Topic: Finance, Banking & Monetary Policy

Will Venezuela Be Next?

Last year, Nicholas Krus and I published a chapter, “World Hyperinflations”, in the Routledge Handbook of Major Events in Economic History. We documented 56 hyperinflations – cases in which monthly inflation rates exceeded 50% per month. Only seven of those hyperinflations have savaged Latin America (see the accompanying table).

At present, the world’s highest inflation resides in Latin America, namely in Venezuela. The Johns Hopkins – Cato Institute Troubled Currencies Project, which I direct, estimates that Venezuela’s implied annual inflation rate is 302%. Will Venezuela be the eighth country to join the Latin American Hall of Shame? Maybe. But, it has a long way to go.

The Hanke-Krus Hyperinflation Table
Latin American edition

Country Month With Highest Inflation Rate Highest Monthly Inflation Rate Equivalent Daily Inflation Rate Time Required for Prices to Double
1. Peru Aug. 1990 397% 5.49% 13.1 days
2. Nicaragua Mar. 1991 261% 4.37% 16.4 days
3. Argentina Jul. 1989 197% 3.69% 19.4 days
4. Bolivia Feb. 1985 183% 3.53% 20.3 days
5. Peru Sep. 1988 114% 2.57% 27.7 days
6. Chile Oct. 1973 87.6% 2.12% 33.5 days
7. Brazil Mar. 1990 82.4% 2.02% 35.1 days

Source: Steve H. Hanke and Nicholas Krus (2013), “World Hyperinflations”, in Randall Parker and Robert Whaples (eds.) Routledge Handbook of Major Events in Economic History, London: Routledge Publishing.

Bulgaria’s Currency Board versus Ukraine’s Chaos

When Communism inevitably and finally collapsed, Bulgaria’s economy was a basket case – behind almost all other communist basket cases, including Ukraine’s. Indeed, Bulgaria defaulted on its debt in 1990. By February 1991, Bulgaria had broken out in a bout of hyperinflation, with the inflation rate at 123% per month. And in February 1997, Bulgaria experienced the agonies of hyperinflation again, with the inflation rate reaching 242% per month. 

As he looked into the abyss, President Petar Stoyanov decided against taking the plunge and appointed me as his advisor in January 1997. I immediately prescribed a currency board system to put an end to Bulgaria’s malady, something I had laid out for Bulgaria back in 1991 (Steve H. Hanke and Kurt Schuler, Teeth for the Bulgarian Lev: A Currency Board Solution. Washington, D.C.: International Freedom Foundation, 1991.).

Bulgaria installed a currency board in July 1997. The lev was backed 100% by German marks and traded freely at a fixed rate of 1000 leva to 1 mark. Inflation and interest rates fell like stones. The economy stabilized, and the Bulgarians learned that, even though stability might not be everything, everything is nothing without stability. Discipline at last.

Yes, the main feature of a currency board is the fiscal and financial discipline that it provides. No more running to the central bank for a fiscal bailout. A currency board ties the hands of those meddlesome monetary authorities. And forget the silly theoretical and obscure arguments made by economists who don’t embrace fixed exchange rates. A currency board regime is all about discipline.

As we watch Ukraine melt down once again, we can see what could have been (and what could be) if Ukraine would have only embraced a system of discipline (read: currency board) – like Bulgaria did in 1997. The following table tells the tale:

Bulgaria versus Ukraine

Country

GDP per Capita (USD)

Fiscal Balances %GDP

Current Account Balances %GDP

General Govt. Gross Debt %GDP

Gross Borrowing Needs %GDP

Import Coverage Ratio (FX Reserves / Imports)

W.B. Ease of Doing Business 2014 Rank

Bulgaria

$7,623

-1.9%

1.5%

16.0%

2.6%

6.7

58

Ukraine

$4,011

-8.7%

-8.9%

42.8%

11.0%

1.9

112

Sources: Bulgarian National Bank, National Bank of Ukraine, J.P. Morgan (Emerging Markets Research), International Monetary Fund (IFS), World Bank (Doing Business). 

Prepared by Prof. Steve H. Hanke, The Johns Hopkins University.

Bank Tax Is Wrong “Fix” for Too-Big-To-Fail

Chair of the House Ways and Means Committee Dave Camp is soon to roll out a plan for comprehensive tax reform. He is to be commended for doing so. Our tax code is an absolute mess with incentives for all sorts of bad behavior. Early reports suggest, however, that Congressman Camp will also include a “bank tax” to both raise revenue and address the “Too-Big-To-Fail” (TBTF) status of our nation’s largest banks. While the evidence overwhelmingly suggests to me that TBTF is real, with extremely harmful effects on our financial system, I fear Camp’s approach will actually make the problem worse, increasing the market perception that some entities will be rescued by the federal government.

Bloomberg reports the plan would raise “would raise $86.4 billion for the U.S. government over the next decade…would likely affect JPMorgan Chase & Co, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley.” The proposal would do so by assessing a 3.5 basis-point tax on assets exceeding $500 billion.

While standard Pigouvian welfare analysis would recommend a tax to internalize any negatives externalities, TBTF is not like pollution, it isn’t something large banks create. It is something the government creates by coming to their rescue. I don’t see TBTF as a switch, but rather a dial between 100 percent chance of a rescue and zero. By turning the banks into a revenue stream for the federal government, we would likely move that dial closer to 100 percent–and that is in the wrong direction. For the same reason, I have opposed efforts to tax Fannie Mae and Freddie Mac in the past. The solution is not to bind large financial institutions and the government closer together, as a bank tax would, but to further separate government and the financial sector. Just over a year ago, I laid out a path for doing so in National Review. Were we to truly end bailouts, limiting government is the only way to get that dial close to zero.   

If we want to use the tax code to reduce the harm of financial crises, then we should focus on reducing the preferences for debt over equity, which drive so much of the leverage in our financial system.  I’ve suggest such here in more detail. There are also early reports that Camp’s plan will reduce some of these debt preferences. Let’s hope those remain in the plan.

Fannie and Freddie Offset Reported Government Spending

The federal government took control of mortgage giants Fannie Mae and Freddie Mac (F&F) in 2008 and have bailed them out with $189 billion of taxpayer money.

Today the mortgage companies have returned to profitability and are paying the government dividends. All profits earned by the companies since August 2012 are going to the federal government, as discussed by the CRS and the Washington Post.

How large are the F&F dividends? You can find out from a number of data sources:

  • FHFA (Table 2) shows that Fannie has paid a cumulative $114 billion in dividends to the government, while Freddie has paid $71 billion.
  • FHFA data show that F&F together paid $131 billion in dividends in calendar 2013, which matches what BEA Table 3.2 shows for federal “income receipts from assets” (dividend portion).
  • CBO (p. 101) says that F&F dividends received by the government were $97 billion in fiscal 2013 and will be $81 billion in fiscal 2014. Curiously, the CBO does not report how large future dividends are expected to be because they account for F&F going forward based on a net subsidy approach.

Here is the important thing for budget wonks and reporters: the money now pouring into the Treasury from F&F is not counted as “revenues” but as “offsetting receipts.” Those receipts are subtracted from federal spending before the “net outlays” reported by CBO and OMB, which people may wrongly assume is total federal spending.

Thus the government was reported to have spent $3.5 trillion in fiscal 2013, but without the F&F offset spending was $3.6 trillion. It is a similar story in 2014. And without the F&F dividends, federal deficits would be about $100 billion a year greater than reported.

Looking ahead, a fear is that with the return to profitability of F&F, politicians will get hooked on the inflows of cash, particularly since it has the magical effect of reducing reported spending. Reformers should press on with privatization and severing government ties to the mortgage companies as soon as possible.

A further discussion of offsetting receipts is here. Mark Calabria discusses F&F here and here.

Friedman and Hanke on Bitcoin

In 2008, Bitcoin was mysteriously introduced to the world in an obscure, technical paper written under the pseudonym Satoshi Nakamoto. By late 2013, the financial press was filled with reportage on Bitcoin and its dramatic price increase.

Well ahead of Satoshi Nakamoto, Nobelist Milton Friedman, champion of free market economics and noted expert on money and banking, anticipated the coming of digital currencies, and foresaw the potential impacts that they would have on finance and economics.

In a 1999 interview, Prof. Friedman concluded:

I think that the Internet is going to be one of the major forces for reducing the role of government. The one thing that’s missing, but that will soon be developed, is a reliable e-cash, a method whereby on the Internet you can transfer funds from A to B without A knowing B or B knowing A. The way I can take a $20 bill hand it over to you and then there’s no record of where it came from.

You may get that without knowing who I am. That kind of thing will develop on the Internet and that will make it even easier for people using the Internet. Of course, it has its negative side. It means the gangsters, the people who are engaged in illegal transactions, will also have an easier way to carry on their business.

Prof. Friedman’s anticipation of Bitcoin is truly remarkable. He even understood the concept well enough to anticipate something like the Silk Road scandal involving illegal Bitcoin transactions.

In April 2013, Nathaniel Popper of The New York Times reported on Bitcoin in an article titled “Digital Money is Gaining Champions in the Real World”. In his reportage, Popper asked me if I thought Bitcoin had the makings of a speculative mania like the 17th century Dutch tulip bulb frenzy. My response was clear and unambiguous: “To say highly speculative would be the understatement of the century.”

Subsequently, the price action in Bitcoin confirms my diagnosis (see the following chart). In January 2013, one could buy a Bitcoin for about $13. By late November, one Bitcoin would have set a buyer back over $1100. And what about Bitcoin’s price volatility? As shown in the chart, Bitcoin’s volatility is truly fantastic.

While the price currently fluctuates around $600, Bitcoin remains far from secure. Serious discrepancies in price exist even between exchanges. For example, the price of a Bitcoin on the Mt. Gox exchange has fallen by over 50% in the past week, while the price of the exact same Bitcoin on the BitStamp exchange has fallen by only 3% in the same time period.

Jared Bernstein’s “Tax Reform” Assault on Pensions, IRAs and 401(k)s

The bad habit of defining “tax reform” in terms of fairness or “closing loopholes” sidesteps the most essential task of effective tax policy – namely, to collect taxes in ways that do the least possible damage to incentives for productive effort, investment and entrepreneurship.

The Joint Committee on Taxation list of “tax expenditures” is arbitrary accounting, not economics, and tax expenditures are not necessarily “loopholes.” These estimates do not take taxpayer behavior into account and therefore do not estimate revenues that could be raised by closing the so-called loopholes (e.g., a higher tax on capital gains would shrink asset sales and revenues). Policies that make sense in terms of economic incentives can therefore be portrayed as useless tax subsidies in the purely static accounting of “tax expenditures.”

For example, a recent New York Times article by former vice presidential adviser Jared Bernstein complains that tax deferral for retirement savings is unfair because, “most savings subsidies go to households that would surely save anyway, while almost nothing goes to the households that need help to save.” 

These “subsidies” for high-bracket taxpayers mainly consist of deferring rather than avoiding taxes, which only partly offsets the way savings are double-taxed. Even if higher-income households would actually save the same without 401(k) accounts (which contradicts research), they would still end up with much smaller retirement savings. Dividends and capital gains would then be repeatedly taxed, year after year, rather than being continually reinvested within a tax-deferred pension, IRA or 401(k) account. 

Estimated “subsidies” from tax deferral are deceptive: Instead of having recent dividends and capital gains taxed at a 15-20 percent rate in recent years, distributions from tax-deferred accounts will later be taxed at rates up to 39.6 percent. It’s a subsidy only if you don’t live much past 70.

Bernstein presents a graph showing the top 20 percent getting a 66 percent share of these “subsidies” for pensions and defined-contribution plans while the middle fifth gets only nine percent and the poorest 20 percent just two percent. What these figures actually demonstrate is that (1) people who work full-time for many years have more income to save than those who don’t, and that (2) people who pay no income tax cannot benefit from any policy that reduces taxable income, even temporarily.

There are five times as many workers in the top 20 percent than there are in the bottom 20 percent. To exclude young singles and old retirees, Gerald Mayer examined the work experience of households headed by someone between the working ages of 22 and 62. Average work hours among the poorest 20 percent still amounted to just 1,415 hours a year in 2010, while those in the middle fifth worked 2,771 hours, and the top 20 percent worked 4060 hours.

If Bernstein’s “subsidies” were properly expressed as shares of income, rather than as shares of foregone tax revenue, the differences nearly vanish. The Congressional Budget Office (the undisclosed source of his estimates) shows tax benefits for retirement savings worth only about twice as much to the top 20 percent (2 percent of net income) as to the middle 20 percent (0.9 percent of income). Retirement savings incentives appear to be worth only 0.4 percent of income to the poorest 20 percent, since they rarely owe taxes, yet annual benefits are a poor guide to lifetime benefits. Those in low income groups while they are young commonly move up to higher tax brackets by the time they start saving for retirement.

The alleged unfairness of lower-income households not getting the same dollar tax break as couples earning more than $115,100 (the top 20 percent) could be alleviated by reducing marginal tax rates on two-earner families. But Bernstein instead suggests “closing loopholes that make it easy for wealthy individuals to exceed contribution limits to tax-preferred accounts (as was found to be the case with Mitt Romney), reducing contribution limits for high-income filers, or simple limiting the value of tax breaks for the wealthiest of filers (e.g. allowing them to deduct such contributions at 28 percent instead of 39.6 percent.” None of these schemes would add a dime to the savings of low or middle-income households, of course, and they wouldn’t work.

It is not legal – and therefore not “easy”– to exceed strict contribution limits for high-income taxpayers, and Mitt Romney certainly did not do so.  What Romney did was to roll over qualified retirement plans into an IRA and then earn high compounded returns on very successful investments.  Similarly, albeit on a much smaller scale, I rolled-over a lump-sum pension into an IRA in 1990 when I changed jobs, and that IRA is now 12-times larger thanks to compound interest and bold investments.  Since I never contributed another dollar after 1990, tougher or lower contribution limits would have been entirely irrelevant.  

Bernstein’s final proposal is from the Obama budget – “allowing taxpayers to deduct contributions at 28 percent instead of 38.6 percent.” But that too is irrelevant. Any alleged “loopholes” for retirement savings have nothing to do with itemized deductions for top-bracket taxpayers, who are not allowed to deduct contributions to an IRA.  Failure to include employer contributions as taxable income is not an itemized deduction to begin with, nor is the exclusion from adjusted gross income for contributions to a Keogh retirement plan for the self-employed.  

In the process of giving “tax reform” a bad name, Jared Bernstein uses a sham fairness argument to justify arbitrary and unworkable anti-affluence policies that are irrelevant to any ill-defined problems. 

 

 

 

 

 

 

The Federal Reserve’s “Foreign Banking Organization” Rule Is Unnecessary

Last November, Arthur Long and I released a policy study on the likely impact of the Federal Reserve’s 2012 “Foreign Banking Organization” proposal.

We argued – along with many others – that the proposal amounted to little more than a costly corporate reshuffling exercise. Of even greater concern, we suggested that the proposal threatened the ability of global banks to allocate capital and liquidity in an efficient manner, would increase financial instability, and dampen economic growth.

Yesterday, the Federal Reserve released a final rule that is essentially the same as the original proposal. The final rule is more lenient only in the sense that it increases the timeframe for compliance, simplifies the leverage requirements a little, and impacts fewer organizations. To that end, the fundamental criticisms still apply, as does the confusion around why such a proposal is necessary.

Governor Tarullo – a leading proponent of the rule – has argued that the Federal Reserve extended financial “support” to foreign banks at unprecedented levels during the crisis and therefore should be given greater oversight of these banks’ activities. That sounds reasonable. But upon closer review, the support he refers to was limited to liquidity provided through the Fed’s discount window. Foreign banks were not eligible to receive TARP or other forms of bailout assistance.

Fed officials have gone to great lengths to argue that providing liquidity through the discount window (which may be provided only to otherwise solvent institutions on a fully collateralized basis) is a legitimate central bank function and is NOT financial assistance constituting a bailout.

I agree (although on this point, I note that I depart quite radically from some of my contemporaries). However, this argument does undermine the central pillar supporting the Fed’s new rule. In addition, if protecting U.S. taxpayers is the fundamental aim, why implement a rule that will close-off the channels of liquidity and support that the U.S. subsidiary could receive from the foreign parent? 

The Fed’s rule may well spark retaliatory actions from foreign regulators, who are even more annoyed about it than the banks they oversee. The losers will be both local and foreign banks and, most importantly, consumers of credit. Governor Tarullo himself noted during yesterday’s open meeting that the rule “may not strike the right balance indefinitely.” The Fed had an opportunity to lead from the front. That it failed to do so is unfortunate.