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Dizzy Miss Izzy

by George Selgin November 24th, 2014 9:21 pm

Dizzy
I'm so dizzy my head is spinning
Like a whirlpool it never ends
And its you, girl, making it spin
You're making me dizzy*

Tell me I'm not with it, if you must, but the fact is that until a couple of days ago I'd never heard of Izabella Kaminska, who bills herself as a "finance blogger" and believer in something called the "collaborative economy," in which sharing things takes the place of buying and selling them, the result being, she claims, a reduced carbon footprint.

Although I rather doubt that we're likely to witness an end to our "propensity to truck and barter" anytime soon, I don't doubt that such an event would in fact reduce carbon emissions: there would, for one thing, be a lot less less breathing going on. But what concerns me isn't Ms. Kaminska's general economic philosophy, to call it that. It's her vertiginous spin on free banking, which she saw fit to air this past week, first on FT Alphaville, and then on a blog of her own called, appropriately enough, Dizzynomics.

All this might have gone happily unremarked had the Econ Blogosphere's Grand Pooh Bah not seen fit to deem the last of these disorienting missives worthy of his readers' attention. And so it happens that, Despicable Free Banking Nobody though I am, I find myself submitting, for The Rt. Hon. GPB's consideration, my own humble post, the gist of which is that Ms. Kaminska hasn't the foggiest idea what she's talking about.

Because I addressed some errors in Ms. Kaminska's FT post in comments to that post itself, I'll embellish a bit here rather than repeat myself.

In discussing the founding of the Bank of England, Kaminska refers to the risk that "a private syndicate" took in "lending money to" the "UK" government. Let pass the anachronism. What matters is that the arrangement in question involved, not a loan directly made by the parties in question, but one made from the proceeds of a public stock offering, the lure for which consisted of monopoly powers the new Bank was expected to command. The stock sold in 12 days, and though the investors (again, not the scheme's principals) could hardly avoid taking some risk, their gamble had every appearance of being a darn safe one. According to Sir John Clapham (History of the Bank of England i, p. 20), among the various projects being floated in those times, "the Bank with its Parliamentary backing, its high sounding name, and its guaranteed income from the taxes was a very attractive proposition. The speed of the subscription need not surprise those more familiar than any pamphleteer of 1695 could be with how and why men invest."

I comment in the FT post itself on Kaminska's suggestion that the Bank of England was particularly effective at enhancing England's prosperity, so let me add here some brief excerpts from the source I referred to in that comment: Rondo Cameron's chapters on "England" and "Scotland" from his edited volume, Banking in the Early Stages of Industrialization (Oxford University Press, 1967). "The English banking system from 1750 to 1844, " Cameron observes, "was far from ideal in its contributions to either stability or growth of the economy as a whole." Topping Cameron's list of that system's infirmities is the Bank of England itself, whose "contributions to industrial finance were negligible, if not negative." Regarding Scotland Cameron says, in contrast, first, that despite having been "a poor country by any standard" in 1750, it "stood with England in the forefront of the world's industrial nations" a century later, and, second, that "the superiority of its banking system stands out as one of the major determining factors" of this relatively rapid growth.

Ms. Kaminska's estimate of the contribution of the Bank of England's monopoly privileges toward British economic stability is just as unfounded as her opinion regarding its contribution toward British prosperity. "Before the Bank knew it," she writes, "its notes had become the most liquid and trusted in the land." Actually, because the Bank didn't even bother to have branches beyond London before 1826, its notes were until that time seldom seen beyond the metropolis. (Nor, prior to the French wars, did the Bank issue notes for less than the princely sum of 10 quid.) If the Old Lady's notes were nonetheless judged safer than those of country banks, that was because those banks were severely under-capitalized and under-diversified. And why was that? Because they were not only denied Joint-Stock status, but subject to a rule limiting their ownership to six partners or fewer. In short the country banks--the only sort, remember, allowed to operate wherever the Bank of England chose not to--were by law prevented from achieving any reasonable degree of financial diversification and strength. Here we see how, like most apologists for central banks, Ms. Kaminska fails to appreciate how the advantages commanded by such banks have as their precise counterpart limitations imposed upon all others. Little wonder so many English country banks fell victim to the Panic of 1825! Contrast, again, the situation in Scotland at the time, with three chartered banks and twenty-nine provincial ones, all commanding nationwide branch networks, and not one bank failure since a private bank failed in 1816--and even that one paying 9s on the pound! "Certainly Scotland," Sir John observes, "appeared to have secrets of sound banking that England might inquire into."

Ms. Kaminska is sanguine enough to allow that the Bank of England's powers tempted it to engage in "imprudent money-printing." But she spoils this lapse from her otherwise unalloyed confidence in the benevolence of state-sponsored monopolies by adding, gratuitously, that the bank was "not helped by the fact that [it] still had to compete with a whole bunch of private banks who were just as keen to issue money to an equally imprudent degree." But, as I've noted, "compete" with "private" (meaning, presumably, country) banks is just what the Bank did not do, at least not until after 1826. Instead, by the terms of its charter it subjected them to inhibiting constraints, and then, having led them on by means of its own generous discounts, led them fend for themselves. (For evidence, see the relevant section of my article, "Bank Lending 'Manias' in Theory and History.")

Kaminska can at least take credit for originality in reporting that, during the 1840s, "a terrible inflation" took hold in England, and that it was to combat that outbreak that Peel's 1844 Act was passed. Alas, the claim owes its originality to the fact that there's not an ounce of truth to it. The same may be said for her claim that the Scottish system was stable only because Scottish bankers "were so good at forging oligopolistic cartels that happily restricted competition." As I noted in my FT comments, there's no evidence that limited entry was a source of any significant monopoly power in Scottish banking. (On the contrary: the system was notoriously efficient.) Nor is there any evidence that Scottish banks policed one another other than by engaging in regular note exchanges, as they would have been no less compelled to do had entry into the industry been open. But let us assume, for the sake of argument, that Ms. Kaminska is correct in holding that oligopoly was the cause of the Scottish system's superior stability. Then why, one wonders, does she not grant that a similar oligopoly might also have made England better off than it managed to be with its patently unstable blend of monopoly and hamstrung polypoly?

In 1833, thanks to a the efforts of the great Thomas Joplin, the terrible Six Partner Rule was partially circumvented by way of the discovery that its language encompassed note-issuing banks only, and not mere banks of deposit. The Bank of England thus faced for the first time competition from other joint-stock banks. Such are the facts. And what does Ms. Kaminska's make of this development? First, that it came, not in 1833--that is, well ahead of Peel's Act--but "in the latter half of the 19th century"; and, second, that it occurred, not because a clever banker discovered a loophole in the law aimed at severely restraining the Bank of England's rivals, but supposedly because restrictions imposed by Peel's Act on the Bank of England itself created "conditions" favoring the rise of "a new type of unregulated" bank. "Some history" indeed.

Ms. Kaminska concludes her remarks on English versus Scottish banking with a long excerpt from the Bank of England's web pages, telling of how it "established the concept of lender of last resort" in the wake of the crises of 1866 and 1890. Had the "concept" thrust down its throat, by Walter Bagehot, is closer to the truth. What that great man had to say concerning the respective merits of the English ("one reserve") and Scottish ("natural") systems is, or ought to be, too well known to warrant repeating.

In her Dizzynomics follow up Ms. Kaminska adds little to the substance of her FT argument against free banking, such as it is, preferring instead to heap anathemas upon free bankers, who according to her reckoning are thick on the ground (were it only so!), and whom she regards as "reason and logic deniers" incapable of grasping the fact "that whenever we've had free-banking systems they've resulted in chaos or alternatively co-beneficial collusion to the point were the system is not free by the standard definition of free."

No one, so far as I know, has ever claimed that the systems generally held out as examples of "free" banking--Scotland, of course, and Canada before 1914, among others--were perfectly so. Not me. Nor Kevin Dowd. Nor Larry White. Nor any other free banker I know. Of course those systems weren't perfectly free. No banking system ever was. Nor has Hong Kong ever witnessed free trade in all its unsullied glory. So what? The question is always whether the examples come close enough to serve as evidence of the likely consequences of the fully-realized alternative. Was Scottish banking, to return to that case, "close enough" to shed light on the consequences of truly free banking? The debate on that question was joined some years back, with Larry White weighing in in the affirmative against the counterarguments of Murry Rothbard, Larry Sechrest, and Tyler Cowen and Randy Kroszner, among others. Ms. Kaminska, having found the opposition's case neatly summarized in a blog post, simply overlooks White's rejoinders. She overlooks as well the not-insignificant body of theoretical work using induction aided by deduction rather than deduction alone to draw inferences about the likely consequences of unalloyed freedom in banking.

Kaminska herself needs no theory, on the other hand, to reach the conclusion that genuinely free banking, unlike the Scottish mongrel, must lead to "chaos." How can she know? As she offers neither evidence nor argument, one must hazard a guess. Mine is that she is referring to the U.S. banking system between the demise of the second Bank of the United States, in 1836, and the outbreak of the Civil War, and that she imagines, as many people do, that because a half-dozen states passed so-called "free banking" laws during that interval, it qualifies as one of perfect freedom from any sort of bank regulation. Excuse me for having had to suppress a yawn just now--it is a long post, after all, and fatigue is setting in, quite possibly for us both. Suffice to say, then, that old banking myths die hard, and that this especially hoary one about U.S. "free banking" seems harder to kill than Rasputin himself. That it is mostly hokum is nonetheless easily established: just have a look at any post-1975 work by an economic historian on the subject, including the locus classicus, Hugh Rockoff's The Free Banking Era: A Re-Examination (Arno, 1975). (A later survey piece is here.)

A misreading of the same U.S. experience seems also to inform several of the obiter dicta that follow Kaminska's opening thrust, including her claim that free bankers fail to "appreciate that it was standardizing certain subjective [?] values like weights, distances, time [sic] itself that has allowed society to cooperate, grow and thrive." (Because antebellum state banking laws generally prohibited branching, state banknotes tended to be subjected to discounts when encountered any distance from their source; in contrast, in the Scottish and Canadian systems, where banks were free to establish branch networks, banknote discounts were unknown.) Ditto her belief that free bankers "advocate a Wild West model where no one can trust anyone and everyone has to do due diligence themselves." (Though it's true that the antebellum [old] west was inundated by all sorts of phony bank paper, that result came about, not because banking was unregulated there, but because territorial authorities, by having outlawed it, made their citizens perfect targets for phony notes purporting to come from legitimate banks down east. Where banking was more, though not perfectly, free, as in 19th century Canada or Scotland, in contrast, it sufficed to trust one bank, and to accept only those notes regarded as current at that bank, to avoid trouble.)

I hope I've said enough to suggest why I find it remarkable than anyone should take Ms. Kaminska's ramblings on free banking (or, I now feel justified in saying, on any subject whatsoever) seriously. Perhaps no one does. Still I wish Tyler hadn't given those ramblings more currency by advertising them, without the benefit of critical comment, on Marginal Revolution: here, surely, is a case where sharing adds to rather than subtracts from the world's burden of hot air.
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*Tommy Roe, "Dizzy."


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Good and Bad News from the UK

by George Selgin November 21st, 2014 7:47 pm

The good news is Wycomb member Steve Baker's excellent speech in Parliament on "Money Creation and Society," the transcript of which I copy below in full.

The bad news is this silly response in FT Alphaville, to which your correspondent has appended a comment.

* * *

Money Creation and Society

Steve Baker (Wycombe) (Con): I beg to move,

That this House has considered money creation and society.

The methods of money production in society today are profoundly corrupting in ways that would matter to everyone if they were clearly understood. The essence of this debate is: who should be allowed to create money, how and at whose risk? It is no wonder that it has attracted support from across the political spectrum, although, looking around the Chamber, I think that the Rochester and Strood by-election has perhaps taken its toll. None the less, I am grateful to right hon. and hon. Friends from all political parties, including the hon. Members for Clacton (Douglas Carswell) and for Brighton, Pavilion (Caroline Lucas) and the right hon. Member for Oldham West and Royton (Mr Meacher), for their support in securing this debate.

One of the most memorable quotes about money and banking is usually attributed to Henry Ford:

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did I believe there would be a revolution before tomorrow morning.”

Let us hope we do not have a revolution, as I feel sure we are all conservatives on that issue.

How is it done? The process is so simple that the mind is repelled. It is this:

“Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”

I have been told many times that this is ridiculous, even by one employee who had previously worked for the Federal Deposit Insurance Corporation of the United States. The explanation is taken from the Bank of England article, “Money creation in the modern economy”, and it seems to me it is rather hard to dismiss.

Today, while the state maintains a monopoly on the creation of notes and coins in central bank reserves, that monopoly has been diluted to give us a hybrid system because private banks can create claims on money, and those claims are precisely equivalent to notes and coins in their economic function. It is a criminal offence to counterfeit bank notes or coins, but a banking licence is formal permission from the Government to create equivalent money at interest.

There is a wide range of perspectives on whether that is legitimate. The Spanish economist, Jesús Huerta de Soto explains in his book “Money, Bank Credit and Economic Cycles” that it is positively a fraud—a fraud that causes the business cycle. Positive Money, a British campaign group, is campaigning for the complete nationalisation of money production. On the other hand, free banking scholars, George Selgin, Kevin Dowd and others would argue that although the state might define money in terms of a commodity such as gold, banking should be conducted under the ordinary commercial law without legal privileges of any kind. They would allow the issue of claims on money proper, backed by other assets—provided that the issuer bore

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all of the risk. Some want the complete denationalisation of money. Cryptocurrencies are now performing the task of showing us that that is possible.

The argument that banks should not be allowed to create money has an honourable history. The Bank Charter Act 1844 was enacted because banks’ issue of notes in excess of gold was causing economic chaos, particularly through reckless lending and imprudent speculation. I am once again reminded that the only thing we learn from history is that we learn nothing from history.

Thomas Docherty (Dunfermline and West Fife) (Lab): I welcome today’s debate. The hon. Gentleman makes a valid point about learning from history. Does he agree with me that we should look seriously at putting this subject on the curriculum so that young people gain a better understanding of the history of this issue?

Steve Baker: That is absolutely right. It would be wonderful if the history curriculum covered the Bank Charter Act 1844. I would be full of joy about that, but we would of course need to cover economics, too, in order for people to really understand the issue. Since the hon. Gentleman raises the subject, there were ideas at the time of that Act that would be considered idiocy today, while some ideas rejected then are now part of the economic mainstream. Sir Robert Peel spent some considerable time emphasising that the definition of a pound was a specific quantity and quality of gold. The notion that anyone could reject that was considered ridiculous. How times change.

One problem with the Bank Charter Act 1844 was that it failed to recognise that bank deposits were functioning as equivalent to notes, so it did not succeed in its aim. There was a massive controversy at the time between the so-called currency school and the banking school. It appeared that the currency school had won; in fact, in practice, the banks went on to create deposits drawn by cheque and the ideas of the banking school went forward. The idea that one school or the other won should be rejected; the truth is that we have ended up with something of a mess.

We are in a debt crisis of historic proportions because for far too long profit-maximising banks have been lending money into existence as debt with too few effective restraints on their conduct and all the risks of doing so forced on the taxpayer by the power of the state. A blend of legal privilege, private interest and political necessity has created, over the centuries, a system that today lawfully promotes the excesses for which capitalism is so frequently condemned. It is undermining faith in the market economy on which we rely not merely for our prosperity, but for our lives.

Thankfully, the institution of money is a human, social institution and it can be changed. It has been changed and I believe it should be changed further. The timing of today’s debate is serendipitous, with the Prime Minister explaining that the warning lights are flashing on the dashboard of the world economy, and it looks like quantitative easing is going to be stepped up in Europe and Japan, just as it is being ramped out in America—and, of course, it has stopped in the UK. If anything, we are not at the end of a great experiment

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in monetary policy; we are at some mid point of it. The experiment will not be over until all the quantitative easing has been unwound, if it ever is.

We cannot really understand the effect of money production on society without remembering that our society is founded on the division of labour. We have to share the burden of providing for one another, and we must therefore have money as a means of exchange and final payment of debts, and also as a store of value and unit of account. It is through the price system that money allows us to reckon profit and loss, guiding entrepreneurs and investors to allocate resources in the way that best meets the needs of society. That is why every party in the House now accepts the market economy. The question is whether our society is vulnerable to false signals through that price system, and I believe that it is. That is why any flaws in our monetary arrangements feed into the price system and permeate the whole of society. In their own ways, Keynes and Mises—two economists who never particularly agreed with one another—were both able to say that currency debasement was the best way in which to overturn the existing basis of society.

Even before quantitative easing began, we lived in an era of chronic monetary inflation, unprecedented in the industrial age. Between 1991 and 2009, the money supply increased fourfold. It tripled between 1997 and 2010, from £700 billion to £2.2 trillion, and that accelerated into the crisis. It is simply not possible to increase the money supply at such a rate without profound consequences, and they are the consequences that are with us today, but it goes back further. The House of Commons Library and the Office for National Statistics produced a paper tracing consumer price inflation back to 1750. It shows that there was a flat line until about the 20th century, when there was some inflation over the wars, but from 1971 onwards, the value of money collapsed. What had happened? The Bretton Woods agreement had come to an end. The last link to gold had been severed, and that removed one of the most effective restraints on credit expansion. Perhaps in another debate we might consider why.

Mr Angus Brendan MacNeil (Na h-Eileanan an Iar) (SNP): Does the hon. Gentleman agree that the end of the gold standard and the increased supply of money enabled business, enterprise and the economy to grow? Once we were no longer tied to the supply of gold, other avenues could be used for the growth of the economy.

Steve Baker: The hon. Gentleman has made an important point, which has pre-empted some of the questions that I intended to raise later in my speech. There is no doubt that the period of our lives has been a time of enormous economic, social and political transformation, but so was the 19th century, and during that century there was a secular decline in prices overall.

The truth is that any reasonable amount of money is adequate if prices are allowed to adjust. We are all aware of the phenomenon whereby the prices of computers, cars, and more or less anything else whose production is not determined by the state become gently lower as productivity increases. That is a rise in real living standards. We want prices to become lower in real terms compared to wages, which is why we argue about living standards.

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Sir William Cash (Stone) (Con): My hon. Friend is making an incredibly important speech. I only wish that more people were here to listen to it. I wonder whether he has read Nicholas Wapshott’s book about Hayek and Keynes, which deals very carefully with the question that he has raised. Does he agree that the unpleasantness of the Weimar republic and the inflationary increase at that time led to the troubles with Germany later on, but that we are now in a new cycle which also needs to be addressed along the lines that he has just been describing?

Steve Baker: I am grateful to my hon. Friend. What he has said emphasises that the subject that is at issue today goes to the heart of the survival of a free civilisation. That is something that Hayek wrote about, and I think it is absolutely true.

If I were allowed props in the Chamber, Mr Speaker, I might wave this 100 trillion Zimbabwe dollar note. You can hold bad politics in your hand: that is the truth of the matter. People try to explain that hyperinflation has never happened just through technocratic error, and that it happens in the context of, for example, extremely high debt levels and the inability of politicians to constrain them. In what circumstances do we find ourselves today, when we are still borrowing broadly triple what Labour was borrowing?

Ann McKechin (Glasgow North) (Lab): I am interested to hear what the hon. Gentleman is saying. He will be aware that the balance between wages and capital has shifted significantly in favour of capital over the past 30 years. Does he agree that the way in which we tax and provide reliefs to capital is key to controlling that balance? Does he also agree that we need to do more to increase wage levels, which have historically been going down in relation to capital over a long period of time?

Steve Baker: I think I hear the echoes of a particularly fashionable economist there. If the hon. Lady is saying that she would like rising real wage levels, of course I agree with her. Who wouldn’t? I want rising real wage levels, but something about which I get incredibly frustrated is the use of that word “capital”. I have heard economists talk about capital when what they really mean is money, and typically what they mean by money is new bank credit, because 97% of the money supply is bank credit. That is not capital; capital is the means of production. There is a lengthy conversation to be had on this subject, but if the hon. Lady will forgive me, I do not want to go into that today. I fear that we have started to label as capital money that has been loaned into existence without any real backing. That might explain why our capital stock has been undermined as we have de-industrialised, and why real wages have dropped. In the end, real wages can rise only if productivity increases, and that means an increase in the real stock of capital.

To return to where I wanted to go: where did all the money that was created as debt go? The sectoral lending figures show that while some of it went into commercial property, and some into personal loans, credit cards and so on, the rise of lending into real productive businesses excluding the financial sector was relatively moderate. Overwhelmingly, the new debt went into mortgages and the financial sector. Exchange and the distribution of wealth are part of the same social process. If I buy an apple, the distribution of apples and money will change. Money is used to buy houses, and we

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should not be at all surprised that an increased supply of money into house-buying will boost the price of those homes.

Mr Ronnie Campbell (Blyth Valley) (Lab): This is a great debate, but let us talk about ordinary people and their labour, because that involves money as well. To those people, talking about how capitalism works is like talking about something at the end of the universe. They simply need money to survive, and anything else might as well be at the end of the universe.

Steve Baker: The hon. Gentleman is quite right, and I welcome the spirit in which he asks that question. The vast majority of us, on both sides of the House, live on our labour. We work in order to obtain money so that we can obtain the things we need to survive.

The hon. Gentleman pre-empts another remark that I was going to make, which is that there is a categorical difference between earning money through the sweat of one’s brow and making money by lending it to someone in exchange for a claim on the deeds to their house. Those two concepts are fundamentally, categorically different, and this goes to the heart of how capitalism works. I appreciate that very little of this would find its way on to an election leaflet, but it matters a great deal nevertheless. Perhaps I shall need to ask my opponent if he has followed this debate.

My point is that if a great fountain of new money gushes up into the financial sector, we should not be surprised to find that the banking system is far wealthier than anyone else. We should not be surprised if financing and housing in London and the south-east are far wealthier than anywhere else. Indeed, I remember that when quantitative easing began, house prices started rising in Chiswick and Islington. Money is not neutral. It redistributes real income from later to earlier owners—that is, from the poor to the rich, on the whole. That distribution effect is key to understanding the effect of new money on society. It is the primary cause of almost all conflicts revolving around the production of money and around the relations between creditors and debtors.

Sir William Cash: My hon. Friend might be aware that, before the last general election, my right hon. Friend the Member for Wokingham (Mr Redwood) and I and one or two others attacked the Labour party for the lack of growth and expressed our concern about the level of debt. If we add in all the debts from Network Rail, nuclear decommissioning, unfunded pension liabilities and so on, the actual debt is reaching extremely high levels. According to the Government’s own statements, it could now be between £3.5 trillion and £4 trillion. Does my hon. Friend agree that that is extremely dangerous?

Steve Baker: It is extremely dangerous and it has been repeated around the world. An extremely good book by economist and writer Philip Coggan, of The Economist, sets out just how dangerous it is. In “Paper Promises: Money, Debt and the New World Order”; a journalist from The Economist seriously suggests that this huge pile of debt created as money will lead to a wholly new monetary system.


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Bitcoin Will Bite the Dust

by Kevin Dowd November 18th, 2014 2:33 pm

At the 32nd Annual Monetary Conference on November 14, 2014, I presented my paper "Bitcoin Will Bite the Dust", which was co-written with Martin Hutchinson. Below is the transcript of my talk and PowerPoint slides. I welcome your comments. A video of the panel is available on Cato's website (my talk starts at minute mark 7:30).

The PowerPoint slides to accompany the talk are here.

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[Slide 1]. Good morning everyone. Bitcoin is the most radical innovation in the monetary space for a long time: an entirely private system that runs itself and does not depend on trust in any central authority. Instead, it relies on distributed trust – trust in the network – to maintain the integrity of the system. We can well understand the attractions of such a system – a tamper proof money supply, no monetary discretion, no QE, no central bank.

There is only one small problem: despite its success to date, Bitcoin is not sustainable. This means it will collapse. What cannot go on, will stop.

Let’s go back to basics. As a first pass, compare Bitcoin to the stone money in Milton Friedman’s case study. In this story, the people of the island of Yap in Micronesia used large round limestone disks as money. These were too heavy to move, so when ownership was to be transferred, the owner would publicly announce the change in ownership. The stone would remain where it was and the islanders would maintain a collective memory of the ownership history of the stones.

Similarly, in Bitcoin, the record of all transactions, the blockchain, is also public knowledge. Both the stone money and Bitcoin share a critical feature: both operate via a decentralized collective memory.

[Slide 2]. Bitcoin is a type of e-cash system in which there is no central body to authorize transactions; instead, these tasks are carried out collectively by the network. The network verifies transactions through competition between individual bitcoin ‘miners’ seeking rewards in the form of new bitcoins. It is this competition that maintains the integrity of the system. This takes us to Bitcoin’s value proposition.

[Slide 3]. The first point is that the system does not depend on trust on any one body to keep its promises; instead, the only trust required is distributed trust. The second point is that it has no single point of failure: it cannot be brought down by knocking out any particular entity. The third point is a high degree of anonymity. This has enabled some bitcoiners to operate outside of government control. Bitcoin is a dream come true for anarchists, criminals and proponents of private money. The fourth pillar of the value proposition is security against tampering: this comes from the incentive-compatibility built into the system. Underlying that, security comes from the Bitcoin protocol, the Constitution of the system. These features ensure that players play by the rules and that bitcoins are not over-issued.

[Slide 4]. Unfortunately, there is a fundamental contradiction at the heart of the system. The problem is that it requires atomistic competition on the part of the miners who validate transactions blocks. However, the mining industry is characterized by large economies of scale. In fact, these economies of scale are so large that the industry is a natural monopoly. The problem is that atomistic competition and a natural monopoly are inconsistent: the inbuilt centralization tendencies of the natural monopoly mean that mining firms will become bigger and bigger – and eventually produce an actual monopoly.

There are not one but two reasons to see mining as a natural monopoly. The first is based on risk aversion. If two miners merge their operations, they get the same expected return as if they mined on their own, but they obtain a return with a higher probability. If miners are risk averse, they are better off by pooling and sharing their profits. But if it makes sense for any two individual miners to pool, it makes sense for any two groups of miners to pool. The limiting case is then one big mining pool, a monopoly.

The second reason for a natural monopoly is even stronger: the negative externalities of competitive mining. The expected marginal benefit from mining depends on the amount of hash power expected by an individual miner, but the difficulty of mining depends on the hash power expended across the network. Individual miners do not take into account the negative cost externalities that their own activities impose on other miners. We then get an equilibrium in which excessive resources are devoted to mining activities: there is excessive use of bandwidth, excessive use of energy and excessive investment in computing resources. In the early days, a home PC could produce hundreds of bitcoins a day; now, a state of the art mining machine can expect to mine only a fraction of a bitcoin a day. We estimate that the energy power devoted to bitcoin mining has increased by a factor of at least 10 billion. Most of this is pure waste as the system could be maintained on a single server. A single operator could avoid most of this waste.

The implications of these centralizing tendencies are totally destructive of the Bitcoin system. They destroy every single element of its value proposition: one by one, the dominos fall down.

[Slide 5]. The first casualty is decentralized trust. Once the individual miners coalesce into a dominant player, then that entity has control over the system: it decides which transactions are to be deemed valid, and which are not. We then have to trust that entity not to abuse its position and are back to the trust model that Bitcoin had tried to escape from.

Going back to our island of stone money, imagine if everyone woke up one morning unable to remember who owned which stones. However, one individual still claims that he can remember and helpfully offers to remember for everyone else. One wonders how well that would work!

By this point, the dominant player has taken control over the system: it becomes the monarch – albeit, a constitutional monarch still constrained by the Bitcoin protocol. Once that dominant player emerges, it also becomes a point of failure of the whole system: one can bring down the system by taking him out. One could imagine Uncle Sam being very interested: if he wanted, he could now take Bitcoin down and stop all that money flowing to the bad guys he is after.

The next casualty is anonymity. A dominant player cannot possibly operate in a clandestine manner beyond the knowledge of law enforcement. And if it cannot operate anonymously, then it cannot escape government regulation. Anonymity would then disappear. The likelihood is that the government would destroy anonymity at a stroke by requiring that the dominant player insist that users register themselves by providing photo ID, social security numbers and proof of address.

It would also become clear that the system no longer assures incentive compatibility. In fact, it never did: it’s just that the system’s incentive compatibility weaknesses took time to become clear.

The last domino to fall would be the Bitcoin protocol. The protocol no longer provides any discipline on the system, because the dominant player can rewrite it at will. At some point the temptation to tamper with it would be too much to resist. Just a like a modern central bank, it would start throwing out bits of the protocol it didn’t like – like the bits that constrain over-issue of bitcoins. The Bitcoin monarchy would then become an absolute monarchy - assuming that there was anyone else left in the system by then.

The question crying out for an answer is why users of bitcoin would continue to have any confidence in the system when every single element of its value proposition had been kicked down. The obvious answer: they wouldn’t.

Remember also that the willingness of any individual to accept bitcoin is entirely dependent on his or her confidence that other people will continue to accept it. There is nothing in the system to anchor the value of bitcoins because bitcoins have no alternative use-value. They are not like gold or tulips.

Nor is there any rational reason to trust in the dominant player to behave itself. Trust comes from credible assurances – it comes from credible precommitment, a willingness to post performance bonds and to submit to account. There is simply no way that a shadowy dominant mining pool can provide such assurances. I doubt it would be willing to anyway.

The most prominent mining pool is GHash.IO. Here is a snapshot from its homepage [Slide 6].

The page announces that GHash is the number 1 mining pool, is trusted by 300k users, and dates all the way back to late 2013(!). We don’t know for sure who is behind it or where it is based. What we do know is that it has a logo that looks like the hammer and sickle and it has a bad rep. It pointedly refuses to adhere to the principles of high-level Bitcoin idealism that the other players adhere to. It has also been associated with a double-spend attack on a gambling website last year. Very reassuring.

Now this might just be coincidence: GHash also shares its name with a character in the film Ghostbusters. Here is a picture [Slide 7].

Cute critter, eh? In the film, Ghash is a power-obsessed poltergeist who pulls other ghosts into a massive mouth in his torso. Once swallowed up, they are drained of their powers until there is nothing left. Meanwhile, Ghash gets bigger and more powerful. By the time the ghostbusters encounter him, he had become too powerful to control: he was able to shoot beams from his eyes, pull up floorboards, disarm the ghostbusters and throw them around at will. Perhaps GHash is a spectral entity in more ways than one!

John Pierpont Morgan once said that the essence of banking is character. Someone I do not trust would not get any money from me on all the bonds in Christendom, he said. We don’t see much of that character here! If you really trust such an outfit with your wealth, we have a bridge to sell you. In any case, there is no reason to want to trust such an entity when you can use reputable systems such as PayPal instead.

[Slide 8].Anyway, return to the main storyline: The whole Bitcoin system eventually becomes a house of cards: there is nothing within the system to maintain confidence in the system, and anything – a scandal, a government attack, whatever – could trigger a loss of confidence leading to a run that brings down the entire system. The rational decision is to sell before that happens. If enough individuals think the same way – and why shouldn’t they? – their expectations will become self-fulfilling: there will be a stampede for the exit, the price of bitcoin will drop to its intrinsic value – zero – and the system will collapse. Only question is when. With the specter of GHash hovering over the system, our guess is soon.

Now I dare say our message is a disappointment to Bitcoiners. I share that disappointment: it would have been great if Bitcoin could displace government money. However, Bitcoin is an experiment, most experiments fail – and Bitcoin is another failed experiment. I don’t wish it so, but that is the way it is. We make this prediction before the event: if we are wrong, we will eat humble pie afterwards. But we don’t think so.

There is also the Bitcoiner lunatic fringe. Their response to even the mildest criticism is to foam at the mouth and hurl abuse at wicked Disbelievers. To them we say: OH DO GROW UP! And if you won’t listen to us, take Voltaire’s advice: “To succeed in life it is not enough to be stupid. You must also have good manners.”

In the meantime, Bitcoin is a sell. Thank you.


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Hayekian Musings of a Gold-Standard Pessimist

by George Selgin November 17th, 2014 10:44 am

I reckon myself a fan of the classical (pre-WWI) gold standard, considering it to have been the best monetary arrangement ever, and a far better one than the various supposedly scientific alternatives seen since. I also bristle at misinformed criticisms of that standard, including the very popular claim that it, rather than the machinations of central bankers bent on severing the normal connection between gold flows and money supply adjustments, was responsible for the Great Depression.

I'm convinced, furthermore, that there is a strong positive relation between the smugness with which an economists dismisses the gold standard (and all having anything nice to say about such) and the likelihood that that economist knows nothing at all about the subject. Evidence of this happened to come across my desk just yesterday, when I found myself obliged to real a stack of papers about Bitcoin. Although they were all perfectly lousy, the one that earned pride of place for dishing-out the single most idiotic bit of disinformation did so by declaring, in the course of a brief (and entirely erroneous) review of the gold standard's shortcomings, that the former connection between the U.S. dollar and gold rested upon gold reserves held at Fort Knox! (The writer, by the way, is a chaired professor at a leading U.S. business school, who holds a Harvard Ph.D. in "business economics.")

But while I'm for barring no holds when it comes to defending the old gold standard against unthinking critics, and even some thinking ones, I've never been one to rest my hopes for monetary reform upon the prospect of its revival. I have a number of reasons for not doing so, including my fear that such a revival, if it could be accomplished at all, could prove extremely disruptive, as well as my belief that to be worth having a revived gold standard would have to be no less international in scope as the original, making gold a poor basis for any unilateral reform. But my main reason consists of my belief that the legal foundations of the historical gold standard may themselves prove impossible to recover. The paper I wrote for this year's Cato Monetary Conference on "Law, Legislation, and the Gold Standard," spells out this last source of my doubts in some detail.

If anyone, having read the paper, thinks he or she can restore my hopes for gold, I am all ears.

Postscript: For some reason SSRN is being stubborn about letting people download my paper using the link supplied. If you find that that's so in your case, just google the paper title and my name, and the appropriate SSRN page with top the results list. You should be able to download the paper without trouble by clicking on that result.


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For your reading

by Kurt Schuler November 12th, 2014 10:54 pm

The Federal Reserve Bank of Richmond's Econ Focus interviewed Richard Timberlake earlier this year and somehow I missed it, (Here is George Selgin's post on Dick's book Constitutional Money and here is my appreciation of Dick on his 90th birthday, two years ago.) The first question and part of Dick's answer to it follow.

EF: Let’s start with a unifying theme of your work: Your support of a gold standard. Several great neoclassical monetary theorists — Marshall, Walras, Wicksell, Fisher, and Keynes — argued that a rules-based fiat money could outperform a gold standard. Why do you disagree?

Timberlake: Let me say first of all that I am not a “gold bug.” Nonetheless, the fact is that an operational gold standard works to promote a free society, and no other monetary policy seems able to do so.

The key word in your question is “could.” But the policymakers won’t allow it to. The reason they won’t is found in public choice economics, which argues that the policymakers, like all other human beings, have a stronger motive to further their own self-interest than to promote sound public policy — not only at the Fed, but everywhere.

And now for something much different. If, like me, you are interested in free banking as a subset of the wider phenomenon of voluntary exchange, you may derive some instruction from these anthropological works:

Keith Hart (London School of Economics and University of Pretoria) and Horacio Ortiz (Centre de sociologie de l’innovation, Paris), The anthropology of money and finance: from ethnography to world history (essay).

Charles J. Opitz, An Ethnographic Study of Traditional Money (a book that catalogs hundreds of different forms that money has taken; the result of the author's years of work collecting many of them).


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Mammom Dearest

by George Selgin November 12th, 2014 12:45 pm

(This past weekend I took part in a Liberty Fund conference having as its main topic David Graeber's Debt: the First 5000 Years (Melville House, 2011), but also addressing parts of Felix Martin's Money: The Unauthorized Biography (Knopf, 2014). Although Martin is an economist and Graeber an anthropologist, the two works have much in common, including their authors' general contempt for what Martin refers to as "Adam Smith and his school," meaning just about every economist who has ever had anything nice to say about either money or free markets.

It so happens that a review I'd written of Martin's work appeared, in somewhat abbreviated form and minus the title I'd given it, in Barron's (together with Larry White's review of Jim Grant's The Forgotten Depression and a review of a book about football that almost certainly got the the most attention) a week prior to the Liberty Fund event. Here, by kind permission of Barron's Gene Epstein, is the original version. By way of further comment I will say only that, as bad as I think Martin's book is, Graeber's is even worse--so much so that I am seriously contemplating having an intern here at Cato compile a list of scholars--and economists especially--who have praised it, so that I might make a mental note to never again take any of their recommendations or criticisms seriously.)

*****

The aftermath of the worst financial crisis since the Great Depression is a good time for taking a hard look at money, that most basic of all financial institutions atop which all the rest teeter. As his book’s subtitle suggests, Felix Martin, having taken such a look, reports, not with a flattering portrait, but with a warts-and-all unmasking.

Mr. Martin’s good prose and eye for money’s naughtier antics help to equip him for his task. Nor is he short of tales to tell, about money’s little prank of masquerading as stone wheels in the western Pacific, its domestication by Greek kings, its adolescent kidnapping by crafty private bankers, its disastrous fling with John Law, and, finally, its post-2001 binge. Mr. Martin relates them all, and many others, with élan.

But in his eagerness to reveal truths to which others have been blind, Mr. Martin ends up exposing, not so much money’s mysteries as his own incomprehension of it. He goes astray, first of all, in assuming that, because credit rather than barter came before money, money consists, not of any physical stuff, but solely of a more-or-less elaborate system of IOUs. But while simple societies may track and settle debts in many different ways, among relative strangers and throughout most of history monetary promises have been promises to pay some particular stuff, whether tobacco, metal discs, or engraved paper strips.

The distinction between monetary promises and the stuff promised is, admittedly, often muddied, as it was when Great Britain’s pound sterling ceased to refer to any actual coin (gold guineas having been worth a bit more than £1), and when modern central banks turned their paper promises to pay gold into what one former New York Fed President dubbed “IOU nothings.” But the fact that a Federal Reserve note is no longer a promise to pay anything doesn’t make the dollar an “arbitrary increment on an abstract value scale” or “a unit of abstract, universally applicable economic value.” When a diner sells me bacon and eggs for $4.99, that doesn’t mean that bacon and eggs are worth $4.99, “universally” or otherwise. It means that to the diner they are worth less, and to me, more.

Mr. Martin’s understanding of what economists have had to say about money is still more inadequate. With the phrase “Adam Smith and his school,” he lumps together every thinker from John Locke and Bernard Mandeville to Friedrich Hayek, throwing some later mathematical economists in for good measure, and excepting only John Law, Walter Bagehot, and John Maynard Keynes. He then attributes to this homogenized mass “a vision of society in which economic value had become the measure of all things” together with a blindness to the “debt and financial instability” to which this crass vision leads. Horse feathers. The monetary theories of John Locke (Martin’s unlikely heavy) didn’t particularly impress Smith, though Locke’s mercantilism did—unfavorably; and far from sharing Mandeville’s identification of narrow self-interest (“private vices”) with public virtue, Smith condemned it as “pernicious.” No one aware of the English currency controversies that raged for decades after the Panic of 1825 could possibly hold English economists oblivious to financial turmoil. Finally (to cut a long list short), in saying that the Bank of England should serve as a lender of last resort, Bagehot was taking issue, not with his fellow economists, but with the Bank’s short-sighted Directors.

If Mr. Martin’s knowledge of the history of economics is less than reassuring, his choice of economic good guys, Bagehot apart, is downright scary. He has soft spots for the ancient Spartans, who (according to him) wisely chose to dispense with money and all the “impersonal and inhumane relations its use entailed,” and for Lenin and his crew, who tried unsuccessfully to do the same. Another of Martin’s heroes is John Law, the Scottish “projector” whose “System,” implemented in France in 1720, was, according to Martin, “ingenious, innovative, and centuries ahead of its time.” Just shy of three centuries, one is tempted to elaborate. (Law’s “system” collapsed, catastrophically, in 1721.)

That a jaundiced view of both money and most expert thinking about it shouldn’t lead to any novel proposal for its reform isn’t surprising. Stopping shy of suggesting another stab at Sparta’s convivial solution, Mr. Martin instead endorses the old-hat idea of making commercial banks keep reserves (of “abstract units,” presumably) equal to their readily transferable liabilities. To be free of the bathwater of financial crises we must, in other words, give old-fashioned banking the old heave-ho.

A proper respect for the crucial role bank loans play in promoting economic growth—in industrialized countries still, but especially in developing ones—combined with a glance beyond the limited experience of a few countries ought to suffice to make anyone think twice about such a Procrustean (if lately de rigueur) remedy: Canada, for instance, which has a very highly developed banking system (and one that has, since 1987, been utterly-free of Glass-Steagall-like regulations separating commercial from investment banking) experienced neither bank failures nor insolvent-bank bailouts during the recent crisis; indeed it has had an almost uninterrupted record of financial stability since the mid-19th century. Scotland long boasted a similar record, with no central bank to look to for bailouts, and very little bank regulation of any kind, until English currency laws were thoughtlessly imposed upon it in 1845.

It happens that Adam Smith supplied an especially eloquent account of the workings and advantages of Scotland’s once brilliant fractional-reserve banking system as he witnessed it in its formative years. That account can be found in Book II, chapter 2 of The Wealth of Nations. Alas, so far as Mr. Martin is concerned, Smith’s real thoughts about money might as well be among the very deepest of its secrets.


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Phil Crane and Gold

by Bradley Jansen November 11th, 2014 1:18 pm

Former US Representative Phil Crane passed away this weekend.  Readers of this blog should remember him as the author of the legislation to re-legalize monetary gold ownership in 1974.

Richard Viguerie's Conservative HQ writes:

In the 1960s and 70s Phil Crane, along with Bob Dornan, Dr. Ron Paul, John Ashbrook, senators Jesse Helms and Strom Thurmond were among the leaders of the conservative movement who challenged not only the Democrats, but the Republican establishment as well. . .

Although his legislative record was one of principled conservatism – over his long career, he got a 99 percent rating from the American Conservative Union – and he authored the 1974 legislation permitting the private ownership of gold, these things are again, somewhat forgotten, but the Republican Study Committee he founded lives on to affect legislation and what happens on Capitol Hill every day.

David L. Ganz in his book "The Essential Guide to Investing in Precious Metals: How to begin, build and maintain a properly diversified portfolio" related the short history of how Rep. Crane was able to reverse the ban on gold and move us towards monetary freedom (p. 65):

Starting in the early 1970s, a group of "gold bugs" began to advocate private gold ownership rights and eventually, they found the ear of some congressmen and senators who bought into their fairness theory and the claimed illegality of the gold seizures and recalls of the 1930s.

In a truly bizarre episode, they tacked a resolution allowing for private gold ownership onto the foreign aid package that the Nixon Administration wanted.  Presidential vetoes were threatened and an alarmist attitude prevailed at the Main Treasury building.

The foreign aid bill with its non-germane gold ownership clause finally made it to a vote in which conservative members such as Rep. Phil Crane, R-Ill., and others voted with liberal Democrats.  Crane said to me later it was the only foreign aid bill that he voted for in his 35-year congressional career.

His rationale: it was more important to get private gold ownership than argue the vagaries of a single year's foreign aid package.

Congressman Ron Paul's Freedom Under Siege similarly credits Congressman Phil Crane and explains a bit more about the general context with Howard Segermark and Sen. Jesse Helms re-legalizing gold clause contracts.

Bruce Bartlett, like me a former staffer for Rep. Ron Paul, shares the story that Congressman Phil Crane shared with him about his visit to Ft. Knox and inspection of the gold there on his blog here.

Although not yet old enough to vote, I supported Congressman Crane in his 1980 presidential run (losing, of course, to Ronald Reagan) and was a big fan of his.  Soon after I started working as the monetary policy staffer of Congressman Paul in 1997, I met the chief of staff, I think it was, for Congressman Crane.  I told him I was a big fan and brought up the gold issue with him.  He told me that he and his boss still favored a return to a gold standard and lamented that so few were interested in these issues anymore.

I'm glad Phil Crane lived long enough to see a rebirth in interest in gold and monetary alternatives and a growing skepticism towards the Federal Reserve.


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Keynes to FDR: Forget Quantitative Easing

by George Selgin November 4th, 2014 10:08 am

From Keynes' "Open Letter to President Roosevelt," published December 16, 1933:

"Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor."

This near the very bottom of the Great Depression. Perhaps Keynes was wrong then. But is there not a strong case to be made, nevertheless, that the recent rounds of QE were, what with all that heaping-up of excess reserves, just so much unhelpful belt-loosening?

What say ye, my Market Monetarist friends?


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Fed needs to stop asset acquisitions for a generation or so

by Walker Todd October 29th, 2014 8:10 pm

The Federal Open Market Committee (FOMC) meeting that ended today (Oct. 29) marked the first chance for the FOMC finally to do the right thing since the onset of the great financial crisis in the late summer of 2008. That right thing consists of resolving not to add even another dollar to the Federal Reserve System's balance sheet for at least the next ten years (and perhaps as long as 30 years) in the absence of officially declared war or national emergency. Thankfully, on an 11-1 vote, the FOMC finally adopted the initial step in that policy direction, agreeing not to make significant additions to the System's securities portfolio, for the time being.

The great financial historian Charles P. Kindleberger (1910-2003), who taught at Massachusetts Institute of Technology throughout the postwar years, was struck by what he perceived as the tension between generally Keynesian monetary policy (ignoring quantities of money and focusing instead on interest rates and unemployment rates) and generally monetarist monetary policy (giving great importance to measurement of quantities of money, tax policy, and sustainable economic growth, with the market sorting out interest rates and unemployment rates). In his Keynesianism vs. Monetarism and Other Essays in Financial History (1985), Kindleberger wrote, essentially, that long periods can pass when Keynesian policies may be pursued with benefit or at least without noticeable harm but that, when the cycles turn and the monetarist policy becomes appropriate, the monetarist approach is "so very timely." Here, reference to monetarist approaches should be understood to be attention to the quantity theory of money: Many Austrian-school economists and even some traditional Keynesians care about and pay attention to the quantity of money.

Thus, the FOMC majority could have concluded today that a Keynesian approach to the financial crisis had a nice, nearly seven-year run but that, with clear statistical evidence of diminishing benefit from the Fed's experiment in expanding reserves to levels well in excess of anything that Kindleberger would have considered wise, it is time to stop. From here on out, probably for ten years or longer (perhaps up to 30 years), the FOMC should pursue monetarist approaches to policy in which, for every dollar of assets added to the System's portfolio, another dollar is sold from that portfolio, even during emergency periods, and in which maturing assets are not replaced, with net shrinkage of the portfolio over time. The FOMC did not adopt this last policy step today, voting essentially to hold the size of the portfolio constant until further notice.

One cannot argue plausibly that necessary market liquidity would be reduced below sustainable levels by attention to the quantity of monetary base that the Fed creates. (Domestic monetary base = currency in circulation plus reserve balances held at the Fed; foreign exchange swap drawings in dollars, currently zero or near-zero, should be added to this amount to find total probable domestic claims against the Fed.) Currently, there are about $1.25 trillion of currency outstanding (with probably about 70 percent held outside our borders), plus about $2.7 trillion of reserve balances held at Reserve Banks. That is nearly $4 trillion of monetary base.

In 2007, the year before the crisis, a Fed balance sheet of "only" $929 billion sufficed to promote strong growth in a $14.5 trillion economy (nominal GDP). The Fed's balance sheet was only 6.3 percent of the entire economy. After countless interventions in the economy and a never-ending series of Quantitative Easings (econospeak for money-printing) since then, the Fed's balance sheet is nearly five times larger, but the economy is only 19.3 percent larger. The Fed's balance sheet is now 25.5 percent of GDP.

One supposes that it takes a lot more money to make the world go around these days, but the economic outcome is far smaller than one would have expected given the amount of monetary input. If the Fed has an econometric model showing how much GDP growth it expects from each new dollar of monetary input, it should disclose that model to Congress now, and if the outcomes are suboptimal or as demonstratively inefficient as I think they are, then Congress should make the Fed stop using that model to drive FOMC policy choices, if the Fed refuses to do so voluntarily.

The Fed courts a real danger of becoming, if it has not already become, the motor of a thoroughly corporatist political economy model for the United States, if not for the entire world. A central bank balance sheet equal to 25 to 50 percent of GDP was considered a hallmark of corporatism in developing economies that the World Bank was trying to reform in the post-1980 years. The Fed should be asked to tell Congress now, before the election next week, how great a percentage of GDP it wishes to hold on its balance sheet without seeking the approval of Congress.

Back to Kindleberger's point: When the time comes around for the monetarist message, it is important for central bankers to heed that message. It is, indeed, time to stop printing money (technically, this is a collaborative exercise involving both the Treasury and the Fed and, behind the scenes, both the White House and Congress).

The following facts are clear: As of mid-2014, the Fed had expanded its balance sheet by $3.483 trillion since August 2007 (375 percent), with nearly all of the increase occurring since the onset of the crisis in September 2008. However, nominal GDP expanded by only $2.850 trillion over the same period (19.3 percent). In other words, only 81.8 cents of new GDP were created for every dollar of Fed-Treasury money printing, an exercise of remarkable inefficiency considering that, for the eleven years before the crisis, 1997-2007, about $13.88 of new GDP were created for every new dollar of money printing. Money printing is an inefficient way of creating GDP, after the crisis, but it has proved to be an efficient way of creating asset price bubbles.

Finally, if one wished to reduce the Fed's role in the economy to the level that prevailed before the crisis, about 6.5 percent of GDP (the range was 5.9 to 6.9 percent over the preceding eleven years), the current size of the Fed's balance sheet would support economic expansion to nominal GDP of $67.9 trillion, about four times the current size of GDP. Historically, it took 15 years for GDP to quadruple, 1969-1984, and that period included the high-inflation 1970s. In a period of lower inflation, after 1984, it took 28 years for GDP to quadruple again in 2012. That is why I proposed, at the beginning of this note, that we simply suspend the monetary policy operations of the Fed for a generation or so until the rest of the economy catches up to all the monetary base that recent Fed operations have created.

We still need banking supervision for as long as we have non-gold fractional reserves, we need the payments mechanisms operated by the Fed, and someone has to buy all that debt that the Treasury has for sale. But it is not clear that the Fed is the entity that should do any or all of these things. On the other hand, we have a large infrastructure investment in the Fed, and we might choose to keep it operating to perform these other functions. Just not monetary policy, not for a good long while, anyway.


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Creativity and crackpots

by Kurt Schuler October 26th, 2014 11:18 pm

Isaac Asimov wrote an essay on creativity in 1959 that was only published recently.  His view is that “the person who is most likely to get new ideas is a person of good background in the field of interest and one who is unconventional in his habits. (To be a crackpot is not, however, enough in itself.)”

Monetary theory and policy have been fertile ground for crackpots (more commonly referred to as “monetary cranks”) from the beginning. Part of the attraction is that the field has some abstruse aspects. Another is that there is the appeal of seemingly getting something for nothing with the right policy, or, contrarily, the suspicion of being swindled by the powers that be.

Far be it from me to issue a blanket condemnation of monetary cranks, though. Some deserve the appellation “interesting fringe thinkers.” Though almost always wrong on the theory, sometimes they have been right on the policy when conventional opinion has been dead wrong! During deflations, schemes such as Silvio Gesell’s proposal for a currency that depreciates if not spent (which interested Keynes and Irving Fisher) offer workarounds for overly tight monetary policy and the consequent fall in velocity. During high inflations, pure gold or barter schemes offer workarounds for overly loose monetary policy.

(Scott Sumner has a recent post somewhat related to these ideas. On a point of personal privilege, though, he should know enough not to refer to Argentina’s monetary system of the 1990s as a currency board. Argentines called it the “convertibility” system. It was a quasi-currency board, with some but not all features of an orthodox currency board, and the distinction is important both in theory and in practice. Few people have looked at the evidence, but Scott should be one of them.)


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