President Trump’s nomination of Jerome Powell as the next chairman of the Federal Reserve System is a bet that he will continue Janet Yellen’s policies and not rock financial markets. The expectation is that Powell will follow the Fed’s already-announced normalization schedule, which calls for slowly reducing the Fed’s $4.2 trillion balance sheet, by rolling off maturing mortgage-backed securities (MBS) and longer-term Treasuries, and gradually increasing the target range for the fed funds rate.[1]

The presidential vote of confidence for Powell reflects the White House and Treasury’s desire for low interest rates to fund the public debt and support high asset prices, as well as the probability that the Senate will quickly confirm the nominee.

Mr. Powell also appears open to revisiting financial regulations, such as the Volcker rule and regulations that discriminate against smaller banks. In testimony, before the Senate Committee on Banking, Housing, and Urban Affairs, on June 22, 2017, Governor Powell set forth “Guiding Principles to Simplify and Reduce Regulatory Burden.” One of the key principles is that Fed policymakers “should assess whether we can adjust regulation in common-sense ways that will simplify rules and reduce unnecessary regulatory burden without compromising safety and soundness.” He emphasized that the Fed’s goal should be “to establish a regulatory framework that helps ensure the resiliency of our financial system, the availability of credit, economic growth, and financial market efficiency.” However, during his tenure on the Fed’s Board of Governors since May 2012, he has consistently voted in favor of tightening the Fed’s grip on financial regulation.[2] Thus, one must remain skeptical about whether he would embrace market-friendly deregulation.

Unconventional Monetary Policy and Uncertainty

Unconventional monetary policy — in the form of quantitative easing (i.e., large-scale asset purchases) and ultra-low interest rates — has misallocated credit, distorted interest rates, encouraged risk taking, inflated asset prices, fueled government deficit spending, and done little to promote long-run private investment.[3]

By purchasing massive amounts of high-risk MBS and long-term government bonds, the Fed helped lower longer-term interest rates but steered credit away from private investment, which was also impeded by stricter macro-prudential regulations. Moreover, by keeping short-run interest rates near zero for more than seven years, paying interest on excess reserves (IOER) above the effective fed funds rate, and convincing markets that rates would stay low for a long time (forward guidance), the Fed has increased the reach for yield and appears more interested in priming Wall Street than in letting markets set interest rates and allocate credit.

The Fed’s current operating procedure is to administer the target range for the fed funds rate using IOER and reverse repos, in contrast to the pre-crisis arrangement whereby the Fed’s open market desk bought or sold short-term Treasuries to increase or decrease bank reserves, and then let market participants determine the effective funds rate.[4] As a result, changes in the monetary base are no longer “high powered” — the money multiplier has collapsed and the monetary transmission mechanism that prevailed prior to 2008 is broken.

Unconventional monetary policy, macro-prudential regulation, and the lack of any monetary rule have increased uncertainty about the future of monetary policy and, thus, have had a negative effect on private investment. To his credit, Mr. Powell has recognized some, but not all, of these problems. In January this year, he told members of the American Finance Association in Chicago that “the current extended period of very low nominal rates calls for a high degree of vigilance against the buildup of risks to the stability of the financial system.” However, he downplayed that risk by saying that “the bottom line is that there has not been an excessive buildup of leverage, maturity transformation, or broadly unsustainable asset prices.”[5]

The Limits of Monetary Policy

The purpose of the Bernanke-Yellen monetary policy has been to lower longer-term rates and pump up asset prices creating a wealth effect to spur spending and real economic growth. But there has been a differential impact favoring the housing and government sectors, while private investment has been sluggish due to regime uncertainty, regulatory costs, and a fall in the private saving rate. From a long-run perspective, the Fed cannot permanently increase wealth by monetary policy. Powell recognizes the limits of monetary policy when he notes that “ultimately, the only way to get sustainably higher interest rates is to improve the broader environment for growth, by adopting policies designed to increase productivity and potential output over the long term — policies that are mainly outside the scope of our work at the Federal Reserve.”[6] Recognition of the limits of monetary policy is an important first step toward sound monetary policy.

The Schizophrenic Nature of Fed Policy

In his January speech, however, Powell is silent on the schizophrenic nature of Fed policy — a policy designed to increase risk taking, allocate credit to favored sectors, and stimulate economic activity but that plugs up the monetary transmission mechanism by paying IOER, and discourages lending to productive ventures by an onerous system of macro-prudential regulation. As market analyst Brian Barnier notes, “Low interest rates don’t help if companies face high risk and uncertainty. Central banks that cause volatility and uncertainty have been defeating their own interest rate actions.”

Normalizing Monetary Policy and Instituting a Rules-Based Regime

Regime uncertainty could be reduced by first normalizing monetary policy by reducing the size of the Fed’s balance sheet and ultimately eliminating IOER and restoring a market-driven fed funds rate. A rule-based monetary regime could then be instituted to guide monetary policy. In the present unconventional regime — with the absence of a competitively determined fed funds rate and a weak link between base money (i.e., currency in circulation plus bank reserves), broad monetary aggregates, and nominal GDP — the implementation of monetary rules such as the Taylor rule and a final demand rule would fail.

Under unconventional monetary policy, we therefore are stuck in a fully discretionary fiat money regime — and, thus, in a fog of uncertainty. Maintaining such a system ignores the institutional uncertainty brought about by not having a credible monetary rule. Such a rule would help depoliticize monetary policy and incentivize the Fed to take a long-run perspective, thereby reducing uncertainty.[7] As Karl Brunner has pointed out regarding the knowledge problem facing monetary policymakers,

We suffer neither under total ignorance nor do we enjoy full knowledge. Our life moves in a grey zone of partial knowledge and partial ignorance. More particularly, the products emerging from our professional work reveal a wide range of diffuse uncertainty about the detailed response structure of the economy.… A nonactivist [rules-based] regime emerges under the circumstances … as the safest strategy. It does not assure us that economic fluctuations will be avoided. But it will assure us that monetary policymaking does not impose additional uncertainties … on the market place.[8]

In a speech at the Forecasters Club of New York in February, Powell argued that monetary rules can help guide policy, but he sees those rules as too simple to take account of the complexity confronting policymakers. He has in mind the Taylor rule, which would set the nominal fed funds rate based on a single equation:

(1) R = r* + π + a (π – π^LR) + b (gap)

where

R = nominal federal funds rate

r* = neutral real federal funds rate

π = the inflation rate

π^LR = 2 percent

gap = percentage deviation of output from its potential level or unemployment from its natural rate.

Taylor, in his 1993 article, set a = 0.5 and b = 0.5.

According to Powell,

I think it’s fair to say that simple policy rules are widely thought to be both interesting and useful, but to represent only a small part of the analysis needed to assess the appropriate path for policy. I am unable to think of any critical, complex human activity that could be safely reduced to a simple summary equation. In particular, no major central bank uses policy rules in a prescriptive way, and it is hard to predict the consequences of requiring the FOMC to do so, as some have proposed. Policy should be systematic, but not automatic.

In fact, complexity is what makes a rules-based regime desirable. No one on the Federal Reserve Board or the Federal Open Market Committee predicted the 2008 financial crisis. The purpose of a systematic, rules-based monetary regime is to keep the economy on track and prevent a sharp decline in final demand. No rule can be perfect; there is always a learning process. But as Brunner noted, a nonactivist rule would reduce uncertainty inherent in a period-by-period discretionary monetary regime. A long-run strategy based on achieving a stable growth path of nominal final demand would avoid the type of errors associated with a purely discretionary regime.

The Great Moderation and the Case for a Final Demand Rule

During the “Great Moderation” (1987–2006), under Fed chairman Alan Greenspan, the trend rate of growth of final demand, as measured by nominal final sales to domestic purchasers (FSDP), was 5.4 percent per year — split into real growth of 3 percent and inflation of 2.4 percent.[9] Cato’s former chairman Bill Niskanen found that variation around that trend “had significant effects on asset prices and the real economy, and most of this variation was a consequence of the Fed’s response to financial crises.” Figure 1 from his 2006 Cato Journal article is reproduced below.

Figure 1: Nominal Final Sales to Domestic Purchasers

Based on his research, Niskanen concluded that the Greenspan Fed implicitly followed a final demand rule but that it overreacted in increasing demand when faced with financial crises. Niskanen sees the primary duty of the Fed as maintaining “a steady increase in aggregate demand consistent with a low target rate of inflation.”

The Great Moderation was also in line with the Taylor rule but that rule depends on knowledge of r* and the output gap, both of which are difficult to estimate. As Powell noted in his February speech, “The neutral rate changes significantly over time, and estimates of its level entail substantial uncertainty.” Moreover, “there is particularly high uncertainty about measuring the deviation of output from its potential,” and the values of the coefficients, a and b, in Taylor’s rule need to be specified.

Niskanen prefers a final demand rule over an interest rate rule, in part, because it does not require imputing values to r*, or estimating the output gap.[10] In the 2009 edition of Cato’s Handbook for Policymakers, he recommended that “Congress should amend the Full Employment and Balanced Growth Act of 1978 to clarify the congressional guidance on the conduct of monetary policy.” In particular, he argued that

Congress is best advised (1) to specify a target rate of increase of final sales and (2) to instruct the Federal Reserve to minimize the variance around this target rate. The target rate of increase of final sales may best be about 5 percent a year, sufficient to finance a realistic rate of economic growth of 3 percent and an acceptable rate of inflation of about 2 percent.[11]

Niskanen saw nominal FSDP as “a feasible target” because it is “almost completely determined by U.S. monetary policy, whereas the rate of economic growth and the inflation rate are separately affected by a variety of domestic and foreign conditions.” The problem is that, under the Fed’s current operating procedure, the link between base money creation and final demand has been severed. Moving to a rules-based regime thus requires normalizing monetary policy and restoring the monetary transmission mechanism as discussed earlier.

Some congressional leaders think it’s time to create a rules-based monetary regime. The Financial CHOICE Act of 2017 (H.R 10), which recently passed the House, would make the Fed responsible for specifying a monetary rule and justifying to Congress any deviations from it.[12] Whether the CHOICE Act passes or not, it is important to consider alternative monetary rules and to be prepared to make the case for rules over discretion when the opportunity for reform arises.

The Phillips Curve Is a Poor Guide for Monetary Policy

The Phillips Curve model of the economy, which posits an inverse relationship between unemployment and inflation, has been a poor guide for monetary policy, yet the Fed still incorporates that relationship into its thinking.[13] With the rate of unemployment now at 4.1 percent, policymakers are puzzled why inflation hasn’t increased to the Fed’s target of 2 percent. They could look to their own operating procedures used since October 2008. Without IOER and Dodd-Frank type regulations, banks would be lending more, and base money would have a stronger impact on overall money growth and the price level.

Powell’s Challenge

Mr. Powell, no doubt, will be under pressure from the White House and Treasury to keep rates low — even if markets are pushing them upward. Intervening to postpone necessary adjustments, however, would only complicate future policy changes and increase the costs of adjustment.

It is essential that Powell understand the risks involved in the post-2008 operating techniques and the underpricing of risk that unconventional monetary policy has occasioned. His challenge will be making the transformation to a new policy regime that gets the Fed out of the business of allocating credit and pegging interest rates at artificial levels.

Conclusion

Congress has ultimate authority for monetary policy. During the confirmation process, there needs to be a discussion of the limits of monetary policy and how Mr. Powell sees the future of monetary policy, and the steps he would take in a crisis situation. Finally, Congress needs to make the Fed accountable for its mistakes and ensure it abides by the rule of law.

_____________________

[1] See George Selgin, “Operation SNAIL,” Alt‑M, September 26, 2017.

[2] See Binyamin Appelbaum, “In Choice of Fed Chairman, Trump Downgrades Deregulation,” New York Times, October 29, 2017.

[3] There is no doubt that nonmonetary forces have contributed to historically low interest rates. Real rates have been declining for some time, due to slower productivity growth, demographics, and other factors (see Powell’s January 7, 2017 speech). It is hard to deny, however, that Fed policy has not contributed to the low-interest environment and helped fuel selected asset prices. Indeed, Powell, in his January address to the American Finance Association, argued that, with regard to the impact of “highly accommodative monetary policies, … studies generally show that they lowered rates across the curve and moved other asset prices as well.” At the same time, he admitted that “isolating the effects of these policies is challenging.” If Mr. Powell is correct that rates are mostly reflecting nonmonetary factors, then asset prices may be sustainable, but if he is wrong, then there is a strong possibility that as the Fed exits its unconventional polices, there will be a significant market correction.

[4] For a detailed discussion of the Fed’s pre- and post-crisis operating procedures, see George Selgin, “Interest on Reserves and the Fed’s Balance Sheet,” testimony before the House Subcommittee on Monetary Policy and Trade, May 17, 2016. See also Norbert Michel and Selgin, “Fed Must Stop Rewarding Banks for Not Lending,” American Banker, May 30, 2017.

[5] The IMF is less sanguine. In its latest Global Financial Stability Report (October 2017), the IMF raises “concerns about a continuing buildup in debt loads and overstretched asset valuations [that] could have global economic repercussions” (p. 42).

[6] Jerome Powell, “Low Interest Rates and the Financial System,” Speech at the 77th Annual Meeting of the American Finance Association, Chicago, January 7, 2017.

[7] Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corporation and former president of the Federal Reserve Bank of Kansas, has argued “that monetary and regulatory policies have for some time been overly focused on short-run effects at the expense of long-run goals, which has unintentionally served to increase uncertainty and economic fragility.” See Hoenig, “The Long-Run Imperatives of Monetary Policy and Macroprudential Supervision,” Cato Journal (Spring/​Summer 2017), p. 195.

[8] Karl Brunner, “The Control of Monetary Aggregates,” in Controlling Monetary Aggregates III, p. 61. Boston: Federal Reserve Bank of Boston, 1980.

[9] Final sales to domestic producers (FSDP) is defined as “the sum of nominal gross domestic product plus imports minus exports minus the change in private inventories.” See Niskanen, “Monetary Policy and Financial Regulation,” in Cato Handbook for Policymakers (2009), 7th ed., p. 377.

[10] In his 1992 Cato Journal article, “Political Guidance on Monetary Policy,” Niskanen examined three viable monetary rules: (1) targeting the price of gold or a broad price index, (2) targeting a monetary aggregate, and (3) targeting nominal GDP or domestic final sales. He argued that “any one of these rules would be better than guidance based on interest rates or exchange rates, or on any real variable such as the growth of output or the level of the unemployment rate” (p. 281). His preferred rule, however, is to minimize “the variance around an approved target path of nominal domestic final sales” — an objective that “is probably the most that can be expected of monetary policy” (p. 285).

[11] Market monetarists, such as Scott Sumner and David Beckworth, prefer to target nominal GDP (NGDP) rather than final sales. Their arguments for a final demand rule, however, are similar to Niskanen’s. For example, Beckworth argues that “a NGDP target aims to stabilize total dollar spending. It is one target that has embedded in it both the supply of and the demand for money (i.e. total dollar spending = money supply x velocity of money). The beauty of a NGDP target is that the Fed does not need to know what is exactly happening to the money supply or money demand. All the Fed only needs to worry about is the product of the two components. There is no need to track the money supply or estimate money demand. By focusing on total dollar spending, the Fed will be fostering a stable monetary environment where movements in money supply and money demand are offsetting each other.” Bill Woolsey, in comparing a monetary rule targeting NGDP versus one targeting FSDP, finds no significant difference.

[12] See Title X of H.R. 10: “Fed Oversight Reform and Modernization.” H.R. 10 also calls for a Centennial Monetary Commission to examine the Fed’s history and to recommend reforms.

[13] See, e.g., J. A. Dorn, “It’s Time to Bury the Phillips Curve,” Investor’s Business Daily, September 26, 2017.

[Cross-posted from Alt‑M.org]

The president just announced his pick to chair the Federal Reserve System. Subject to Senate confirmation, current Fed governor Jerome “Jay” Powell will succeed Janet Yellen as Fed chair in February 2018. Market reaction to this announcement has been sanguine, with commentators describing Powell as the “continuity candidate.”

It is perhaps strange that Powell should be so-described, when Janet Yellen was still in the running for a second term until very recently. The point, though, is that Powell’s views are much closer to Yellen’s than the other candidates interviewed by the president — former Fed governor Kevin Warsh and Stanford economist John B. Taylor — either of whom might have heralded a departure from the status quo.

Powell is often characterized as a moderate dove or neutral on the path of interest rates. He is seen to mirror Chair Yellen in many respects, having supported every move made by the Fed since his appointment to the Fed Board in 2012. What’s more, Powell has already been confirmed by the Senate twice: once to complete Frederic Mishkin’s term as Fed governor, and again in 2014 for his own 14-year term. This fact surely wasn’t lost on an administration desperate for policy wins: a twice-confirmed Fed governor, who is a Republican, is likely to face the easiest confirmation process.

As chair, it is unlikely that Powell will make significant changes to the Fed’s normalization plan. The Fed has been painstakingly deliberate in communicating its intentions about interest rates and the balance sheet; Powell, who supports “forward guidance” as a policy tool, will not want to disrupt that. And with historically low volatility in financial markets right now, Powell won’t want to risk another “Taper Tantrum” that would mar the beginning of his tenure as Fed chair.

None of this means there won’t be any changes at the Fed once Powell is in charge. For one thing, Powell is skeptical about some post-crisis financial regulations. He testified recently that there is room for relaxing or even eliminating elements of newly-imposed regulations stemming from Dodd-Frank. Powell has been particularly outspoken on the need to exempt small banks from regulations designed to apply to large financial institutions. In private, Powell has also voiced concerns that even the most well-intentioned regulations can have unseen, adverse effects.

One worry about Powell is how he would handle a recession, or — even worse — another financial crisis. He is a lawyer by training and was a partner at private equity firm The Carlyle Group before coming to the Fed. Nevertheless, his former colleagues note that he devoted himself to learning macroeconomics and was quick to come to grips with the intricacies of monetary policy. Powell is also known to lean on the Fed’s staff for guidance — a detail that suggests he will lead by consensus.

That said, Powell has gone further than many of his colleagues on the subject of monetary policy rules. In a speech last February, Powell closed by discussing the usefulness of such rules. He highlighted the Cleveland Fed’s rules-based dashboard, and suggested it was the type of analytical tool the FOMC ought to use to guide monetary policy. In short, Powell sees value in using rules as benchmarks that can improve the analysis performed by the central bank. John Taylor, the father of the most famous monetary rule, has expressed support for such a strategy.

Powell ended that February speech by saying, “Policy should be systematic, but not automatic.” If the Fed delivers on that promise under his leadership, it will be taking a step in the right direction.

[Cross-posted from Alt‑M.org]

This primer is supposed to introduce readers to the workings of the present U.S. monetary system. So it’s only natural that it should take established monetary arrangements for granted, including an official, “fiat” dollar currency managed by the Federal Reserve System.

And while I haven’t hesitated to point out shortcomings in the Fed’s management of the dollar, and have even dared to suggest some ways in which that management might be improved upon, I haven’t questioned the fact that, whether it does so competently or not, the Fed is indeed ultimately “in charge” of the U.S. monetary system. That is, I’ve assumed, that the U.S. dollar is the only important domestic currency unit, and that the total quantity of dollar-denominated exchange media, the behavior of the general level of prices, U.S. dollar exchange rates, and the periodic flow of domestic dollar-denominated payments, remain under the discretionary control of the FOMC.

Monetary Policy, Broadly Understood

But while a monetary policy primer must generally deal with existing monetary arrangements, it doesn’t follow that it should overlook others altogether. “Policy,” according to Webster, is “a high-level overall plan embracing the general goals and acceptable procedures especially of a governmental body.” And though, within the set of possible plans, the most readily-implemented ones take existing institutional arrangements for granted, there are always other, more radical options that involve either replacing established arrangements or confronting them with rival ones with which they must compete.

Radical policy alternatives are, inevitably, controversial ones as well; so a primer is hardly the place for any detailed consideration, let alone a defense, of any of them. Instead, we must settle for a quick glance at several especially prominent or intriguing possibilities, all of which involve moving away from the present, discretionary system and towards a more-or-less “automatic” alternative.

Back to Gold?

Among various proposals for reforming the present U.S. dollar, none are more controversial than those for re-instating an official gold standard, meaning an arrangements in which official paper U.S. dollars are once again made fully convertible into a fixed quantity of gold, as they had been until 1933. The proposal is controversial in no small part because, so far as many economists are concerned, the historic gold standard was itself a disastrous failure, the passing of which calls, not for tears of regret, but for cries of “good riddance!”

How to account, then, for the gold standard’s enduring appeal, especially among conservatives and libertarians? Part of the answer is that, whatever its shortcomings, a gold standard has the indisputable merit of serving to automatically stabilize the long-run purchasing power of any money tied to it. That property, far from being mysterious, stems from the simple fact that under a gold standard the profitability of gold prospecting and mining increases, other things equal, as prices generally fall, and declines as prices generally rise. Consequently although the general level of prices can fluctuate, it tends to revert over time to a fixed mean.

Another part of the answer is that the gold standard’s critics often exaggerate its shortcomings, especially relative to those of actual (as opposed to idealized) fiat standards. On a blackboard, of course, a fiat standard can readily be shown to outperform a gold standard in the long-run perhaps, but certainly in the short-run. But that’s true only because, on a blackboard, a fiat standard can be made to do whatever the chalk-wielder likes. In practice, on the other hand, fiat standards can and often do behave very badly indeed. What self-respecting economist, right now, would relish the opportunity to lecture a roomful of Venezuelans on the theoretical advantages of irredeemable paper money?

Moreover, while the international gold “exchange” standard that was cobbled together after World War I was a disaster waiting to happen, the prewar “classical” gold standard’s commerce-invigorating combination of generally fixed exchange rates and reasonable (if less than perfect) price-level stability has never been matched since.

But the most important reason why gold still commands such a following is, if you ask me, more prosaic: it’s simply that, for those who distrust bureaucratic control, whether of money alone or of economic activity more generally, the gold standard is simply the most salient alternative. Gold was the last, the most universally embraced, and the most successful of all commodity standards, as well as the one that coincided with a period of remarkable economic progress concerning which even John Maynard Keynes — that arch critic of the “barbarous” gold standard — waxed eloquent:

What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort… But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages. The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages… He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could dispatch his servant to the neighboring office of a bank or such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference. But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.

Nostalgia versus Expediency

But however much one may regret the passing of the classical gold standard, it doesn’t follow that we can do no better than to try and restore it. “In commerce,” the great William Stanley Jevons famously said, “bygones are forever bygones”; and what Jevons says of commerce goes for money as well. Gold may have served as a relatively successful monetary standard in the past. But it doesn’t follow that there’s anything sacrosanct about gold today, or that a gold standard is still the best of all possible options for fundamental monetary reform.

On the contrary: an official attempt to once again make paper dollars convertible into gold today would be a step no less arbitrary or “constructivist” (in F.A. Hayek’s sense of the term), than an attempt to make them convertible into silver, palladium, or Japanese yen. To be sure, gold has a nostalgic appeal lacking in the rest. But allowing that consideration to be decisive would be like deciding to replace an aging fleet of jet aircraft, not with newer jets, but with as many propeller-driven biplanes. Don’t get me wrong: I’m not saying that gold convertibility couldn’t possibly be a good idea. I’m just saying that it wouldn’t qualify as a great idea simply by virtue of its historical preeminence. The only real test ought to be whether a revived gold standard would deliver better results than any equally practical (and not merely theoretical) alternative.

Finally, even if no new system could beat a restored classical gold standard, it doesn’t follow that such a restoration is possible. If getting one nation alone to return to gold is bound to be extremely difficult, getting a large number of advanced nations to do so simultaneously, so as to have a truly “classical” set-up like the one that existed before 1914, would be a truly Herculean challenge.

Furthermore, official gold standards can survive only if citizens trust their governments and central banks to generally keep promises to trade gold for paper. Such trust, having been dealt a severe blow by World War I, died a slow and painful death in the decades that followed it. A new gold standard commitment by the Fed, or by any other central bank, today, is bound to run afoul of this reality, especially by becoming the object of attacks by skeptical speculators. If history is any guide, sooner or later those attacks would force even the most well-meaning central bankers to break their gold-standard promises all over again, though perhaps not on time to avoid leaving their economies in shambles.

Self-Regulating Fiat Money

If trying to revive the classical gold standard, or something close to it, is like trying to piece Humpty-Dumpty back together, that doesn’t mean that we have no choice but to settle for a paper dollar managed by a committee of fallible (and occasionally fumbling) bureaucrats. In particular, the difficulties inherent in trying to tame the dollar by once again making it convertible into a scarce commodity can be avoided by relying instead on a quantity-based monetary rule. Because such a rule provides for automatic adjustments in the quantity of standard money without allowing people to convert that money into something else, it can’t fall victim to a speculative attack, and is that much more likely to endure.

As we’ve already reviewed some general arguments in favor of having a monetary rule, there’s no need to review those arguments again here. Instead, I’d like to consider a radical variation on the old theme, consisting of a quantity rule that’s enforced, not by a committee, either voluntarily or with the help of sanctions imposed whenever the rule is breached, but by means of some sort of automatic, fail-safe mechanism.

The general idea is one Milton Friedman entertained for many years. “We don’t need the Fed,” he said (in one of many similar interviews he gave in the 1990s). “I have, for many years, been in favor of replacing the Fed with a computer” programmed to “print out a specified number of paper dollars…month after month, week after week, year after year.”

Although the constant (“k‑percent”) money growth rate rule that Friedman once favored has itself fallen out of fashion, his idea for a computer-driven money supply couldn’t be more à la mode. Computers are, for one thing, capable of doing a lot more than they were back in the 90s. And even in the 90s they might have been capable of managing the money supply so as to maintain, not a stable growth rate for B or M1 or M2 or some other monetary aggregate, but a stable level of nominal spending. The smooth growth of spending would in turn supply, for reasons we’ve considered previously, robust protection against severe economic fluctuations.

Indeed, while it’s easy to imagine a circumstance in which a constant money growth rule could turn out to be a recipe for macroeconomic chaos, it’s darn difficult to imagine a situation in which there’d be much to gain, and little to lose, by sacrificing a stable and customary overall growth rate of spending growth for some other monetary policy objective. A bout of exceptionally rapid spending? A fine way to boost asset prices, no doubt, until one considers the inevitable denouement! Slower spending than usual? Tell it to your average businessman, or employee! Those (mainly Fed insiders) who rail against what they like to characterize as “inflexible” rules (as if a “rule” could be anything but inflexible!) forget — or pretend not to know — that while some rules would indeed prevent the Fed from having the flexibility to do the right thing, others would mainly serve to deny it the flexibility to do wrong things. A stable spending rule, including one that’s “rigidly” enforced by a computer, though it would rule out many bad monetary policy options, would also “rule in” the good ones.

NGDP Futures

Scott Sumner has come up with an alternative plan for targeting nominal spending, which relies not on a computer but on trading in futures to keep spending on target. The plan, called “NGDP Futures Targeting ‚” starts with the Fed settling on an NGDP growth-rate target — say, 4 percent — and then offering to enter into NGDP futures contracts, with payoffs depending on the future level of NGDP, to anyone who expects it to either exceed or fall short of target. Traders who expect NGDP to come in above target will go long on the futures, while those expecting it to fall short will go short.

How, then, does the Fed manage to actually achieve its target? The answer becomes evident when one considers the link between the futures contracts it enters into for its monetary policy operations. When the Fed sells futures to investors who are betting on excessive NGDP growth, it is withdrawing base dollars from the economy, just as it might by engaging in open-market asset sales. In contrast, when it buys contracts from short sellers, it expands the monetary base. In other words, the very persons who are betting that the Fed will miss its target are also driving it to adjust its policy in a direction calculated to make them lose their bets! As a means for further reinforcing this built-in feedback mechanism, Sumner would also have the Fed engage in “parallel” open-market operations for each NGDP contract purchase or sale. In short, by offering to “peg” the price of its futures by engaging in as many contracts as it takes to keep the price on target, the Fed essentially stands ready to expand or contract the monetary base by whatever it takes to keep expected NGDP on target.

That, at least, must suffice for the barest of summaries of a plan that has since appeared in several, subtly-distinct versions, each of which has spawned its share of subtle (and not-so-subtle) controversy, with some critics claiming that Sumner’s scheme, or some versions of it, unworkable. Do those critics have a point? Perhaps they do, but that’s not our concern. We’re here neither to praise nor to bury, but only to have a gander at, this and other intriguing future possibilities for monetary policy.

Bitcoin and All That

Of these possibilities none are more intriguing than those held out by so-called cryptocurrencies, including Bitcoin and its various “altcoin” offshoots. As I observed some years ago (and as Tim Sablik explains in this Richmond Fed piece), when it was just starting to gain economists’ attention, Bitcoin has properties in common with both gold and other commodity monies on the one hand and deliberately managed fiat monies on the other. Like gold, Bitcoin is unalterably scarce: just as there is only so much gold on the planet, whether mined or as-yet unmined, there are only so many bitcoins to be had — 21 million, to be precise — of which not quite 17 million have been mined as of this writing. And like gold mining, bitcoin “mining,” which involves the use of computer-power to solve a mathematical puzzle, is costly. Since bitcoin “miners” compete for the privilege of being responsible for some share of any periods’ bitcoin output, the marginal resource costs of mining a batch (or “block”) of bitcoin tends to equal the market value of the coins produced.

Yet unlike gold, and like a fiat money, both the maximum possible output of bitcoin and the number of coins mined in any given period is controlled, not by mother nature, but by a protocol programmed into Bitcoin’s open-source software. The protocol adjusts the difficulty of the puzzle bitcoin miners must solve so as to keep total bitcoin output on a predetermined schedule, according to which bitcoin output gradually tapers off, asymptotically approaching, but never quite reaching, its 21 million coin limit. The decentralized nature of Bitcoin’s software means that no one is either “in charge” of the protocol or capable of altering it. A majority of miners can, however, agree to form themselves into a new branch network or “fork” that uses a modified copy of Bitcoin’s original protocol, as happened on August 1, 2017, when “Bitcoin Cash” split-off from what became known thereafter as “Bitcoin Core.” Although the fork created as many new “Bitcoin Cash” coins as there had been Bitcoin Core coins beforehand, it left the Bitcoin Core protocol itself unchanged.

Bitcoin’s odd blend of commodity- and fiat-money properties led me to dub it a “synthetic commodity money” some years ago. But the exciting thing about Bitcoin and its various spinoffs and rivals isn’t merely that they comprise a distinct sort of basic money, but that their combination of commodity- and fiat-money features is capable, in principle at least, of combining the best properties, while avoiding the worst, of each of those more traditional alternatives.

One of the more common complaints against a commodity standard is that it exposes the value of money to shocks stemming from either new commodity discoveries or from changes in the non-monetary demand for the standard commodity. Bitcoin and other such “synthetic” commodity monies are, on the other hand, not subject to similar shocks, because the amount miners can extract is strictly pre-programmed, and because they have no non-monetary (e.g. ornamental or industrial) value.

The big beef against fiat money, on the other hand, is that its quantity can be altered by the authorities placed in charge of it, not only for the sake of promoting economic stability, but for other reasons, if not arbitrarily.

It doesn’t follow, of course, that any old cryptocurrency would be a hands-down winner in a race against any established fiat money. Despite its ultimate limit of 21 million coins and skyrocketing transactions fees, Bitcoin might still seem a safer gamble than, say, the Venezuelan Bolivar. But would it really supply a better or more durable monetary standard than the present U.S. dollar?

But the question isn’t whether Bitcoin can beat the present fiat dollar. It’s whether the basic technology pioneered by Bitcoin might allow some other self-regulating cryptocurrency to do so. Besides giving rise to its own “Cash” spinoff, Bitcoin has already spawned dozens of “altcoin” rivals, with others yet to come. It’s at least conceivable some one or more of these might harbor such properties as would make it a worthy opponent to the present dollar, if not something clearly superior. Consider, if you will, the immense variety of ordinary commodities that either have served as money in the past, or that might have done so, from cowrie shells and tobacco to silver, gold, and even (as more than one prominent economist once proposed) common bricks. Each had its merits and its drawbacks; and every one of them was imperfect. But now consider that the cryptocurrency revolution presents us with a whole new universe of new, albeit synthetic, options to draw upon, each of which has been deliberately endowed with properties calculated to make it an attractive medium of exchange. Call me an optimist, but it seems to me only natural to suppose that one of these innovative products might someday prove just the thing to give even the best discretion-wielding central bankers a run for their (that is, our) money.

Choice in Currencies

For an upstart currency to make inroads on an established fiat money requires, at very least, that established and would-be monies compete on a reasonably level playing field. That means having rules and regulations that make it relatively easy for persons to either partly or entirely “opt out” of an official currency network, and to “opt in” to one or more alternative networks. I say “relatively easy” because it’s inevitably costly to switch from one currency network to another, and especially so when the switch is from a bigger network to a smaller one. A level playing field therefore means, not one where rivals are necessarily well-matched, but one where the game isn’t rigged in the home team’s favor. In other words, the laws should not themselves favor official money over other alternatives.

It was with that intent in mind that F.A. Hayek, in making his now-famous 1976 case for “Choice in Currency,” called upon

all the members of the European Economic Community, or, better still, all the governments of the Atlantic Community, to bind themselves mutually not to place any restrictions on the free use within their territories of one another’s — or any other — currencies, including their purchase and sale at any price the parties decide upon, or on their use as accounting units in which to keep books.

“There is no reason whatever,” Hayek went on to argue,

why people should not be free to make contracts, including ordinary purchases and sales, in any kind of money they choose, or why they should be obliged to sell against any particular kind of money. There could be no more effective check against the abuse of money by the government than if people were free to refuse any money they distrusted and to prefer money in which they had confidence. Nor could there be a stronger inducement to governments to ensure the stability of their money than the knowledge that, so long as they kept the supply below the demand for it, that demand would tend to grow. Therefore, let us deprive governments (or their monetary authorities) of all power to protect their money against competition: if they can no longer conceal that their money is becoming bad, they will have to restrict the issue.

Although Hayek’s advice seems perfectly reasonable, putting it into practice turns out to be a lot harder than he seemed to think, and not just because governments’ would rather keep currency playing fields slanted their way. Consider the case of Bitcoin. In March 2014, the IRS classified it and other cryptocurrencies as capital assets (“intangible property”) rather than as currency, making any trade involving them the basis for either a short- or a long-term capital gains tax, depending on how long the coins were held before being disposed of. As the folks in the Coin Center (a non-profit cryptocurrency advocacy group) explain, this tax treatment puts cryptocurrencies at a disadvantage, not just relative to the U.S. dollar, but relative to official foreign currencies, which enjoy an exemption when it comes to relatively small transactions:

Say you buy 100 euros for 100 dollars because you’re spending the week in France. Before you get to France, the exchange rate of the Euro rises so that the €100 you bought are now worth $105. When you buy a baguette with your euros, you experience a gain, but the tax code has a de minimis exemption for personal foreign currency transactions, so you don’t have to report this gain on your taxes. As long as your gains per transaction are $200 or less, you’re good to go.

Such an exemption does not exist for non-currency property transactions. This means that every time you buy a cup of coffee, or an MP3 download, or anything else with bitcoin, it counts as a taxable event. If you’ve experienced a gain because the price of Bitcoin has appreciated between the time you acquired the bitcoin and the time you used it, you have to report it to the IRS at the end of the year, no matter how small the gain. Obviously this creates a lot of friction and discourages the use of Bitcoin or any cryptocurrency as an everyday payment method.

The obvious solution, the Coin Center goes on to suggest, is “to simply create a de minimis exemption for cryptocurrency the way it exists for foreign currency.” But hold on: to really achieve Hayek’s ideal, it won’t do to level the capital gains tax portion of the currency playing field for cryptocurrencies only, rather than for all potential, unofficial dollar substitutes. But then, just what shouldn’t count as such a potential substitute? Surely gold qualifies. But why not silver, or cigarettes, or… the point, as we know from experience, is that all sorts of things are “potential” exchange media, and therefore potential currencies. So, to really allow them all to compete on equal terms, one would at very least have to exempt all of them — from taxes to which official dollar trades aren’t subject.

In short, Hayek’s ideal is just that: something to have governments strive for, rather than something they can be expected to fully achieve in practice.

What’s more, Hayek was far too optimistic regarding the likely consequence of making it easier for people to choose among rival currencies. “Make it merely legal” for them to switch to something else, he wrote, “and people will be very quick indeed to refuse to use the national currency once it depreciates noticeably.” But would they? Unlike, say, shoes or soda water, money is a “network” good, meaning that one of the most important, if not the most important, determinant of the attractiveness of any particular money is the size of the network of persons prepared to accept it. You might think gold an ideal monetary commodity, and I might hold that Bitcoin is to the dollar what sliced bread is to bread of the old-fashioned sort. Yet when it comes to going shopping, what either of us must first consider is, not what sort of money we like, but what the shopkeepers are prepared to take in exchange for their goods.

It follows that, even if official and unofficial currencies really could have a level playing field to compete on, that field would still be one on which official money would generally enjoy a huge “home team” advantage. For this reason, the mere fact that an official currency is depreciating “noticeably” isn’t enough to incite people to abandon it in droves. Instead, it might take a very substantial rate of depreciation, or some like cataclysm, to bring about rapid change. Cataclysms aside, upstart currencies are more likely to have to start by clawing their way into established currency markets one painful inch at a time, though with each becoming easier than the last as their own, initially tiny networks begin to blossom.

Free Banking

The alternatives I’ve considered so far have all consisted either of potential replacements for the U.S. dollar or of novel means for regulating the stock of official (that is, Fed-created) U.S. dollars themselves. Emphasizing such alternatives makes sense, after all, in a primer concerned with “monetary policy,” where the most fundamental choices are those concerning what type or types of basic money to employ, and how best to regulate the supply of basic money, assuming that it doesn’t adequately regulate itself.

But what about alternatives consisting of banks’ readily convertible IOUs, like most bank deposits today that, by virtue of their instant convertibility into official dollars, are very close substitutes for them? Because such bank-created substitutes necessarily “piggy back” on the basic monies into which they can be converted, their presence can’t generally make up for misbehavior or mismanagement of the quantity of basic money itself, and might even aggravate that misbehavior. A fiat money stock that’s allowed to grow so rapidly that it would result in a 20 percent annual rate of inflation in a pure fiat money system will, for example, produce the exact same rate of inflation in an economy in which payments are made exclusively by means of bank IOUs backed by a fixed fractional reserve of the same basic money.

Moreover there’s nothing at all radical about having banks supply such alternatives, at least to a limited extent. Today and for some time past bank deposits of various kinds have served, with the aid of checks and, more recently, debit cards, as close substitutes for official monies, to the point of being far more extensively employed in exchange than official monies themselves.

It would, nevertheless, be wrong to suppose that there’s no scope for a potential beneficial radical reform involving bank-supplied alternatives to basic money. On the contrary: plenty of scope exists for expanding the role of such alternatives, particularly by doing away with long-standing restrictions on commercial banks’ ability to challenge central banks’ monopoly of circulating (or hand-to-hand) payments media.

Once upon a time commercial banks routinely issued their own circulating paper notes; indeed, until the latter half of the 19th century bank notes were the most important liability on banks’ balance sheets, which were far more commonly employed in making payments than either checks or coins. Nor did central bank notes, which themselves started out as mere IOUs redeemable in gold or silver, only to be transformed into inconvertible fiat money later on, come to generally displace notes of commercial banks until the last decades of the 19th century, and the opening ones of the 20th, when the proliferation of central banks typically went hand-in-hand with laws forcing commercial banks out of the paper currency business.

Received opinion has it that commercial bank notes had to go because central bank currency was better. But now and then received opinion is nothing but hokum, and this happens to be one of those instances. Had central bank notes been better than their commercial counterparts, it shouldn’t have been necessary for governments to suppress the latter. Instead, the mere availability of official alternatives should have sounded the death knell of the commercial stuff. Yet instead of that having been the case, in every instance the commercial bank notes had to be snuffed-out, leaving people no choice but to employ official paper money. Nor did the commercial bank currency go down without a fight, in which prominent economists often took part, with many of the most prominent (and most better ones, if I may say so) challenging governments’ efforts to establish official currency monopolies, and championing the alternative of free trade in banking, or “free banking,” for short.

Strictly speaking, “free banking” means more than just allowing ordinary banks to issue paper currency. It also means leaving them free of other restrictions, including restrictions upon their ability to establish branch networks, lend to whomever they wish, charge whatever rates they wish, and hold whatever levels of cash reserves and capital they wish to. Freedom of note issue is only the most controversial of these many aspects of freedom in banking, in part because allowing it would make it possible for the public to rely exclusively on privately-supplied exchange media, with official dollars playing their part only behind the scenes, as bank reserves. Furthermore, in times past, when official money consisted, not of any central bank’s inconvertible “liabilities,” but of gold or silver coin, not having to rely on a central bank as a source of paper money meant not having to have a central bank at all !

Could a monetary system lacking a central bank possibly have been any good? Darn tootin’!

Of all relatively modern monetary systems, none have earned more kudos than the two that most closely approximated the free-banking ideal, namely, the systems of Scotland between the latter 18th century and 1845 and Canada from 1870 and 1914. In both of these, bank-supplied notes and deposits commanded such a high degree of confidence that gold and silver coin hardly circulated. The public’s disdain for precious metal money in turn allowed Scottish and Canadian banks to operate on reserve cushions that were slim even by today’s standards. That in turn made Scottish and Canadian banks highly efficient intermediaries, with almost all of their clients’ savings going to fund relatively productive bank loans and investments. Yet despite this high degree of efficiency, bank runs were extremely rare in both systems, while banking crises, involving simultaneous problems at many banks at once, were almost unheard of.

Why, in that case, does free banking, and especially the idea of letting banks issue their own currency, seem so far-fetched today?

Partly it’s because the Fed and other central banks, upon which we’re now all too inclined to turn to for information about monetary history, have underplayed such success stories as those of Scotland and Canada whilst sugarcoating their own records. But in the U.S. case it’s also due to confusion about the meaning of “free banking.” Whereas that phrase can refer to genuinely free banking systems like those of Scotland and Canada, it can also refer to any of the systems established through so-called “Free Banking” laws passed by eighteen states between 1837 and 1860. Despite their names the later laws didn’t come close to allowing genuine freedom in banking. Instead, they all imposed important restrictions upon the banks established under them, including the requirements that those banks refrain from establishing branches, and that they back their notes entirely with specific securities — usually consisting of state government bonds. In several instances such restrictions, far from guaranteeing the soundness of the banks that were forced to abide by them, led to notorious abuses and failures, including episodes of “wildcat” banking. All in all, the misnamed “Free Banking” era proved to be one of the most unfortunate chapters in U.S. monetary history, because of the direct damage done by bank failures, of course, but also because those failures gave freedom in banking a bad name it didn’t deserve.

But what relevance has free (that is, genuinely free) banking today? It’s relevant, first of all, because an understanding of its workings suggests that freedom in banking isn’t necessarily inimical to soundness in banking, and that the wrong sort of regulations can in fact be worse than no regulations at all. It also suggests that, even if we are determined to rely on a fiat-money issuing Fed as our ultimate source of monetary control, we need not rely upon them to supply hand-to-hand currency. Instead, we might let commercial banks back into that business, while limiting the Fed’s ordinary involvement in the market for money to the “wholesale” part of that market — that is, to supplying banks with reserves. Commercial banks that could issue their own notes would presumably also be free to experiment with other forms of non-deposit money, including “smart” stored value cards, that might eventually replace paper money altogether, except on rare occasions when people lost confidence in the private stuff. I dare say, indeed, that had commercial banks been left in charge of supplying currency all along, paper money would some time ago have gone the way of horses, buggies, spittoons, and slide-rules. What else save a bunch of government monopolists could have managed to keep such low-tech stuff as paper currency in play for so long?

Should We, Can We, “End the Fed”?

While in times past free banking was an alternative to central banking, that’s no longer so. Today’s commercial bank deposits are claims, not to gold or silver coin, but to central bank issued fiat money; and were commercial banks able to supply their own notes or stored value cards to take the place of central bank notes in payments that don’t involve drawing upon bank deposits, those notes and cards would also represent claims to central bank money.

In short, so long as we stick to the present fiat dollar standard, instead of replacing it with either a natural or a synthetic commodity standard, no amount of freedom in commercial banking will suffice to render the Fed entirely otiose. No wonder that, when former U.S. Representative Ron Paul and his many devotees campaign to “End the Fed,” they have in mind, not just letting bulldozers loose on the Eccles Building, but once again making official dollars claims to some fixed quantity of gold.

Whether one is a hard-core libertarian or not, it’s interesting to ponder the extent to which the Fed’s role might be reduced, with the help of various more-or-less radical reforms, without either abandoning the present, inconvertible U.S. dollar or sacrificing its integrity.

We’ve already considered how a carefully-programmed computer, or having the Fed peg the price of NGDP futures, could render the FOMC redundant — in so far at least as that body’s challenge can be boiled down to one of maintaining a stable level of overall spending. We’ve also seen how letting commercial banks issue circulating currency would make it unnecessary for the Fed to be in the currency business, though it would still require keeping plenty of Federal Reserve notes on hand in case a banking panic should break out. Finally, in an earlier chapter we’ve seen how allowing “flexible” open-market operations could make it unnecessary for the Fed to ever make any direct loans to troubled financial institutions.

Yet these are far from being the only possibilities for having a leaner, if not a meaner, Fed. The Fed’s reduced involvement in currency provision and last-resort lending would mean a corresponding decline in the importance of the regional Fed banks, apart from the New York Fed, which handles the system’s open-market operations. The Fed’s involvement in check clearing could also be reduced, by returning that activity to the private sector, which handled it perfectly well until the Fed muscled its way in after 1913. Finally, most of the vast army of economists and other staff personnel presently employed at the Fed, who even now are mainly busy performing tasks that have nothing much to do with fulfilling the Fed’s mandate, could be made to seek more productive employment elsewhere.

In short, sticking to a fiat dollar doesn’t rule out reforms that would dramatically reduce the Fed’s role in the monetary system. Instead of the present, Leviathan Fed, one might have what might be called a “Nightwatchman” Fed, capable of doing those things that any responsible fiat money issuing central bank ought to do, but incapable of doing many of the things that irresponsible central banks do all too often.

A Concluding Plea for Open-Mindedness

By surveying some more radical options for monetary reform, I don’t pretend to have made a compelling case for any of them. My only goal has been to suggest that all sorts of alternatives exist, and that each of them has its merits. Will any of them really help? Is one better than the rest? Are there others not mentioned that deserve our consideration? The correct answer to all these questions, and others like them, is “Maybe.” In other words, such alternatives are, or ought to be, worth thinking about, even if some might ultimately be judged unattractive. Allowing ourselves to think outside the established monetary policy box can never do us any harm. Nothing could be more dangerous, on the other hand, than for all of us to assume that, despite its obvious faults, ours happens to be the best of all possible monetary systems.

[Cross-posted from Alt‑M.org]

The Bitcoin system has the great virtue of securely sending value directly from stranger to stranger. It is open to anyone, anywhere in the world. The sender does not need to trust the recipient, nor any bank or other institution, to accurately record the transfer. The Bitcoin “blockchain” provides a readily consulted online public ledger with immutable records. Transfers are indelibly captured, like flies in amber, and made tamperproof by massive duplication and reconciliation of the ledger over thousands of nodes.

Bitcoin also has well-known limitations as a currency, however. First, it doesn’t scale well. The Bitcoin blockchain can process about four transactions per second, whereas Paypal does hundreds, Visa or Mastercard thousands. The blockchain has become congested as the number of transactions has grown. (Reducing the congestion was the motivation for the proposals to enlarge the block size that recently roiled the bitcoin world.) Validation takes at least ten minutes, longer for more secure validation, and even longer when the system is congested.

Cryptocurrency pioneer Nick Szabo has clearly explained that this tradeoff — high security at the cost of slow transaction speed and low capacity for transaction validations per second — is built into Bitcoin’s massive-duplication design:

Bitcoin’s automated integrity comes at high costs in its performance and resource usage. Nobody has discovered any way to greatly increase the computational scalability of the Bitcoin blockchain, for example its transaction throughput, and demonstrated that this improvement does not compromise Bitcoin’s security. … Compared to existing financial IT, Satoshi [Bitcoin’s pseudonymous designer] made radical tradeoffs in favor of security and against performance.

Thus a blockchain system like Bitcoin is not itself capable of quickly processing large numbers of retail payments.

Second, there is the network property of a monetary standard: each of us prefers to be paid in the currency accepted by the largest number of our potential trading partners. This property favors the incumbent standard (the fiat dollar in the US) over both bitcoin and gold. It reinforces the volatility drawback: when your rent and utility bills are denominated in dollars, it is risky to hold a bitcoin balance for the purpose of paying them.

Third, bitcoin’s purchasing power is for now highly volatile. Broader holding of bitcoin as a medium of exchange would reduce volatility, but all three problems impede that.

These drawbacks have inspired initiatives to combine the benefits of blockchain technology with the use of gold-denominated tokens in place of bitcoin. Gold as a potential medium of exchange arguably has lesser limitations than bitcoin on all three scores. First, its payment processes scale well. Second, its value (in dollars or in purchasing power) is somewhat less volatile over daily to monthly horizons, and is much less volatile over longer horizons. Third, its popularity as an asset in private hands is greater. As of 15 October, 2017, total bitcoin balances are worth $92 billion, whereas worldwide private investment holdings of gold coins, bullion, and ETFs are estimated at $1.7 trillion. Gold holdings are more than 18 times larger; bitcoin holdings are less than 6% of gold in private hands.

Initial popularity matters for gaining widespread use in the face of an incumbent currency. Popular dollarization in Latin America and elsewhere gives us a model of how a non-incumbent currency gains a toehold and then spreads. Popular dollarization typically begins with the dollarization of savings, when the local peso becomes a less reliable long-term store of value than the dollar. Dollarization of pricing and payments spread when the peso inflation rate rises to double digits, requiring more frequent revision of peso prices, and imposing a high cost of holding pesos even from paycheck to paycheck.

Several about-to-launch new projects, described below, hope to create gold-based payment systems, while using some form of blockchain technology to enhance the security of holdings and transfers. If gold-backed accounts or digital gold currency tokens with cryptographically secured transfers are successfully launched, users will be able to adopt a modern gold standard as easily as they can now adopt the bitcoin standard.

Gold holding is already widespread as an investment (a saving and tail-risk-hedging) vehicle, as noted, but convenient gold payment mechanisms have been lacking. The enterprise called E‑gold was a prototype — a service for individuals to buy, hold, and easily transfer gold account balances — until it was shut down by US authorities in 2005 for nonconformity with US Treasury “anti-money-laundering” and “know your customer” rules. The upcoming new enterprises all promise to comply with AML and KYC requirements for money service businesses.

A gold-denominated digital payment system will have to operate very differently from bitcoin (or any other cryptocurrency). For this reason it is highly misleading to call it “Cryptocurrency backed by gold” as one promotional article has.

A gold-backed account or digital token rests on a commitment to redemption at par, or a price commitment, by contrast to bitcoin’s commitment to the quantity in circulation. The payment processing system will also be different. It cannot be purely peer-to-peer because it requires a gold vault-keeper or equivalent trusted intermediary to maintain the price commitment. But the use of a single trusted limited-access ledger, rather than Bitcoin’s distributed trustless open ledger with its massive duplication in record-keeping, brings a large advantage in the speed and cheapness of payment processing.

Investment Platforms

The first three projects I will describe do not aim at providing a payment system so much as a low-cost platform for investing in gold. Think of them as would-be competitors to gold ETFs or to bullion warehousing services with easy conversions from and into US dollars, like GoldMoney. I will then turn to projects with more potential to generate a sizable payment system.

1. Royal Mint Gold

On its website, Royal Mint Gold (RMG®) calls itself “The New Digital Gold Standard.” This is misleading because, unlike a gold standard in the usual sense, it isn’t a payment system. It elsewhere more accurately calls itself “an investment product” and “a new, cost-effective, convenient and secure way to trade physical gold” with online access and distributed-ledger transparency.

RMG, which promises to come online before the end of 2017, offers much to interest gold investors. It partners The Royal Mint (hereafter TRM), owned by the UK government, with the Chicago Mercantile Exchange (CME). Both are venerable and credible. (There was talk about privatizing TRM in 2011, but it didn’t happen. As a state-owned enterprise, does TRM enjoy sovereign immunity against lawsuits? I don’t know.) TRM will manage the gold vault, and the CME Group will provide the trading platform for electronic warehouse claims to allocated gold in the vault. The RMG system promises that “For every RMG that’s on the network, there’s one gram of gold that’s sitting in our vault.” A proprietary blockchain will be used to record and track whose gold is in the Royal Mint vault. There will be “live, transparent pricing” on the CME trading platform.

To attract gold investors, RMG promises zero “ongoing” management and storage costs. The RMG webpage compares how value grows with the price of gold under its 0% fees, “giving an investment in RMG a projected higher return than physical gold” held in “a traditional gold ETF [that] is assumed to charge an average 0.4% annual storage and management fee.” But where, you might cynically wonder, do the revenues come from to cover TRM’s vault costs?

Here: You buy in at a premium over the spot price of gold (how high is not yet revealed), so TRM gets some float. (They promise to maintain the premium by buying back unwanted RMG as necessary.) You sell out for a transaction fee. You can cash out, and take physical delivery of gold, only in the form of “physical gold bars and coins produced by The Royal Mint,” for which there is a “fabrication and delivery” fee that is presumably large (not yet specified, and it is not clear whether it will be contractually fixed in advance.)

A system that runs on transaction fees even for internal transfers among account-holders discourages using its accounts as checking accounts.

How big does RMG hope to be? “The initial amount of RMG at launch could be up to $1 billion worth of gold. It will be offered through investment providers. Further RMG will then be issued based on market demand.” For perspective, gold ETFs added $2.3 billion on net in the second quarter of 2017.

To summarize, RMG is not a payment system or a currency, much less a cryptocurrency. It is a warehouse claim to gold in a specific vault. It will be salable to the extent that there are many bidders for claims to gold in that vault, but you can’t transfer it to another RMG holder at a zero transaction fee, like writing a check, the way you could with E‑gold.

Incidentally, there are two London wholesale payment systems marrying gold to blockchain. A Bloomberg Markets article explains the business case:

About $27 billion of gold changes hands every day in over-the-counter markets where settlements can sometimes take days, leaving price risk for buyers and sellers. Using blockchain promises more transparency, security and speedier deals.

One project to provide this service is called Tradewind, supposed to launch in early 2018. Another is Bankchain Precious Metals. Tradewind promises to provide “a distributed ledger that will handle trade settlement, account management and record-keeping.” Bankchain Precious Metals promises “the instantaneous transfer of payments and ownership of the bullion stored in various vaults in London.”

2. OneGram

Launched in Dubai, OneGram offers a gold-backed (and Sharia-compliant) cryptoasset with blockchain features. Investors in OneGram will be shareholders in a vault full of gold, and will profit as and when the vault accumulates more gold per share.

Its white paper explains:

OneGram aims [at] using blockchain technology to create a new kind of cryptocurrency, where each coin is backed by one gram of gold at launch. In addition, each transaction of OneGram Coin (OGC) generates a small transaction fee which is reinvested in more gold (net of admin costs), thus increasing the amount of gold that backs each OneGram. Therefore, each OGC increases in real value over time, making OneGram unique among cryptocurrencies.

The vault will be located in the Dubai Airport Free Zone. OneGram promises that it will be audited by PricewaterhouseCoopers.

OneGram promotes its cryptoasset as a payment medium, declaring that the “payment institution license is already in place.” But transfers of OGC will be subject to a transaction fee of 1%. The promoters call the fee “small,” but it is high enough compared to ordinary deposit transfer to discourage using OGC as a payment medium.

How the price of gold will be continuously transmitted to the OGC cryptocoin is unclear, because it isn’t clear how the cryptocoin can be converted into the quantity of gold that it is supposed to represent. OneGram promises to have a “payment gateway” for OGC in Dubai and Abu Dhabi, “with fiat conversion.” But how conversion to fiat will be priced is not specified.

OneGram’s ICO (initial coin offering) ran from May 21 through September 4, 2017. It offered 12,400,786 coins, priced at the spot price of one gram of gold (which averaged around $41 during the period) plus 10%, for total revenue of about $550 million if all the coins sold. A September 6 press release, which announced that the initial coin sale had ended, curiously omitted mention of the quantity of coins actually sold. It also announced that launch of the cryptocoin has been pushed back from October 2017 to “the first quarter of 2018 to ensure that we launch a solid and secure technology solution.”

Critically limiting the potential of OGC to become an important medium of exchange is the feature that no more OGC will be created even if new adopters want in: “100% of total coin supply is pre-mined.” This means that the size of OneGram payment community in value terms will at most grow only slowly with transaction fees, assuming that the price of OGC remains tied to the value of the gold in the vault.

3. OzCoinGold

Much like OneGram, the Australian/​American project OzCoinGold promises a limited issue (in this case 100,000 troy ounces maximum, giving a potential market cap of only $128 million at the recent gold price of $1280 per ounce). As with OneGram, the quantity limit prevents widespread use as a medium of exchange. Each cryptoasset token, labelled OzGLD, will be “100% backed” by gold, but with two catches: only one-third of the gold reserves will be above ground as bullion (the other two-thirds will be the proven reserves of a gold mining company), and the tokens can be redeemed for gold only after five years. Audit reports will be uploaded to a blockchain. Accordingly the main sales pitch is as an investment vehicle: it hopes to be “the easiest, most effective and cheapest way to own or invest in gold.”

Payments Platforms

Moving on to gold-blockchain combinations better designed to be payment services, I consider four, beginning with those farthest from launch.

1. Digix Gold Tokens

Although its software is not yet fully coded, the developers of Digix gold tokens have at least spelled out their concept in detail. Digix is headquartered in London. As explained in a press release on Medium, Digix aims at “tokenizing valuable real-world assets” on the Ethereum blockchain. It “intends to be the first to launch a fully trackable and auditable crypto gold token.” A DGX 1 token “contains the right to 1 gram of gold that is stored in an audited vault.” As a claim to gold, like a transferable warehouse receipt, the token “can be easily traded or pledged against a loan without moving the physical gold” from its vault. Validity of ownership is certified through a “Proof of Asset protocol.”

What exactly does it mean to “tokenize” gold? Consider a universal open shared ledger, running on top of the Ethereum blockchain, that records ownership, and transfers of ownership, of a numbered 10g gold bar stored in a known vault. The gold bar has been “tokenized.” As with a unit of bitcoin, once I record a transfer of ownership to you on the blockchain, you can now further pass on the token, or redeem it, and I no longer can.

In other words, DGX is a spendable digital warehouse claim for gold, with ownership validation on the Ethereum blockchain. Of course, payment by transferring claims to vault gold without moving the gold is pretty old hat. Italian banks were doing it around 1200 AD. What’s new is that these claims are warehouse rather than debt claims, and transfers take place in currency-like fashion on the blockchain rather than by use of named account balances on the books of the depository.

The Digix sales pitch is both to gold investors, and to transactors who want to hold purchasing power in spendable cryptoasset form at least temporarily. Unlike unbacked IOU-nothing cryptocurrencies, DGX tokens are claims to physical gold expected to trade at a price tied to the price of physical gold. Gold exhibits less purchasing power volatility than BTC or ETH.

But if reduced volatility of purchasing power is what you want, why not hold the cryptoasset Tether, the price of which has been held fairly steady (so far) at $1? Some people don’t trust Tether. Tether claims to have 100% dollar reserves parked in audited accounts in licensed banks, but it lacks full transparency and there has been controversy over its terms of service. Digix promises greater transparency: warehousing of gold in vaults that are certified members of LMBA, the London Metal Bullion Association, with “Realtime Transparency; immutable on-chain auditing records for your viewing from Inspectorate and PWC; accessible at anytime, anywhere.”

To warehouse your gold, whether purely for storage or (combined with a transfer mechanism) for use as a payment medium, requires you to pay a fee to cover the cost of storage. A typical arrangement is for the warehouse to deduct a percentage storage fee periodically from each account. Gold ETFs typically charge around 0.4% per year. If there is a transfer mechanism, the warehouse may also charge a transaction fee when fulfilling a transfer request. The planned Digix fees appear to be similar to ETF fees. Storage fees will be 0.4% per year to the vault owner. In addition, an Administration fee of 0.2% per year will be charged by the Digix organization, making total annual fees 0.6%. Transaction fees will be 0.1% of transacted amount.

The medieval Italian banks already mentioned introduced the option of accounts with lower fees for customers who wanted not pure storage but rather transaction services, a way to pay people without lugging gold coins around. Such customers brought in loose rather than bagged coins, and consented to fractional reserves, allowing the bank to cover its (reduced) storage costs by interest earned in lending out most of the gold. The advantage for the bank was of course the interest income on the coins lent out. The advantage to the customer was lower storage and transaction fees. Competition among fractional-reserve banks soon reduced storage fees to zero, and even led banks to pay interest on transaction accounts.

Digix promises to tie the price of DGX to the price of gold the old-fashioned way, by redeemability: “Physical Gold Redeemable at any time at our partnering custodial vaults.” The holder of DGX can “Redeem 100 DGX tokens for 100g of physical gold” in person or by mail. However it has not yet specified whether redemption will be at a zero or a positive price. In traditional banking the redemption fee is zero, but it can be zero in this warehousing system only if storage fees are high enough.

The most impressive evidence that Digix intends to promote DGX as a widely used medium of exchange is that they have partnered with a payment card provider (Monolith Studio, whose platform is called TokenCard) to provide an “Ethereum powered” gold-backed debit card. The announced aim is “to ensure gold tokens can be spent efficiently at minimal cost.”

The intriguing vision of Digix and TokenCard is that people will put themselves on a new digital gold standard. A news account quotes Monolith’s co-founder as saying: “Together with Digix, we will be able to offer one of the only true commodity backed debit cards, and bring back the gold standard in a meaningful way.”

2. Glint

The Glint webpage describes its project as a “new global currency, account and app.” Although it says that the project is “Launching in Q4 2017,” no specific roll-out date is offered. Headquartered in London, Glint Pay Services Ltd claims “permission to issue electronic money and provide payment services” from the Financial Conduct Authority under the Bank of England. Its co-founder is CEO of Gold​MadeS​im​ple​.com, an online bullion dealer.

The project has curiously little press coverage online, only a single article which reads like a paid press-release placement. It is very sketchy on details. “Glint is a stealthy London fintech startup that promises to turn gold into a ‘new global currency’. … Glint will offer a frictionless way to both store and spend your money in gold, including at the point of sale, just like a regular local currency. The bigger picture is that gold historically has been a better storage of value than any government-created currency, and therefore — with the aid of technology — is (arguably) a good candidate for an alternative global currency.”

Obviously more details are needed.

3. DinarCoin (DNC)

Despite “dinar” being the Arabic name for a gold coin (derived from the Roman denarius), DinarCoin (DNC) is not linked to Islamic finance. The parent firm DinarDirham is registered in Hong Kong, with offices in Singapore and Kuala Lumpur. It describes the DNC as a “unique digital currency created … on the Ethereum blockchain. The value of each DNC is based on the worldwide gold spot price. DNC can be used for trading, investment and also to make payments.”

Here’s the sales pitch:

If you’re a person that’s interested in precious metals, but are concerned with storage, security, and actually being able to use your metals as cash for purchases, then DinarDirham is for you. You can actually store, secure, and use your gold on the blockchain, and have the ease and convenience of not needing to have it on your person, and accessing it worldwide in minutes.

It will be

a simpler way to transfer gold, as akin to PayPal with dollars. The aim of the DinarDirham is not only to provide additional value and stability to the coin but also to perpetuate the use of bullion as an accepted form of digital currency.

Of course, physical gold isn’t stored on the blockchain. But the record of a contractual claim to gold can be. The promoters promise that “For the lifetime of a DNC a corresponding value of XAU [physical gold] will be held in escrow. … [W]hen DNC is created it is registered on the Ethereum Blockchain and the Bitcoin Blockchain. The total amount of DNC in circulation can be verified on either Blockchain, and audited against the total XAU held in escrow … by DinarDirham.” Of course, the accuracy of such a comparison is only as great as the accuracy of the reports of the “total XAU held in escrow.” Unlike consensus-validated bitcoin ledger changes, the accuracy of unilaterally altered ledger entries relating to external facts, like the volume of vaulted gold held by DinarDirham, is not ensured by the blockchain.

Unlike OneGram, the volume of DNC payments has the capacity to grow should it catch on as a medium of exchange. If demand growth begins to push the bid price of DNC slightly above the spot price of gold, either the parent firm or one of its “liquidity providers” stands to make an arbitrage profit by buying physical gold, putting it in an escrow vault, and selling additional DNC into the market, until the premium subsides. The vaults are associated with Associated Bullion Exchange, an electronic exchange for allocated precious metals in storage.

The “redemption” mechanism is not straightforward. DNC “can be redeemed for physical gold,” the website says, via a DinarDirham blockchain-recorded digital asset called a Gold Smart Contract (GSC). Unless 1 DNC can always procure 1 GSC, however, “used to purchase” would be more accurate than “redeemed for.” Another account does say that a DNC holder can “purchase” a GSC and then use it “to collect gold from one of many available vaults.” If in fact 1 DNC trades at a variable price for 1 GSC, which is redeemable for 1 gram of gold, it isn’t clear how the price of DNC is supposed to be pegged to the price of gold.

The announced payment-system plans are ambitious. The CEO says:

We are building an entire ecosystem around DinarCoin — exchange, DinarCoin ATM, merchant gateway and debit cards to allow our users to use their digital assets anywhere in the world. Also, physical Dinar Gold Coin (4.25 grams) is already available to order in South East Asia.

How far along is the project right now? Unclear. It hasn’t posted much lately. DNC isn’t listed on CoinMarketCap. I could not find any report on the value of DNC coins currently in circulation.

4. GoldMint

GoldMint is based in Russia. Surf to its webpage from a US location, and you are immediately confronted by a black drop-down box that declares that you may not invest in its ICO if you are domiciled in the US, Canada, China, or Singapore. Its first phase is an ICO ending this month (hoped-for sales, $49 million) for a token called MNTP. A “prelaunch” coin running on the Ethereum blockchain, MNTP will migrate in Q2 2018 to become MNT — the “stake” in the proof-of-stake GoldMint blockchain — which will process transactions in a gold-backed cryptoasset confusingly named GOLD (all caps).

What is most novel and remarkable about GoldMint is that the parent firm claims to be developing hardware called “Custody Bot automated storage facilities,” which it plans to deploy at pawn shops and shopping centers worldwide. Custody Bots will be “programmed to automatically identify and store gold jewelry, small ingots (up to 100 grams) and coins, without human intervention,” taking escrow custody of them for people who want to take out loans collateralized by the gold. (Loans collateralized by gold jewelry are already popular in India, by the way.) Through the spread of Custody Bot automated storage facilities, according to the GoldMint white paper, the firm hopes eventually to handle the storage of gold reserves worth, in US dollars, tens of billions.

More importantly for currency purposes, Bot-stored gold can alternatively be tokenized and traded as the cryptoasset GOLD, which “will become the trading unit for these operations.” GoldMint promises that units of GOLD will always be “100% backed by physical gold and ETF” that the firm holds.

Because the price of gold is less volatile than the price of bitcoin, the firm’s pitch goes, “Crypto traders and enthusiasts can hedge the risks of storing their assets in [a] highly volatile crypto market environment by transferring their savings to cryptoassets GOLD. [Also:] Low volatile GOLD cryptoassets can be used as a payment unit both for companies and individuals.”

GoldMint will not redeem GOLD for gold at par, but it promises to sell you 1 GOLD cryptoasset for a 5% premium over the London spot price of one ounce of gold, and to buy it back at a 3% premium. Thus the total fee for making the round-trip fiat-GOLD-fiat will be 2%. In addition it will assess an “On-Chain transaction fee” of 0.3%, three-fourths of which will go to the miners on the GoldMint blockchain. These seem like fairly competitive fees.

The most important questions about the potential of GoldMint as an important gold-backed currency are about the trustworthiness of its buyback promise, and the reliability of its blockchain for payment validation.

Conclusion

I am not endorsing or recommending investment in any of these projects. Caveat emptor. But I think the last three listed warrant our attention as attempts, in the spirit of E‑gold, to provide modern gold-based payment systems with online access. All three explicitly promise not to hold fractional reserves, and say that you can track the volume of cryptoasset on their ledger to see that it matches the number of gold grams or ounces held in their vaults. But if one of them becomes popular as a one-hundred-percent-reserved gold payment system, perhaps a subsequent innovator will offer zero storage fees and interest on account balances by re-introducing gold-denominated fractional reserve banking. Such a bank, supposing that it surmounts legal obstacles but lacks government deposit insurance, would have to provide as much transparency as potential clients demand to show that it has enough gold and other liquid assets available to redeem promptly all claims that are likely to be presented.

Stay tuned.

[Cross-posted from Alt‑M.org]

During the Western Han Dynasty (206 B.C. – A.D. 9), the question of monetary freedom was vigorously debated. There were as yet no banks or paper money in China — money consisted solely of coin. Private mints competed with government mints, either in the shadow market or legally. In 81 B.C., the issue of whether the state or the market would be the best guardian of sound money came to a head in the famous “Discourses on Salt and Iron,” which were compiled by Huan Kuan in his book Yantie lun. The relevant chapter for our study is chapter 4, “Cuobi” (“Discordant Currencies”).

In this article, I provide some background for the debate between the Confucian scholars who favored private (competitive) coinage and the statesmen, particularly Sang Hongyang, who defended the government’s monopoly on coinage. I then consider the arguments of those engaged in the 81 B.C. debate over the role of government in coinage and the lessons learned.

Background

The first emperor of the Western Han Dynasty, Gaozu (202–195 B.C.), banned government minting, legalized private mints — most likely because of the severe shortage of coins that impeded trade — and adopted the Qin Dynasty’s standardized bronze coin, the banliang (or “half ounce” = 12 zhu).[1] Its relatively heavy weight (about 8 grams) made it unsuitable for widespread use. The demand for lighter coins to facilitate trade led private mints to produce a large quantity of lighter “elm-seed” coins that weighed 0.2 to 1.5 grams. Those coins retained the conventional banliang inscription, making their face value much greater than their intrinsic value.[2] Of course, merchants would not accept them at face value.

Banliang 4 Zhu Coin

In 186 B.C., Empress Lü reinstituted the Imperial Mint with the hope of gaining control over the monetary system. The first coin brought out by the government was a banliang coin weighing 8 zhu. Next, in 182 B.C., a new banliang coin called the wufen, which weighed only 2.4 zhu, was circulated. The demonetization of the 8 zhu coins, which allowed bronze to be restruck into a much larger nominal stock of money, led to inflation. Consequently, in 175 B.C., Emperor Wen of Han increased the metallic content of the banliang to 4 zhu, and once again allowed private mints the freedom to coin money provided they complied with the standard weight of 4 zhu and produced only bronze coins. The see-saw between government and private mints continued when, in 144 B.C., Emperor Jing of Han ended competitive coinage and reinstituted the government’s monopoly. Private coining was made a crime and those convicted could face the death penalty.[3]

The substantial difference between the face value and intrinsic value of banliang coins during the early Han period provided fertile ground for counterfeiting. However, money exchanges developed to discover the true value of banliang coins, adjusting their nominal value to reflect their weight (or intrinsic value), rather than passively accepting the fictitious value of 12 zhu. Eventually, in 120 B.C., a new bronze coin, the 3 zhu cash coin, replaced the old 4 zhu banliang coin — and its face value was made equal to its intrinsic value. Finally, in 119 B.C., Emperor Wu of Han introduced the wuzhu (or 5 zhu) bronze coin, which was extensively used until the 7th century.

At first, the wuzhu was minted by both the central government and the prefectures, but in 113 B.C. minting became the sole responsibility of the Imperial Mint.[4]

The 81 B.C. Debate Over Monetary Freedom

When Emperor Wen of Han legalized private mints in 175 B.C., Jia Yi, a former official, argued that competitive coinage would lead to debasement, a plethora of cash coins that would confuse the public, and result in the manipulation of money exchanges. He therefore recommended restoring the state monopoly on coinage and controlling the supply of copper.[5] His advice was rejected but the debate over private coinage reemerged in 81 B.C.

The Main Arguments

Sang Hongyang, a statesman who had been a key advisor to Emperor Wu, took the lead role in arguing against private coinage and in support of government monopoly. Meanwhile, more than 60 Confucian scholars (literati) from across China made the case for monetary freedom as the best way to provide sound coinage.

In his argument against monetary freedom, Sang Hongyang contended: “If the currency system is unified under the emperor’s control, the people will not serve two masters [the state and the market]. If coin issues from the ruler, the people will have no doubts about whether it is genuine or not.”[6]

The literati, who favored economic freedom, as opposed to the interventionist policies initiated by Emperor Wu, disputed that argument:

In high antiquity, numerous forms of currency existed, wealth circulated, and the people were happy. Later, when the old types of currency were replaced with silver coins inscribed with tortoises and dragons, the people became deeply suspicious of the new coins. The more often the currency system changes, the more suspicious the people become.

Subsequently, all the old currencies circulating throughout the realm were demonetized and sole authority to mint coin was vested in the Three Officers of the Intendancy of Natural Resources. Officials and artisans alike steal from the profits of the mint. Moreover, they fail to ensure that coins are made to exact standards; some coins are too thin or too thick, too heavy or too light. Farmers are not expert at perceiving the qualitative differences between different coins. When comparing one coin to another, they trust the old coins but harbor suspicions about the new ones, without really knowing which is genuine and which is false. Merchants and shopkeepers pass off bad coins in exchange for good, taking in coins worth double their face value while fobbing off debased ones. … If people must discriminate between different types of coin, then trade will be harmed, and consumers in particular will suffer.

Therefore, the sovereign provides for the people’s welfare by not restricting the use of natural resources … [and] he facilitates the use of currency by not prohibiting people from freely minting coins.[7]

It is clear from these passages that the literati based their case for monetary freedom on sound economics and the positive consequences competitive coinage was expected to have on human welfare. As Richard von Glahn, an eminent historian of Chinese monetary history, notes,

The Confucian scholars arrayed in opposition to Emperor Wu’s policies of state intervention in the economy rejected the contention that a state monopoly on coinage is the best defense of sound money. The market, they suggested, will compel private coiners to maintain proper standards of size, weight, and purity. A state monopoly on coinage, in contrast, allowed the state to debase its own coin with impunity.[8]

They also thought that, from an ethical view point, a government monopoly is unjust, because it prevents free competition and allows officials to use their power to debase the currency for personal gain.

Although the literati had ethics, history, and logic on their side, they were unable to end the state monopoly on coinage. Government officials’ inclination to abuse their power by manipulating the monetary system for fiscal purposes and their own profit was simply too strong. Consequently, “the court debate in 81 B.C. marked the last serious challenge to the principle of a [monopoly] sovereign currency.”[9]

A Catallactic View of Money

The proponents of competitive coinage held a catallactic (i.e., exchange) view of money. They held that money, as a medium of exchange, evolved from commodities that had an exchange value in barter economies. The literati argued: “The ancients had marketplaces but no coinage. Everyone exchanged what they had for what they lacked .… In later ages, tortoise and cowrie shells, gold, and bronze coins emerged as the media of exchange.”[10] They did so because those commodities had a nonmonetary value, were scarce enough and durable enough to serve as money, and engendered the people’s trust—not because the sovereign mandated their use as money. In Mengerian terms , they had wide “marketability” — not just personal use value.[11]

Knife-shaped money

Spade-shaped money

The Confucian scholars who participated in the 81 B.C. debate over coinage no doubt were familiar with the writings of Sima Qian (c. 145–86 B.C.), the “Grand Historian,” who wrote: “When farmers, artisans, and merchants first began to exchange articles among themselves, manifold forms of currency — tortoise and cowrie shells, gold and bronze coin, and knife-shaped and spade-shaped money — came into being.”[12]

Sima Qian, the Grand Historian

According to von Glahn, Sima Qian and Confucian scholars “evoked an image of a spontaneous emergence of the market as a reproof of meddlesome rulers who manipulated the currency system for their own profit.”[13] However, while Sima Qian criticized government intervention, he did not favor private coinage, which he thought could be disruptive.[14]

The catallactic (market-based) doctrine of the origin of money was not widely shared. Most authorities rejected it in favor of the long-held chartalist view that money originated from rulers who sought to improve the welfare of their people. As expressed in the Guanzi (a book by Guan Zhong, a 7th century B.C. statesman): “Tang [mythical founder of the Shang Dynasty] used the metal of Mount Zhuang, and Yu [founder of the Xia Dynasty] took the metal of Mount Li, to cast money, which they employed to redeem the children from bondage.”[15]

Lessons

A study of the monetary history of the Western Han Dynasty is instructive in showing the tension between state power and private initiative in meeting the demand for currency as the economy and population grow. Government officials’ inclination to abuse their power when they have a monopoly on coinage is evident during the early Han Dynasty, as is the monetary chaos that can occur when there is a lack of a genuine rule of law.

The court debate in 81 B.C. shows that there was support for competitive coinage and that the literati from across China believed that, under just laws that were enforced, private mints could bring about monetary harmony. The debate also shed light on the importance of market forces in understanding the origin (or early history) of money. They thus give us another bit of evidence in the long-standing controversy over the state theory of money (chartalism) and the exchange (catallactic) theory of money, also known as “metallism”.[16]

_________________

[1] Nishijima Sadao, “The Economic and Social History of Former Han,” p. 586; in The Cambridge History of China: Volume 1, The Ch’in [Qin] and Han Empires, 221 B.C.–A.D. 220, edited by Denis Twichett and Michael Loewe, New York: Cambridge University Press, 1986.

The Han banliang was effectively a monetary unit, the actual metallic equivalent for which tended to change over time, while the zhu was a stable weight unit, equivalent to so many grams. Thus coins that bore a banliang value were given a nominal rating equal to12 zhu/​banliang. The difference between the nominal and actual value was the difference between that rating and the coins actual weight in zhu. For an excellent history of coinage during the Qin and Western Han Dynasties, see http://​www​.cal​gar​ycoin​.com/​r​e​f​e​r​e​n​c​e​/​c​h​i​n​a​/​c​h​i​n​a​2.htm.

[2] Nishijima, p. 586.

[3] Ibid.; see also Richard von Glahn, Fountain of Fortune: Money and Monetary Policy in China, 1000–1700, p. 35, Los Angeles: University of California Press, 1996.

[4] Nishijima, p. 587; Walter Scheidel, “The Monetary Systems of the Han and Roman Empires,” Princeton/​Stanford Working Papers in Classics, Paper No. 110505 (February 2008), p. 8.

[5] Jia Yi’s commentary was preserved in the Hanshu (History of the Former Han) compiled by Ban Biao, Ban Gu, and Ban Zhao. It appeared in 111 A.D. See Scheidel, p. 8.

[6] Huan Kuan, Yantie lun, 4, “Cuobi,” p. 16; English translation in von Glahn, p. 36.

[7] Yantie lun, pp. 16–17; in von Glahn, pp. 36–37. “Currency” refers to so-called cash coins, not to paper currency.

[8] Von Glahn, Fountain of Fortune, p. 36.

[9] Ibid., p. 37.

[10] Yantie lun, p. 16.; in von Glahn, p. 27.

[11] See Carl Menger, Principles of Economics (1871), chap. 8, “The Theory of Money.” Translated by J. Dingwall and B. F. Hoselitz, with an introduction by Friedrich A. Hayek. New York: New York University Press, 1981.

[12] Sima Qian, Shiji (Records of the Grand Historian), 30.1442. Beijing ed.; von Glahn, p. 26.

[13] Von Glahn, p. 27.

[14] Ibid., p. 35.

[15] Guanzi, 75, “Shanquanshu,” III: 73 (Guoxue jiben congshu edition); in von Glahn, p. 26. Accordingly, von Glahn (p. 28) notes: “By the late imperial times, the Guanzi version of the origin of money prevailed over catallactic theories.”

[16] On the case against chartalism (also known as cartelism), see Lawrence H. White, “Why the ‘State Theory of Money’ Doesn’t Explain the Coinage of Precious Metals,” Alt‑M (August 24, 2017), and George Selgin, “‘Lord Keynes’ Contra White on the Beginnings of Coinage,” Alt‑M (August 30, 2017).

[Cross-posted from Alt‑M.org]

China-based cryptocurrency exchange BTCC suspended all domestic trading in yuan last weekend. The decision came on the heels of a September 5 statement from regulatory authorities in China, which required all domestic cryptocurrency exchanges publish closing announcements, stop registering new users, and establish a schedule to cease yuan-denominated trading by September 15. Huobi and OKCoin — two other exchanges based in China — have announced similar plans to stop trading. To be clear: China has not banned the use of cryptocurrencies. It has banned cryptocurrency exchanges and initial coin offerings (ICOs). Even still, it has prompted some to consider whether a government might ban cryptocurrencies like bitcoin — and, perhaps more importantly, whether such a ban would be effective.

There seems to be no denying that governments can ban cryptocurrencies. Bolivia, Ecuador, Kyrgyzstan, and Bangladesh have already done so. Russia issued a draft bill to ban cryptocurrencies in October 2014 and recent rumors suggest it might follow through. More broadly, governments have taken steps to prevent other alternatives to their preferred monies. Cambodia recently suggested it might ban the dollar. Syria prohibited the use of any foreign currency in 2013. And the U.S. government shut down Liberty Dollar and E‑Gold in the mid-2000s. Can governments ban cryptocurrencies? Absolutely. The question is whether — or, to what extent — a ban will actually discourage use.

Some bitcoin proponents have argued that governments cannot really prevent bitcoin use. Jon Matonis once stated that “a government ban on bitcoin would be about as effective as alcohol prohibition was in the 1920s.” How could a government prevent people from using bitcoin? It’s online. It’s pseudonymous. And, as Matonis notes, “demand for an item […] does not simply evaporate in the face of a jurisdictional ban.”

Or, does it? For starters, one must recognize that monetary demand — that is, the demand to use an item as a medium of exchange — is not quite like the demand for most other goods. Monies are subject to network effects. I can enjoy a fine bathtub gin even if no one else does. But the usefulness of a would-be money like bitcoin depends crucially on whether other people are using it. We must coordinate beliefs. If one does not believe others will use bitcoin, she will be less inclined to accept it herself. For cryptocurrencies that lack some non-monetary use, that means demand might fall to zero even if everyone would prefer it to the relevant alternative.

In general, governments might determine the medium of exchange by coordinating beliefs, employing transactions policy, and punishing users of alternatives. By declaring an item legal tender, for example, the government might create an especially salient focal point around which individuals can coordinate on a particular money. Legal tender status might be nothing more than a designation; it need not convey any special privileges under the law (though sometimes it does). Since I want to use the money you are using and you want to use the money I am using, simply stating that the dollar is legal tender and bitcoin is not legal tender might be enough to generate coordination on the dollar. As a large and powerful player in the economy, governments are often in a position to provide such a focal point.

Of course, if the net gains from switching to bitcoin are greater than the costs of coordination, we might establish some competing focal point to coordinate on the superior alternative. In this case, governments might resort to transactions policy — that is, committing to accept and spend its preferred money — in order to prevent bitcoin from gaining widespread acceptance. By collecting taxes and spending dollars (and not bitcoin), the government guarantees some demand for dollars and, correspondingly, limits the potential network size of bitcoin. Some governments will not be able to determine the medium of exchange with transactions policy. But a sufficiently large government can.

Even if a government is not large enough to determine the medium of exchange via transactions policy, it still has one last trick up its sleeve: punishments. By punishing those employing an alternative money, it lowers the expected benefits of the alternative and, hence, the relative demand for its preferred money. Whereas a sufficiently big government is required to determine the medium of exchange with transactions policy, a government of any size can determine the medium of exchange with punishments, so long as it is willing and able to mete out sufficiently severe punishments.

There are some obvious limits to the government’s ability to punish cryptocurrency users. For one, it has to find them. And, as Matonis and others have noted, cryptocurrencies like bitcoin are pseudonymous, making it difficult to tie an individual to his or her balance of bitcoin. Difficult, but not impossible.

Even if one has access to a perfectly anonymous payment mechanism, many transactions inevitably reveal one’s identity. When you purchase a good or service, there is usually some point in the transaction where you actually receive the good or service. And, at that moment, your identity is vulnerable to detection. That you can send or receive an anonymous payment is of little consequence if the other party in the transaction is a government agent. Sting operations are real.

More importantly, exploring the limits also reveals the vast range of transactions that would be relatively trivial to stamp out. A ban with significant punishments for those caught sending and receiving cryptocurrencies would surely see those “bitcoin accepted here” signs disappear. It would make finding a trading partner willing to use bitcoin a lot more cumbersome. Most people prefer to be on the right side of the law most of the time. Most routine transactions do not warrant the added costs of obscuring one’s identity or vetting one’s trading partner. Why risk being caught using a banned currency to buy milk and bread? Privacy is just not that important to most people in most situations. No doubt a government would find it difficult — perhaps even impossible — to eliminate all bitcoin transactions. But a committed government would have little trouble making bitcoin sufficiently unattractive for most users, significantly limiting bitcoin’s potential network size. In such a world, bitcoin would function as a niche currency — or, not at all.

There are exceptional cases, to be sure. If the government’s preferred currency is poorly managed (think: hyperinflation, not two-percent) or black market transactions are the norm, one might not hesitate to use a banned alternative. That seems to be the case in Venezuela at present. If one must operate outside the law just to buy lunch, she might not be too concerned about the risk of additional sanctions for using bitcoin. And, since everyone else is operating outside the law, she might be reasonably confident that others will accept bitcoin as well. But such cases are the exception. When bitcoin proponents maintain that governments cannot prevent bitcoin use, they do not usually limit the claim to such extreme scenarios.

Fortunately, very few countries have taken steps to ban cryptocurrencies to date. But the threat is legitimate. Governments might not be able to prevent all cryptocurrency transactions, but they can significantly discourage their use. With this in mind, we should continue to push for choice in currency. We should continue to explain the benefits of financial privacy and stateless monies. However, we should also support sensible regulation that would preserve most of the benefits from cryptocurrencies while eliminating the major justifications for outright bans. It is a second-best solution. In a world with powerful governments, it might be the best one can hope for.

[Cross-posted from Alt‑M.org]

In a note to my last post, I observed that Liberty Street Economics, the blog of Federal Reserve Bank of New York, promised a follow-up to its post addressing the advantages of the Fed’s interest payments on required reserves. The follow up would address the benefits of paying interest on banks’ excess reserves and of thereby establishing a “reserve-abundant regime.”

That follow-up post has since appeared, under the title “Why Pay Interest on Excess Reserve Balances?” As I’d anticipated, it answers the question it poses by outlining some supposed benefits of having banks sit on immense piles of cash, without so much as hinting at the existence of any countervailing costs. As soon as those costs are considered, the supposed benefits turn out to be largely, if not entirely, fictitious.

Real and Pseudo Reserve Economies

According to the post’s authors, Laura Lipscomb and Heather Wiggins (Board of Governors) and Antoine Martin (FRBNY), a major advantage of paying interest on excess reserves (IOER) is that, by ensuring that banks possess “a relatively abundant supply of [excess] reserves,” it “makes the U.S. payment system more efficient.” Besides no longer having to rely “on intraday and overnight credit from the Fed,” the authors explain, banks made flush with reserves “are more willing to relinquish reserves early and are therefore engaging in less economizing and hoarding of reserves, making the payment system more efficient.”

“Less economizing and [less] hoarding”? Usually, when we speak of someone “economizing” on X, we mean that he or she makes do with less of X. To do less economizing of X is therefore to require more of X. So how can banks do “less economizing and hoarding of reserves”? They can’t. They can either economize less and hoard more, or they can economize more and hoard less.

Nor can there be any doubt which of these alternatives IOER encourages. Before that policy was introduced, U.S. banks seldom held more than $2 billion in excess reserves collectively. Today they hold more than $2 trillion. If that isn’t less economizing and more hoarding, I can’t imagine what would qualify. Certainly to claim, as Lipscomb, Martin, and Wiggins do, that it marks an improvement in the efficiency of the payments system, seems on the face of it quite a stretch.

But let’s allow the authors to elaborate:

When reserves are scarce, banks are more reliant on the reserves they receive from other banks to make their own payments than when reserves are more abundant. So reserve scarcity exposes the payment system to a greater risk that a disruption at one bank could spill over and affect the system as a whole. Also, having a larger share of payments settled early reduces the potential consequences of a late day operational disruption.

Furthermore,

the amount of intraday credit the Fed needs to extend to banks to cover daylight overdrafts … is much lower when the supply of reserves is high. … A large supply of reserves gives banks a sizable buffer to make payments throughout the day without needing to wait for the receipt of other payments or relying on daylight credit from the Fed or other counterparties.

Finally,

In addition to needing less daylight credit, banks require less overnight credit in the form of discount window loans when reserves are abundant. The relatively abundant reserve environment means that fewer banks are caught short of balances at the end of the day, or at the end of a reserve maintenance period, which can lead to a scramble for funds, a spike in the federal funds rate, and banks occasionally accessing the discount window.

What’s wrong with that? The terminology, for starters. In the absence of IOER, although excess reserves are certainly “scarce” in the sense of being valuable, and therefore unlike salt water to a sailor or sand to a Bedouin, they are not usually “scarce” in the sense of being in short supply. The difference matters because, despite the impression conveyed in the above passages, the “scarcity” of reserves, properly understood, is not a problem with which bankers must cope, like so many farmers coping with a drought. Rather, the degree to which reserves are “scarce” is one normally chosen by the banks themselves. In econ lingo, it is itself the solution to an optimization problem, involving the weighing of private benefits and costs, including the costs of having to rely on occasional intraday and overnight loans.

The economics of the problem in question are actually pretty simple — so simple that, over the course of three decades, I taught them to several thousand undergraduates. As it happens, I still have a copy of my class notes. Here is the relevant page:

For “prudential” read “excess,” and never mind the typos. The point is that the mere fact that banks can avoid having to borrow if they hold more reserves hardly suffices to establish that getting them to do so makes either the banks themselves or the public better off.

An Inefficient Reserve Market?

Am I then claiming that, without IOER, the market for bank reserves would be perfectly efficient, with banks holding just the right amount of excess reserves? Not at all. Without IOER, the market for excess reserves might be inefficient for several reasons. It might be so because the Fed doesn’t charge banks the right price for daylight overdrafts or overnight loans. And it might be so because the Fed doesn’t reward them sufficiently for holding excess reserves.

Setting aside the problem of routinely mispriced Fed credit, which was once very serious but has since been somewhat rectified, many economists, myself included, have long understood that there’s a case for reducing banks’ opportunity cost of reserve holding by paying a positive return on reserves. But that hardly means that banks can’t be overcompensated for their reserve holdings, or that they can’t thereby be encouraged to hold inefficiently large quantities of excess reserves.

The well-known arguments for paying interest on bank reserves are in fact arguments for paying a rate of interest reflecting the true opportunity cost of reserve holding. That means a “Friedman rule” rate not lower but also no higher than market rates on other liquid and risk-free assets.

Furthermore, because the Friedman rule applies to a hypothetical economy free of nominal rigidities and other frictions, even that rate is likely to be too high in practice. In their recently published study devoted to determining an optimal IOER rate in light of real-world frictions, Matthew Conzoneri, Robert Cumby, and Behzad Diba arrive at an optimal steady state tax on excess reserves of 20 to 40 basis points, implying an optimal IOER rate equal to the Friedman rate minus that optimal tax. Allowing for what the authors’ refer to as a “bank lending externality” pushes the optimal IOER rate down even more, and can even make it negative.

Yet almost since IOER was first introduced, in October 2008, the Fed’s practice has been to set its IOER rate above, if not substantially above, corresponding market rates, and to thereby encourage banks, not merely to fine-tune their reserve holdings to equate marginal (social) benefits and costs, but to pile-up as many reserves as the Fed sends their way.

In short, slice and dice it however you like, there is no way to make sense of Liberty Street Economics’ claim that the Fed’s interest payments on excess reserves serve to achieve an optimal quantity of bank reserves, or to otherwise make our payments system more efficient.

There’s No Such Thing as a Free (Liquid) Lunch

But hold on: can’t the Fed produce reserves costlessly? And doesn’t that mean that, even if there are more than enough of them, their presence can’t possibly be wasteful?

No, and no. Even if it didn’t cost a thing for the Fed to increase the nominal quantity of reserves, it costs plenty to get banks to increase their excess reserve holdings, which is what the Fed does by paying interest on excess reserves. Every dollar that banks keep in the form of excess reserves is a dollar they might instead have traded (along with some others) for a security, or lent. (And if you think that banks don’t lend reserves, you need to read this Nick Rowe post.)

As the chart below shows, in the good-old, pre-IOER days, when U.S. commercial banks hardly held any excess reserves, their total loans and leases amounted to about 100 percent of their deposits. Today, in contrast, banks hold excess reserves equal to about 20 percent of their deposits, and loans and leases equal to about 80 percent of their deposits. That change is a truer index of the cost of IOER.

None of this would matter if the Fed acted as an efficient savings-investment intermediary, as commercial banks are able to do, at least in principle. But the Fed isn’t a commercial bank, and it doesn’t employ funds at its disposal the way commercial banks do. It makes loans to other banks, but not to businesses or consumers. And its investments are typically confined to Treasury and some agency securities.

High-Tech Financial Repression

When central banks of less-developed countries impose high reserve requirements on their nations’ banks, for the sake of steering more of their citizens’ savings onto their own balance sheets, and thence to their governments’ coffers, economists call it “financial repression.” And they condemn it.

How come? Because ever since Adam Smith wrote his eloquent chapter (No. 2 of Book 2) on the subject, they’ve understood the crucial role bank lending plays in boosting economic productivity and otherwise spurring growth. In recent decades that understanding has been reinforced by a vast crop of writings on the topic, both theoretical and empirical.

When, on the other hand, the Federal Reserve gets banks to accumulate trillions of dollars in excess reserves, and to thereby fund its acquisition of an equivalent amount of government and mortgage-backed securities (where by “vast” I again refer not just to nominal but to real quantities), Federal Reserve economists call it “making the payments system more efficient”!

Call it what they will, the Fed’s policy is also financially repressive. By diverting savings to the government and its agencies and to whatever endeavors they favor, it denies that much funding to other prospective borrowers, many of whom — and small business owners especially — would employ the funds in question more productively.

According to a recent working paper by Brian Chen, Samuel Hanson, and Jeremy Stein, all of Harvard, overall bank lending to small businesses has yet to fully recover the ground it lost in 2008, and has hardly recovered at all at the top 4 banks. The evidence suggests, furthermore, that this sustained decline, which may have played a part in “the weak productivity growth in the decade since the crises,” reflects “a systematic and sustained supply-side shift.” Although Chen, Hanson, and Stein don’t investigate the cause of the shift, and don’t mention IOER as a possible culprit, it is certainly a likely suspect. Among other things it’s well-known that the biggest banks have also been among the chief accumulators of excess reserves.

But surely, you may be thinking, there’s a difference between forcing banks to hold more reserves, as some less-enlightened central banks have done, and rewarding them for doing so. There is, but it doesn’t make the Fed’s policy much less financially repressive. The difference is that, instead of imposing a “reserve tax” on banks and their depositors, the Fed’s above-market IOER rate grants them a subsidy proportional to the difference between the actual IOER rate and its optimal counterpart. Although the subsidy serves to somewhat enhance rather than to reduce the attractiveness of bank deposits, that slight gain is more than offset by the diversion of deposited savings to less productive uses.

Who, then, foots the bill for the subsidy? Taxpayers do. That becomes evident once one considers that the Fed, being a relatively inefficient intermediary, can afford to pay above-market rates on banks’ reserves only by either (1) sacrificing some of the revenue it would ordinarily remit to the Treasury or (2) taking extraordinary risks in order to earn more revenue than usual. As Deborah Lucas explained at a recent Shadow Open Market Committee meeting, the Fed has taken the latter course by using bank reserves, which are short-term assets, to fund longer-term Treasuries and MBS. “There is,” she adds, “no free lunch from that transaction.” Instead, the Fed’s extra earnings reflect increased risk, which

ultimately falls on taxpayers, who serve as (conscripted) equity holders for any risky government investment. When the budget treats cash flows generated from a market risk premium as revenues but does not recognize an offsetting cost, it is arguably equivalent to levying a hidden tax that confiscates the risk premium to pay for additional spending.

Off Balance

In fairness to the authors of the Liberty Street Economics post, they never actually claim to be offering an objective assessment of the the Fed’s practice of paying interest on banks’ excess reserves. Instead, they state their intent is to review some “potential benefits” of that practice. So perhaps it is unfair of me to suggest that their review is misleading.

But I don’t think so. First of all, when economists refer to a policy’s “benefits,” they often mean its net benefits. So when that’s not what they mean, they should be clear about it, by at least noting that the policy also has costs that they have chosen not to consider. They should also make it clear that, because they are considering only the benefit side of a full cost-beneft reckoning, their assessment should not be understood as implying that the policy is a good idea. Instead of taking such precautions, Lipscomb, Martin, and Wiggens make it all too easy for readers of their article to assume that the “benefits” it describes do in fact suffice to justify the Fed’s IOER policy.

Yet all is not lost, for our authors can easily make up for any misunderstanding their post may have caused. To do so, they need only publish a companion piece, which they could call “Why Not Pay Interest on Excess Reserve Balances?,” addressing all the disadvantages of paying interest on banks’ excess reserves, and especially of paying it at above-market rates. The piece should of course address the drag on productive investments that comes from stuffing banks with reserves they don’t need. But it needn’t stop there. It could also point out how above-market IOER undermines monetary control, and how (by severing balance-sheet management from monetary control) it makes it all too easy for the Fed to play the part of a fiscal fairy godmother. Needless to say, the essay should studiously avoid even a whisper concerning any potential benefits to be expected from the policy.

I should think that a month would be more than enough time for three experts to prepare the essay in question. So let’s give them a deadline: November 1st. If they come through, we can all celebrate the general gain in understanding to which their two-part assessment is bound to contribute. And if not, we will still have learned something, to wit: that the Fed’s own assessments of the merits of its policies are best taken with a grain of salt.

[Cross-posted from Alt‑M.org]