communications Commission (FCC) promulgated guidelines to preserve this principle in November 2011. “The FCC’s rules focus on four primary issues:

  • Transparency. Fixed and mobile broadband providers must disclose the network management practices, performance characteristics, and terms and conditions of their broadband services;
  • No blocking. Fixed broadband providers may not block lawful content, applications, services, or non-harmful devices; mobile broadband providers may not block lawful Web sites, or block applications that compete with their voice or video telephony services; and
  • No unreasonable discrimination. Fixed broadband providers may not unreasonably discriminate in transmitting lawful network traffic.
  • Reasonable network management. ISPs may engage in reasonable network management to maintain a high quality of service for broadband Internet access.” FCC Openness Principles

In this permissive environment the Internet flourished, developing in directions and ways no one could have imagined only a few decades earlier. “But two years ago, the federal government’s approach suddenly changed. The FCC, on a party- line vote, decided to impose a set of heavy-handed regulations upon the Internet. It decided to slap an old regulatory framework called “Title II”—originally designed in the 1930s for the Ma Bell telephone monopoly—upon thousands of Internet service providers, big and small. It decided to put the federal government at the center of the Internet.” Ajit Pai’s Newseum Internet Freedom Speech

What happened? Were the principles of an open Internet with fair access to all suddenly being violated or under threat in 2015? Is the proposed return to the status quo before 2015 really a threat to the principles of net neutrality?

Like all other economic activities, every aspect of the Internet costs money that someone has to pay. Those who built and maintain the Internet Backbone (NTT, Cogent, GTT, etc.), the facilities and networks of the ISPs (Verizon, AT&T, Comcast, etc.), and the content providers (Netflix, Facebook, Snapchat, HBO, etc.) did so to make money (or at the very least to cover their costs). We all know about content and service providers who thought first about how to attract users and only later how to get them to pay (e.g., Facebook and Amazon). They gradually developed their business models over time and some worked and others didn’t. What worked best (most cost efficient use of Internet resources, etc.) was not and could not have been foreseen in the beginning of the Internet’s development. Had the regulations imposed in 2015 been imposed two decades earlier, it is very unlikely we would be enjoying the Web we have today. Freezing or constraining the business models of the key players with very prescriptive regulations is neither necessary nor wise. As Mike Montgomery put it in The Hill: “The digital world moves at the speed of light. To slow that growth to the speed of bureaucracy would have serious negative effects on the burgeoning tech industry which is creating jobs faster than almost any other industry out there.” (see the link below)

Markets function best when profits are maximized by providing the best service at the lowest cost. In such cases, which is the general case, incentives are aligned, i.e. what best serves the supplier/producer also best serves the general public/consumers. Two forces operate to insure that the Internet is open to all. The first was a broad public consensus that the Internet should be open to all on fair terms (no discrimination against—filtering out or blocking—any one or any idea or point of view). The second is that discriminating in any way blocks some customers and thus reduced profits. The incentives for ISPs to provide fair access to all aligned with the public’s expectations of and desires to have fair access.

Ideology enters the discussion when people disagree over the meaning of fairness. Some people think that some classes of users (the poor, IT startups, etc.) should have the cost of their use of the Internet paid by someone else (tax payers, cross subsidies from larger, established users/suppliers, etc.). ISPs, the gateways to the Internet, have no profit incentive to provide such subsidies. Fairness for most economists is when each user pays the marginal cost of their use (plus a small profit margin).

The primary legitimate concern with respect to the net neutrality I want to see is that industry consolidation has reduced the number of ISPs to the point that over half of the country has only one (i.e. no) choice. The only competition in some areas comes from your cell phone plan. Thus there is a legitimate concern with the possibility that an ISP might charge different prices for fundamentally the same service and that those ISPs that are beginning to produce their own content might favor it over competitors’ content with faster lanes or worse.

There were indeed a few problems during the long era of light touch regulation prior to 2015. Verizon’s dispute with Netflix over download speeds and AT&T’s blocking Facetime video but not Skype on iPhones (not even an Internet issue), for example. This occurred before and were resolved before the 2015 FCC regulations on the basis of existing legislation. Excessive concentration and abuses of market power can be and have been dealt with via existing anti trust laws and state and individual civil suits.

The United States has generally allowed markets to develop fairly freely, only applying regulations to deal with real problems when they occur. I represented the IMF as an observer at a G10 Deputies Working Group on E-money meeting at the BIS in Basel Switzerland in December of 1996. The G10 Deputies are the Finance Ministers and Central Bank Governors of the ten largest economies in the world. The meeting was chaired by a young Tim Geithner, then the Deputy Assistant Secretary for International Monetary and Fiscal Policy in the U.S. Treasury Department. The meeting was to determine the regulatory approach to the prospective emergence of Electronic Money, now referred to as Cyber money. We considered reports on developments to date and took the wise decision to stand back and watch how things developed before formulating regulatory advice.

More recently the Federal Reserve’s Faster Payments Task Force project and the Federal Reserve’s cautious approach to bitcoin and other digital currencies reflects a similar attitude. That attitude, to repeat, is that no one knows for sure the direction that the development of new technologies will take in the search for maximizing their benefits thus profits. Government can at best play a supportive role of providing a flexible legal and regulatory framework within which new products and services can be explored. If problems arise, the government can review with consumers and producers how best to deal with them. The approach to regulating bitcoin and other digital currencies is still evolving.

A counter example to the above enlightened approach is the U.S. approach to Anti Money Laundering and Combating the Financing of Terrorism (AML/CFT), which has imposed enormous regulatory costs on payments of all sorts with no discernable benefits.

Those who believe that private sector behavior and the development and use of technology can be carefully and successfully regulated by government suffer what I have called hubris in other contexts. See, for example: https://works.bepress.com/warren_coats/38/. Nonetheless, in the case of so called net neutrality greater certainty about the legal and regulatory environment in which the Internet must operate would help further its development and evolution, especially if the light touch regulation under which it has developed is restored. Congress should write net neutrality into law.

An excellent discussion of these issues can be heard in this podcast on the Future of Internet regulation with FCC chairman Ajit Pai

Buy American, Hire American

President Trump continues to repeat his populist slogan “Buy American, hire American,” reflecting the way he and Steve Bannon appear to understand what is needed to make America Great Again. Thus, with apologies, I endeavor again to explain why this catchphrase is fundamentally wrong and would actually make America weak. “Trade and Globalization” “Save trade”

If buying an American made product or service (100% American, 90%, 51%?) or hiring an American worker is my best option, I would not need to be compelled to do so by the government. If it is not my best option, being compelled to do so forces me to accept an inferior option. It would make me worse off. The Trump family understands this as their hotels import and purchase foreign made products (from China, Philippines and India, to name a few) and Ivanka sells clothing made in China.

It is obvious that being forced to buy and hire American would make many of us worse off (not to mention diminish our freedom of choice), but are there compensating benefits or gains for others in the American economy that would justify making us worse off? “Teeing up Trump tariffs”

Buy American

If I must buy an American made Corvette rather than a German Porsche, does the American economy benefit? To simplify, leave aside the fact that a substantial part of the components making up a Corvette are imported from various countries. The fact that I had to be forced to buy the American car rather than the German one, i.e. that it was an inferior deal, means that the American workers who make it were reallocated from the production of export products at which the United States had a comparative advantage. Trading less as a result of buying American mean allocating American workers to producing things (Corvette) that they are not as productive at making. They would be moved from producing Boeing aircraft to sell to Germany (to pay for our imports of Porsches) to producing Corvettes. So in addition to my being made worse off as a result of having to buy American, the American economy as a whole would be worse off as a result of a less productive work force and thus lower overall income (lower GDP). This is Econ 101.

In addition, as noted by the Financial Times, “Attempts to restrict procurement to domestic companies tend to backfire. They induce retaliation from trading partners, harming US businesses trying to sell abroad. They raise input costs, ensuring less infrastructure is built and fewer construction workers are hired for each dollar of public spending.” “The Pitfalls of having to buy and hire American”

Hire American

The meaning and impact of a requirement to hire Americans is a bit more complex. If the terms to American companies of employing the workers needed, whether they are citizens, permanent residents, or temporary or permanent immigrants from abroad, are not competitive with importing the product or service, American companies will in effect hire foreigners abroad (i.e. they will import the goods and services produced abroad). Thus it is a bit unclear what “hire American” means. “The long, rough ride ahead for ‘Made in America'”

Presumably, “hire American” refers to our immigration policies. Indeed our immigration laws need fixing. This includes providing a solution to the status of the 10 or 11 million people living here illegally, and adjusting immigration quotas to better match the needs of American firms for workers without undercutting the status of existing American workers. “Illegal-aliens”

The decline in American manufacturing jobs is largely the result of automation, not foreign trade. Manufacturing employment has fallen almost everywhere in the world as manufacturing output has increased. Automation enables the work force to produce more and thus enjoy a higher living standard. It need not cause unemployment.

The wonderful film “Hidden Figures” tells the true story of the large number of human “computers” employed by NASA (the National Air and Space Administration) who cranked out the numbers needed to put Americans in space and bring them home again. The stars of the film are three black women whose mathematical skills were indispensible to NASA. At the end of the day and in time for the first American to orbit the earth in 1961, new IBM’s mainframe computers proved essential to crunch the critical data fast enough. Overnight the human computers were no longer needed. But rather than becoming unemployed, most of them retrained to program and run the IBM computers with an unbelievable boost in productivity. While other things also affected NASA’s workload, the employment data are interesting. In 1960 NASA had 13,500 in house employees, which increased to 41,100 by 1965 and gradually drifted down to 18,618 in 2010. The numbers for contract workers on the same dates were 33,200 in 1960, 369,900 in 1965 and zero in 2010.

The President’s appeal to Buy American and Hire American, in addition to restricting our freedom of choice, flies in the face of what made America Great in the first place. As proclaimed by the Financial Times: “The principle should remain to keep the US economy as open as possible to the inflow of good products and good workers from abroad. Slamming down the drawbridge is only likely to impoverish the residents of the citadel.”

 

President Trump and manufacturing jobs

President Trump intends to bring back manufacturing jobs. How might he do that and what would it mean for our economy and our workers?

Keeping in mind that our manufacturing output has steadily increased over the years and is now at an all time high, though the number of manufacturing jobs has steadily declined. Bringing back manufacturing jobs means rolling back and undoing the technical advances that made manufacturing workings more productive. But if we increase the number of workers in manufacturing by making each worker less productive (shelving some of the productivity enhancing technical advances), where will these workers come from? Presumably not from Mexico. They will have to give up what they were producing before in order to take the new manufacturing jobs.

Looking more carefully at such a policy reveals that it would make us poorer. Without Trump’s arm twisting (carrots and sticks—tax breaks, i.e., bribes, and/or tax or other penalties), the workers in question would be employed doing things that were more profitable (i.e. more productive and contributed more to our income) than in manufacturing. Trump would have those workers move from where they are more productive to where they would be less productive. I assume that such a policy reflects ignorance rather than malice, but what ever his motivation, the result of Trump’s protectionist threats would be to lower our standard of living.

If President Trump intends to return power from the government to the people, as he claimed in his inauguration speech, he will have to stop threatening companies to produce things in the U.S. when they would otherwise find it more profitable (cheaper) to produce them abroad and import them. Anything and everything that adds to our economy’s productivity (specializing in what we are best at and exporting it to pay for imports that other countries are better at making) increases our incomes. Trump should stop interfering with our private economic decisions and get on with the other aspects of his promises (tax and regulatory reform) that will increase our well-being.

Globalization and Nationalism: Good and/or Bad?

Globalization is under attack and nationalism is on the rise. The evidence includes the election of Donald Trump. But what is this globalization these people are so opposed to?

After 1945—after the Great Depression and two world wars—Western nations established an international system of rules that honored national sovereignty, facilitated the flourishing of global commerce, and encouraged respect for human rights and liberties. This liberal international order resulted in the longest period of peace among the world’s major powers the world had ever seen, broad-based economic growth that created large middle classes in the West, the revival of Europe, growth in poor countries that lifted hundreds of millions of people out of poverty, and the spread of freedom across the globe. Fareed Zakaria, Washington Post/2016/11/17/. This is the liberal international order that I largely support.

What exactly is under attack and what is on the rise? In a very insightful article in the National Review, Michael Lind characterizes the globalist view as follows: “In the 1970s and 1980s, libertarians made all of the major arguments heard from globalists since the 1990s: Favoring citizens over foreign nationals is the equivalent of racism; national borders impeding the free flow of labor and goods are both immoral and inefficient; the goal of trade and immigration policy should not be the relative security or relative wealth of particular countries, but the absolute economic well-being of all human beings.” Michael Lind, National Review, Sept 15, 2016

What about the rise of nationalism in relation to globalism? I believe strongly in the economic benefits of the freest possible global trade, but it would be a mistake to overlook or ignore the concerns of those who oppose it. In this note I attempt to restate the case for freer trade in terms that should appeal to economic nationalists who wish American trade (and other) policies to reflect the interests of Americans first (before taking into account the benefits to the rest of the world). I also reflect on the international rules of trade from the perspective of the sovereignty concerns of nationalists, or what economist Larry Summers calls “responsible nationalism.” Voters deserve responsible nationalism not reflex globalism

I was forced to think more carefully about the case for freer trade by the opposition to globalization expressed by many of Trump’s supporters. But I quickly discovered that my friend Michael Lind has been there before (see above) as has the brilliant social psychologist Jonathan Haidt who noted that: “those who dismiss anti-immigrant sentiment as mere racism have missed several important aspects of moral psychology related to the general human need to live in a stable and coherent moral order.” Jonathan Haidt: “When and why Nationalism Beats Globalism”, The American Interest, July 2016

Haidt’s closing words succinctly summarize our challenge: “The great question for Western nations after 2016 may be this: How do we reap the gains of global cooperation in trade, culture, education, human rights, and environmental protection while respecting—rather than diluting or crushing—the world’s many local, national, and other “parochial” identities, each with its own traditions and moral order? In what kind of world can globalists and nationalists live together in peace?”

Immigration and trade are intimately linked – if Mexicans can make it in Mexico and export it to the U.S. they will be less interested in moving to the U.S. in order to build it there (in fact, net Mexican migration to the U.S. has been negative for the last few years)—and thus I will look at both.

The most promising starting point in my view is with the sovereignty of each American citizen. Unlike the Magna Carta, which wrested more autonomy for the people from the King, the free men and women of revolutionary America gave up a limited amount of their autonomy to a new state in order to better protect their property and individual rights. The direction of delegation was the exact opposite of what the world had ever seen before. It is not without profound significance that our Constitution begins with “We the people.”

Thus it is quite appropriate to judge governmental authority and policies by the standard of how well they serve our individual sovereign interests. In evaluating those interests, it is appropriate to do so from the perspective of John Rawls’ veil of ignorance, i.e. principals of fairness—rules of the game—that we accept as fair without knowing which positions in society we will occupy. This is the perspective of free market, competitive capitalists and is opposite to the perspective of crony capitalists who exploit the power of government for their personal benefit.

We have surrendered limited (enumerated) powers to our governments (local, state, federal, etc.) in order to enjoy greater security and protection of our property but also to support and protect our freedom to trade and to enjoy its benefits. No one really needs to be convinced that being able to specialize in what we make best and trade it for other things we need has enormously increased our wealth over being self-sufficient (no trade). No one needs to be convinced that by investing in tools and better technologies we have been able to produce more for trade and thus become wealthier. But investing and trading require common understandings with those with whom we trade—the rules of trade. We have long ago understood that we all benefit from giving up some of our sovereignty to our government to negotiate and enforce the agreed rules of trade, protect our property, and mediate disputes over whether the rules were followed.

The simple act of entering into a contract with someone involves giving up the freedom to act as we want each moment in exchange for a similar commitment by our counterparty for the mutual benefit of both of us. Where the mutual benefits of such rules are greater than the cost of the forgone freedom of action, the agreement is a positive sum arrangement—win-win. Conforming to international product standards, e.g. adhering to standards of weights, measures, voltage, labeling, etc., facilitates trade. The key policy issues in this area are the nature and details of the rules of trade that best serve our personal interests (in the Rawlsian sense) and thus our community and national interests, and the extent of the market in which we are able to trade (village, province, nation, world). “Free Markets Uber Alles,” Dec 2014

The more widely we can trade, the greater is our opportunity to specialize in what we produce and to develop and apply more productive technologies.

“Trade and Globalization,” Aug 3, 2016. Our founding fathers were rightly concerned about the power of the new American government to limit the right of its citizens to trade. In fact, the U.S. Constitution prohibited the States from interfering with trade across State borders (interstate commerce). Article I, Section 8, Clause of the Constitution states that the United States Congress shall have the power “To regulate commerce with foreign nations, and among the several States, and with the Indian Tribes.” While Congress has occasionally used this power to impose restrictions on trade across national borders, the majority of Americans still believe that cross border (international) trade has been mostly good for the U.S. (65% in 2015). The wrong-headed effort to save American jobs during the Great Depression with high tariffs imposed by the Smoot Hawley Tariff Act of 1930, precipitated retaliatory tariffs around the world and a disastrous collapse of global trade and employment. U.S. imports and exports fell by more than half and the whole world was made poorer by it.

As noted above, the resulting increase in the world’s wealth from technical progress and trade has been enormous. But the incentive created by trade in a large market to innovate new products and more efficient ways to produce them has also meant that some of the existing products and/or technologies lose out and must give way to the improved ones. Those producing the old products and services are forced to find new ones and if necessary new productive skills.

The United States has generally grown economically faster than most other countries, in part, because its citizens have not been willing to allow those who lose out in such competition to block progress by the “winners” by protecting their products and jobs. The ultimate willingness of Americans to accept and protect the dynamic economics of competitive national and global markets rests, I think, on the three pillars: maximum wealth creation, maximum opportunity for everyone (the chance to win at a fair game), and help for those who lose out.

Americans should only be willing to give up some of their personal sovereignty to their government when they gain more in exchange in the Rawlsian sense of a positive sum, fair game. We should impose the same conditions on the extension of the rules of trade beyond national boundaries. This is the standard by which bilateral, regional and global trade agreements should be judged. They have the largest potential for win-win expansions of mutual trade and the greater income and wealth that expanded trade can produce. The Bretton Woods institutions created after World War II (the IMF, World Bank and World Trade Organization) established the institutional arrangements for such international cooperation. It is important to insure that such agreements do not increase the protection of “privileged” industries or sectors of the economy. In fact, they should diminish such protections where they already exist, which is why many European industries and interests oppose the Transatlantic Trade and Investment Partnership (TTIP). Much of the Trans Pacific Partnership (TPP) has this positive character. American leadership in creating the international institutions through which we interact with others abroad, i.e., through which the rule of law is established and enforced internationally, has ensured that the international order has remained true to the values on which America was founded.

The evolution of man established the family as the unit of first and primary concern. The well being of one’s family stands above the interests of all others. However, the process of civilization has been one in which mechanisms of trust and mutual assistance have convinced individuals to yield some of their sovereignty to larger units (village, state, etc.) under conditions that strengthened the security and well being of family units. Globalization is the logical conclusion of such a process. It is the development of laws of cooperation and the mechanisms of their enforcement (i.e. the rule of law) that potentially raise the welfare of everyone. But the details of the expanding circles of cooperation are important and must not violate genuine national and family interests.

In listening to the views of many Trump supporters I concluded that their anger and demand for big change derives from feelings that their government—especially the federal government—is not serving their legitimate interests and in fact is interfering with their lives without commensurate benefits. “The reason Mr. Trump won, [Mr. Bannon] says, ‘is not all that complicated. The data was overwhelming: This is a change election. People weren’t happy with the direction of the country. So all you had to do was to give people permission to vote for Donald Trump as an agent of change, and make sure he articulated that message.’” steve-bannon-on-politics-as-war-WSJ

So what are the Trump supporters mad about? What do they want to change? To the extent that they are concerned about the same things I am, it is that too much of our individual sovereignty has been taken by an overweening government, which has become a big brother who attempts to make our decisions for us for our own welfare. Our personal choices have increasingly been taken away from us and with them our opportunities. The “elites” have arranged the rules for there own benefit. It is no longer a fair game.

The weaknesses of current arrangements at the national level that seem to anger Trump supporters largely concern: a) regulatory capture of an over extended regulatory state, b) inadequate provision of a level playing field and c) an inefficient and poorly designed safety net for the losers in the competitive game. Very briefly:

  1. a) The crony capitalism reflected in President Eisenhower’s famous concerns with the risks of a military industrial complex, have metastasized into a much broader capture by legacy industries of a much more extensive government intrusion into the economy. Wherever government regulates (and some are actually helpful), the most affected, established firms are best placed to insure that such regulations benefit rather than hurt them, usually by protecting themselves from the competition of new comers. Wall Street comes to mind. Changing direction on bank regulation, Cayman Financial Review April 2015
  1. b) A level playing field. Good quality education (especially K-12) is one of the most important ways for the poor and initially disadvantaged to get into the productive economy and to rise as far as their talents and energy will take them. But the education provided to this group is often of poor quality. The iron grip of teachers’ unions has often served the interests of teachers at the expense of their students. School choice (tuition vouchers) would introduce badly needed competition in the provision of education to all – the poor as well as the rich (who all ready enjoy considerable choice).
  1. c) An efficient safety net. When jobs disappear to technological advancements (e.g., increased automation) the affected workers and capital need to be reallocated to more productive uses. But this is economist speak. The workers involved often lose their human capital (i.e. their existing skills lose value in the market place) and need to retrain for new tasks. Older works might never rebuild new skills sufficient to restore their previous incomes. Government policy should give more attention to vocational training (and retraining). But the ultimate safety net should be strengthened and redesigned by replacing existing welfare programs and social security with a guaranteed minimum income for each and every citizen (in the spirit of Milton Friedman’s negative income tax). US federal tax policy, Cayman Financial Review July 2009

Responsible Nationalism and Globablization

As Michael Lind observed earlier, America has been dividing into liberal internationalists like myself who live in the big urban centers and civic nationalists, who live in the rest of the country. The civic, economic, responsible and just plain old nationalists seem to be reacting against their sense of a loss of control over their own lives. Big brother seems to be regulating more and more what we can do, say, produce, or buy. Their opportunities are being thwarted by an unfair game—crony capitalism for the well-placed elites. This sense of a loss of control is compounded by concerns over the lack of control of our borders against undesirable immigrants and potential terrorists. While the assimilation of different cultures into the framework of basic American values of personal freedom and responsibility can be touchy and challenging at times, the finger pointing and pressure from the American left for full cultural integration feeds the fears of many of a loss of cultural, ethnic, and religious identity.

When some groups receive preferential treatment some other groups are necessarily discriminated against. While I have tried hard to accept the logic of “Black Lives Matter,” it always rubbed my sense of fair play the wrong way. All lives matter. Thus while I am saddened that it seems necessary to some white males (I am guessing they are males because that is what the press always says) to carry signs saying “White Lives Matter,” I can understand. If we need to say the one, we need to say the other if we still have any sense of fairness.

So there are plenty of things for Trump supporters to be angry about and to want to change. But now that we have him, what changes should we push for? I am particularly interested in changes that will reassure Trump’s angry voters to support American participation in the liberal global order. In evaluating what is in our national interest, we need to consider the long term rather than immediate benefits of a rule based, freely competitive world order.

We should push for a thorough reform of our tax system (see my article above), strengthen our safety net for those displaced by technology (by far the major source of job losses in the U.S.) and trade, and shift more of the regulation of commerce to the market (to consumers and owners) thus significantly reducing government regulation. We must also fashion an immigration policy that meets the needs of our economy without overwhelming the capacity of our society to absorb new members. Existing long term, undocumented residence need to be offered a realistic path to legal status. But most of all, in fashioning these and other changes we need to listen carefully and constructively to each other’s concerns and take them into account.