Topic: Finance, Banking & Monetary Policy

Bob Murphy on Free Banking in Canada

A few months after my April 2018 Soho debate with him concerning whether fractional reserve banking is damaging to an economy’s health, Bob Murphy gave a lecture on “Rothbardians vs. ‘Free Bankers’ on Fractional Reserve Banking.”

Bob devotes a substantial chunk of that lecture to elaborating upon what he considers shortcomings of my particular arguments in favor of free banking. Though he is generous enough to allow that my theoretical arguments are not quite a cinch to refute, he thinks rather less of the empirical evidence I offer in support of those arguments. In particular, he calls the evidence supporting my claim that the Scottish and the Canadian free banking systems were quite stable “very weak.”

So far as the Scottish episode is concerned, Bob’s claim rests mainly on the fact that, between 1797 and 1821, Scottish banks followed the Bank of England’s example, though without the statutory permission Parliament had granted it, of temporarily “restricting” specie payments. So far as he’s concerned, their having done so is ipso-facto proof of their having run roughshod over their creditors’ rights and reduced their welfare. In truth the story of the Scottish bank restriction, and the correct lessons to be drawn from it, are far less straightforward than Bob supposes. Having already devoted three longish posts to explaining what happened (here, here, and here), I leave it to my readers to decide whether the evidence I assemble in those posts suffices to exonerate the Scottish bankers, as I believe to be the case. I also continue to look forward to Bob’s own response to that evidence.

Efficient “Central Bank Digital Currency” Is a Fantasy

In January I had the pleasure of participating on a panel on “The New Financial System: Decentralized?” at the Blockchain Economic Forum in Davos, Switzerland. (Video of the panel is here.) The panel was preceded by a talk by Prof. Nouriel Roubini of the NYU Stern School of Business (video here; all quotes below are my own transcriptions). In his talk Roubini made remarkable claims for what he called a “central bank digital currency.”

A terminological clarification is immediately needed: the “central bank digital currency” that Roubini and other economists advocate is not in fact a currency. Their proposals are for transferable account balances, not for media that circulate peer-to-peer like coins or paper notes without requiring any new ledger entries. Roubini himself points out, no doubt correctly, that central banks have no incentive to issue a digital cryptocurrency or a token that would pass anonymously or pseudonymously in peer-to-peer transactions, not going through the interbank clearing system but rather validated by a distributed-ledger system.

Because the proposals for transferable account balances make “digital currency” a misnomer, I suggest that we more accurately call them proposals for “central bank retail accounts” or CBRA.

The primary version of CBRA that Roubini discusses would allow ordinary households and businesses to open checking accounts on the central bank’s balance sheet. (At present only approved financial institutions and the US Treasury have accounts on the books of the Federal Reserve System.) In his words:

Suppose you create a digital central bank currency. Effectively what does it mean? … It’s a centralized ledger where all the transactions occur. … [E]very individual has also an account with the central bank and therefore access to the balance sheet of the central bank the same way Citibank or JP Morgan or any other commercial bank does. … So if I had to give you money, I could do it by transferring through the balance sheet of the central bank … the same way the banks do in the interbank system.”

I put aside for now one objection to CBRA: If checkable deposits become central bank liabilities, the loanable funds they provide will no longer be allocated by the competitive private banking system, but rather by the government, which is a recipe for inefficiency and cronyism. I will assume, as Roubini at one point suggests, that the Federal Reserve will conduct wholesale auctions to lend the funds back to the commercial banks. We can then focus only on the provision of checkable deposit services.

The Modern New Deal That’s Too Good to Be True

This morning I responded to leading Modern Monetary Theory (MMT) proponent Stephanie Kelton’s Huffington Post op-ed, “How We Can Pay for a Green New Deal,” with a tweet observing that

My comparison of basic MMT arguments with plain-vanilla Keynesianism is hardly novel: many others have made it, less succinctly but more compellingly: I recommend, in particular, the writings of Thomas Palley — who is himself a self-described (but not at all naïve) Keynesian — on the topic. As for “especially naïve,” that has simply to do with the fact that, unlike the situation in 1936, when Keynes published his General Theory, it is anything but obvious today that there’s a vast supply of unemployed resources to be drawn upon.

Unsurprisingly my post met with backlash from several MMT fans, starting with Nathan Tankus, who replied that it appeared that I must not actually have read Professor Kelton’s piece, since its point was “precisely that our budgeting process needs to emphasize the conditions of the real economy and that the ability to extract dollar revenue tells us nothing about how close we are to full employment.” Professor Kelton herself thereupon chimed in, “Incredible, isn’t it?,” presumably in reference to my clueless interpretation of what she wrote.

The Fed Marches On

So it has come to pass. In his recent press conference, Chairman Jerome Powell has at last made official the Fed’s plan to stick to its post-crisis “floor” system of monetary control, which uses changes in the interest rate paid on banks’ excess reserve balances, rather than routine open-market operations, to keep the federal funds rate at its assigned target. Powell has also affirmed previous reports that the Fed may stop shrinking its balance sheet well before it reaches $3 trillion — the (itself still hefty) minimum it might reach if the Fed kept to its original unwind plan. The unwind might even end before the Fed’s assets fall below $4 trillion, or not far from where they are today.

Although he’s generally not one for making forecasts, yours truly has long anticipated both developments, in writings here on Alt-M and elsewhere. He has said as well that the Fed is likely to start Quantitatively Easing again at the first hint of another crisis. I’ll add here the prediction that it will do so before, or instead of, setting its IOER rate back to zero, just as happened during the last crisis. In short, I repeat my belief that it’s quite possible that Jerome Powell will have the dubious honor of becoming the Fed’s first “Six Trillion Dollar Chairman.” And because, under a floor system, the size of the Fed’s balance sheet has no direct bearing on the level of short-term interest rates, there’s practically no limit to how big it might get without interfering with the Fed’s ability to hit its interest-rate targets.

Fed officials insist, of course, that the advantages of this brave new regime outweigh any dangers it poses, and that they’ve only decided to stick to it after carefully weighing its pros and cons. Perhaps. But I have my doubts.

Irving Fisher’s Search for Stable Money: What We Can Learn

Irving Fisher’s classic treatise, The Purchasing Power of Money: Its Determination and Relation to Credit, Interest and Crises (1911), still offers valuable insights regarding monetary reform. This post examines some of Fisher’s insights and draws some lessons for Fed policy.

The Importance of Stable Money

Fisher recognized “the evils of monetary instability”—that is, “periodic changes in the level of prices, producing alternate crises and depressions of trade.”  He argued that “only by knowledge, both of the principles and of the facts involved, can such fluctuations … be prevented or mitigated, and only by such knowledge can the losses which they entail be avoided or reduced” (Fisher 1912: ix). [1]

The main principles that guided Fisher’s work were embodied in the quantity theory of money and the theory of monetary disequilibrium.  The former held that, ceteris paribus, the purchasing power of money (the reciprocal of the price level) depends on the quantity of money relative to real output (trade).  If the economy is at full employment and the velocity of money is stable, then the purchasing power of money will be inversely related to the stock of money.  If money moves in line with trade and velocity is stable, then monetary equilibrium will prevail and the value of money will also be stable (see Fisher 1912: 320).

When Fisher wrote The Purchasing Power of Money, the United States was still on the classical gold standard; there was no central bank.  In his book, he defined money as “what is generally acceptable in exchange for goods” (p. 8).  He recognized that “money never bears interest except in the sense of creating convenience in the process of exchange” and that “this convenience is the special service of money and offsets the apparent loss of interest involved in keeping it in one’s pocket instead of investing” (p. 9).

Fisher also importantly recognized that “money itself belongs to a general class of property rights” known as “currency” or “circulating media.”  More specifically, “currency includes any type of property right which, whether generally acceptable or not, does actually, for its chief purpose and use, serve as a means of exchange” (p. 10).  While Fisher classified bank notes as money and circulating media, he viewed checkable bank deposits as currency, not money in the strict sense (p. 11).

“Primary money” referred to commodity money (gold coin at the time), while “fiduciary money” (notably bank notes) referred to money whose value depended “on the confidence that the owner can exchange it for other goods” (ibid.).  “The chief quality of fiduciary money,” wrote Fisher, “is its redeemability in primary money, or else its imposed character of legal tender” (p. 12).

Fisher refined the quantity theory of money to take account of monetary disequilibrium and used statistical methods to test the theory against historical data.  Like his contemporaries, he understood that the fundamental cause of business fluctuations was erratic money.

Interventionist Assumptions in the World Bank’s “Doing Business” Index: Part 1

This is Part 1 of a two-part series on the World Bank’s Doing Business Report. In this entry, I discuss the World Bank’s implicit embrace of occupational licensing restrictions. In the next entry, I will discuss the World Bank’s dim view of private, contractarian approaches to corporate governance. 


I. Introduction

The World Bank’s annual Doing Business Report represents an invaluable resource to researchers, policymakers, entrepreneurs and investors. It comprehensively ranks how well each country in the world has managed to achieve John Adam’s elusive aphorism:  “the rule of law, not of man”. Its findings are cited thousands of times each year by academics and are directly incorporated into regression models to form the basis of a substantial empirical literature spanning developmental economics to comparative political economy. It is subsequently relied on by other similar projects, such as the Fraser Institute’s Economic Freedom index as a part of its own ranking methodology.

Which is why its flaws matter. While the Report generally ranks relatively laissez-faire economies with an efficient and uncorrupt civil service ahead of kleptocratic kludgeocracies, it nonetheless incorporates several interventionist assumptions into its measure of the ease of doing business. I will explore several such examples below. For instance, the Report rewards countries with a higher score on their Dealing with Construction Permits index if they have a stringent, government-administered occupational licensing and permitting regime for architects and construction projects. In the “Protecting Minority Investors” category, the Report similarly punishes countries if they even allow for corporate governance structures other than the Platonic Form envisioned by the World Bank. In this instance, it privileges a mandatory, anticontractarian approach to corporate law over the enabling, contractarian approach.  How does preventing parties from Coasian bargaining around contractual defaults so as to achieve a Pareto-improving outcome increase the ease with which they do business?      

Before we examine these interventionist assumptions, let’s begin with how the Report measures ease of doing business. First, it creates a series of index variables (e.g. protecting minority shareholders, labor market regulations) comprising multiple indicia, and then aggregates these variables into a single Ease of Doing Business score for each country. Many of these are unobjectionable:

“The time necessary for the judge to issue a written final judgment once the evidence period has closed.” [Contract Enforcement]; “Whether unmarried men and unmarried women have equal ownership rights to property. A score of -1 is assigned if there are unequal ownership rights to property; 0 if there is equality.” [Registering Property].

II. Dealing with Construction Permits

Yet in several categories, the World Bank has decided that the more government requirements needed before a given transaction is authorized, the better. The main culprit here is the “Building Quality Control” subcategory of the “Dealing with Construction Permits” index, weighted as 25% of that index. The three separate sub-sub-categories of “Building Quality Control” are Quality Control Before/During/After Construction. Higher scores are awarded to countries that require either direct approval by a government entity, or approval from a “licensed” engineer and/or architect to review the plans/building, but only if that license is granted by “the national association of architects or engineers (or its equivalent)”. In other words, in a country with an unrestricted, competitive market for safety appraisals, allowing builders to contract with the top-rated such firm counts for naught unless that firm has been officially sanctioned by the occupational guild or by the government itself.

So as to remove any doubt about the entry-restricting credentialism embraced by this occupational licensing framework, it is given its own sub-index, the “Professional Certification Index.” The highest possible score is awarded if:

National or state regulations mandate that the professional must have a minimum number of years of practical experience, must have a university degree (a minimum of a bachelor’s) in architecture or engineering, and must also either be a registered member of the national order (association) of architects or engineers or pass a qualification exam.

Lower scores are meted out for less stringent (read: arbitrary and restrictive) requirements.

Kareken-Wallace and Cryptoassets: Why Bitcoin and Beam Are Not Perfect Substitutes

Some prominent economists have begun to analyze formally the market for a privately issued outside money that they associate with Bitcoin. Rodney Garratt and Neil Wallace (2018) (ungated version here) model the relative values of (exchange rates between) “Bitcoin 1” and other hypothetical cryptoassets (“Bitcoin 2,” etc.). Linda Schilling and Harald Uhlig (2018) take a related approach to the exchange rate between “Bitcoin” and “the US dollar.” I use quotation marks here to indicate that the authors’ subjects are modeling entities, named after but not the real things. Their correspondence to the real things should not be taken for granted.

Both pairs of authors draw on a well-known theoretical result by Kareken and Wallace (1981): when two fiat currencies are perfect substitutes, the equilibrium exchange rate between them is indeterminate. To get the intuition, imagine that any payment made in US dollars can equally be made in Canadian dollars valued according to the going exchange rate. Nobody then has a reason to swap one currency for an equivalent amount of the other. No matter the level of the exchange rate, there is no pressure for it to change. Only the combined real money supply and demand matter, and any exchange rate is consistent with combined real combined real supply equaling combined real money demand. The combined real money stock could be 99% US dollars (at an exchange rate making one USD worth many CAD) or 99% Canadian dollars. Either rate is compatible with monetary equilibrium.