Latest Cato Research on Finance, Banking &amp; Monetary Policy https://www.cato.org/ en The New Deal and Recovery, Part 4: FDR’s Fed https://www.cato.org/blog/new-deal-recovery-part-4-fdrs-fed George Selgin <p>“Roosevelt had conducted an active monetary and fiscal program of recovery…working along lines suggested by Keynes.” Eric Rauchway, <em>The Money Makers</em>, p. xvi.</p> <p>As we saw in <a href="https://www.alt-m.org/2020/06/29/the-new-deal-and-recovery-part-3-the-fiscal-stimulus-myth/" rel="nofollow noopener noreferrer">the last installment to this series</a>, New Deal fiscal policies did little to help the U.S. economy recover from the Great Depression. Yet the U.S. did see substantial gains in output and employment between 1933 and 1937. If those gains weren’t a result of fiscal stimulus, what caused them? And just what did New Deal policies have to do with these causes?</p> <h4>A Money‐​Fueled Recovery</h4> <p>The answer to the first question, according to most economic historians, is growth in the U.S. money stock, which rose from just over $4 billion in late 1933 to nearly under $23 billion by late 1941. “Nearly all of the observed recovery,” Christina Romer says in the abstract to <a href="https://www.jstor.org/stable/2123226?seq=1" rel="nofollow external noopener noreferrer" target="_blank">her influential 1992 article</a>, “was due to monetary expansion.” Just as the monetary collapse of 1929–33 contributed to the “Great Contraction” of 1929–33 (to use Milton Friedman and Anna Schwartz’s famous term for it), money growth fueled a “Great Expansion” between 1933 and 1937, reviving the overall demand for goods and services, raising equilibrium prices, and boosting output.</p> <p>According to Romer’s calculations, illustrated in the chart below, if instead of growing exceptionally rapidly the U.S. money stock had only grown at its average historical rate, “real GNP would have been approximately 25 percent lower in 1937 and nearly 50 percent lower in 1942 than it actually was.”</p> <p><strong>Figure 1.</strong> <strong>United States Real GNP and Predicted GNP, 1933–1942</strong></p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="0f65d8ba-7121-47ea-8e7d-1fc19529e4d9" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-07/1.jpg?itok=SIhcUVs9 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-07/1.jpg?itok=ftvAtkpa 1.5x" width="700" height="450" src="/sites/cato.org/files/styles/pubs/public/2020-07/1.jpg?itok=SIhcUVs9" alt="United States Real GNP and Predicted GNP, 1933-1942" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Romer, Christina D. “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (1992): 757–84. Accessed July 6, 2020. <a href="http://www.jstor.org/stable/2123226">www​.jstor​.org/​s​t​a​b​l​e​/​2​1​23226</a>. </div> </figcaption></figure><p>For comparison’s sake, here is Romer’s chart showing how much New Deal fiscal policy contributed to the post‐​1933 recovery:</p> <p><strong>Figure 2. The Contribution of New Deal Fiscal Policy to the Post‐​1933 Recovery</strong></p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="7e317ebb-db13-4c00-8ef1-c6a0b8b75125" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-07/2.jpg?itok=Y3rE_KP6 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-07/2.jpg?itok=X9tq9Und 1.5x" width="700" height="453" src="/sites/cato.org/files/styles/pubs/public/2020-07/2.jpg?itok=Y3rE_KP6" alt="The Contribution of New Deal Fiscal Policy to the Post-1933 Recovery" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Romer, Christina D. “What Ended the Great Depression?” The Journal of Economic History 52, no. 4 (1992): 757–84. Accessed July 6, 2020. <a href="http://www.jstor.org/stable/2123226">www​.jstor​.org/​s​t​a​b​l​e​/​2​1​23226</a>. </div> </figcaption></figure><p>But before we assign credit to the New Deal for any part of the Great Expansion, we have to ask what role New Deal policies played in boosting money growth. As we’ll see in a moment, that growth depended both on the extent of the Fed’s net purchases of commercial paper and Treasury securities and on growth in the Fed’s gold reserves. This post will concentrate on the Fed’s direct contribution to money growth and the New Deal’s bearing on it. My next post will look into the effect of New Deal policies on the Fed’s gold reserves.</p> <h4>Sources of Money Growth</h4> <p>To assess the New Deal’s role in the Great Expansion, we must first consider the proximate causes of that period’s money growth. The most important of these causes consisted of growth in the size of the Fed’s balance sheet. As that grew, so did the sum of bank reserves and the public’s holdings of Federal Reserve notes. The size of the Fed’s balance sheet in turn depended on the amount of gold (or “gold certificates”) that came its way, and also on the nominal value of commercial paper (“bills”) and Treasury securities the Fed acquired through its lending and open‐​market operations. The other source of changes to the money stock consisted of changes in the ratio of the total money stock to the quantity of Fed assets, which itself depended mainly on what ratio of reserves to deposits banks wished or were required to maintain.</p> <p>The progress of these different money stock determinants can be seen or inferred from the following chart, in which the blue line shows the U.S. “M1” money stock (currency in circulation plus bank demand deposits), the red one shows the Fed’s gold holdings, and the purple one shows the Fed’s holdings of bills and securities. I’ll come to the green line later. The values are all index numbers, with March 1933 = 100. Using these makes it easier to assess the relative importance of the different factors driving money growth.</p> <p><strong>Figure 3. Growth within the Great Expansion</strong></p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="a33db312-4c58-45d7-9006-2931290b26c6" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-07/3.png?itok=_itmFkaD 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-07/3.png?itok=q6FxPpSy 1.5x" width="700" height="282" src="/sites/cato.org/files/styles/pubs/public/2020-07/3.png?itok=_itmFkaD" alt="Growth within the Great Depression" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">National Bureau of Economic Research, retrieved from FRED, Federal Reserve Bank of St. Louis </div> </figcaption></figure><p>A remarkable conclusion that emerges from this chart is that the rapid money growth between 1933 and 1937 was <em>entirely</em> due to growth in the Fed’s gold holdings. The banks, for their part, <em>increased</em> their reserve ratios over time, causing both bank deposits and the total money stock to grow less than proportionately with the Fed’s gold holdings. Finally, the Fed’s bill and security holdings remained almost constant. Its commercial paper holdings, very modest to begin with, actually <em>fell </em>by $10 million between December 1933 and December 1934, after which they were virtually constant. And although the Fed bought $600 million in Treasury securities between April and December 1933, it made no more purchases between then and 1937, when it added a measly $50 million to its holdings.<a href="#_ftn1" id="_ftnref1" name="_ftnref1">[1]</a></p> <p>In short, although the Fed let its balance sheet and bank reserves grow passively in response to gold inflows, contributing to money growth to that extent, it did next to nothing to actively encourage money growth.</p> <h4>The New Deal and Fed Policy</h4> <p>Why did the Fed do so little? It certainly wasn’t because there was no “Keynesian” case for additional monetary stimulus: for all the progress the U.S. economy made between 1933 and 1937, at the end of that upturn it was still running well below full capacity, with output barely above its 1929 level, and an unemployment rate still well into double digits.</p> <p>Yet instead of taking steps to ramp‐​up the money stock, Fed officials became increasingly worried about…inflation! Noticing that banks had been storing‐​up excess reserves, they feared that a revival of bank lending might lead to <em>excessive</em> money growth, and therefore refrained from contributing directly to that growth. Then, finding a merely passive stance inadequate, they joined forces with the Treasury to <em>offset</em> gold inflows. These steps were among several that contributed to the “Roosevelt Recession” of 1937–8, which undid many of the gains of the preceding four years. Far from regarding these anti‐​inflation measures as consistent with his own theories, Keynes is supposed to have complained that Fed and Treasury officials “professed to fear that for which they dared not hope.” Only after the ’37-’38 debacle did “Keynesian” ideas begin to inform Roosevelt’s fiscal and monetary policies.<a href="#_ftn2" id="_ftnref2" name="_ftnref2">[2]</a></p> <p>What role did the New Deal play in all this? The answer is, a much bigger one than you might think. The <a href="https://en.wikipedia.org/wiki/Glass%E2%80%93Steagall_Act_of_1932" rel="nofollow external noopener noreferrer" target="_blank">1932 Glass‐​Steagall Act</a> (not to be confused with the 1933 New Deal measure of the same name) had somewhat relaxed gold’s grip on U.S. monetary policy by allowing the Fed to issue <a href="https://en.wikipedia.org/wiki/Federal_Reserve_Bank_Note" rel="nofollow external noopener noreferrer" target="_blank">“Federal Reserve <em>Bank</em> Notes”</a> backed by certain Treasury securities instead of bills or gold.<a href="#_ftn3" id="_ftnref3" name="_ftnref3">[3]</a> The Emergency Banking Act of 1933 in turn made all direct U.S. obligations, as well as the Fed’s holdings of notes, drafts, bills of exchange and bankers’ acceptances, temporarily eligible as collateral for Federal Reserve Bank Notes. Finally, Roosevelt made the gold constraint almost entirely irrelevant, first by suspending gold payments and then (in January 1934) by officially devaluing the dollar. Following these steps, although the Fed could and generally did allow its balance sheet to grow passively with its gold receipts, it also enjoyed considerable freedom to alter the supply of currency and bank reserves independently of changes to its gold holdings.</p> <p>Had these changes alone occurred, they would only have enhanced the Fed’s discretionary powers, making it, rather than FDR or the New Deal, responsible for any subsequent lack of monetary stimulus. But other New Deal steps dramatically reduced the Fed’s independence, placing monetary policy almost entirely under the administration’s control. It follows that, if the money stock didn’t grow as much as it should have, the blame ultimately rested with the administration.</p> <h4>The Thomas Amendment</h4> <p>After the Emergency Banking Act, which allowed FDR to put the gold standard on ice, the next significant increase in FDR’s monetary policy powers came with the controversial <a href="https://www.encyclopedia.com/economics/encyclopedias-almanacs-transcripts-and-maps/thomas-amendment" rel="nofollow external noopener noreferrer" target="_blank">Thomas Amendment</a> to the <a href="https://en.wikipedia.org/wiki/Agricultural_Adjustment_Act" rel="nofollow external noopener noreferrer" target="_blank">Agricultural Adjustment Act</a> of May 12th, 1933. That amendment allowed FDR to ask the Fed to buy up to $3 billion in Treasury securities directly from the Treasury or (if the Fed demurred) to have the Treasury itself issue up to $3 billion in its own “greenbacks.” It also allowed him to revive bimetallism by authorizing the minting of full‐​bodied (as opposed to token or subsidiary) silver coins and the tendering of silver certificates for silver received by the Treasury for that purpose. Finally, the Thomas Amendment gave the president the power to reduce the gold content of the dollar by as much as 50 percent, paving the way to devaluation.</p> <p>These were sweeping powers—or so it seemed, at least, to the amendment’s conservative critics, including Lewis Douglas, FDR’s very orthodox budget director, who thought they’d put paid to Western Civilization! <a href="https://books.googleusercontent.com/books/content?req=AKW5QacG2wXDXECDsUMs7E1is5AqxvdiuaZs7yzUO4Xy9QyWefQoSyJCukz2UW3pdhR0X3EAGcUHwFsQEY_qVlR6Qfe-YM9-Hn9wgOWVvTZFGmhscZD-IBM2AYwcFaraVorJzIgPDu141BW-dhqfCzXQ3Lci8PHEK4ww5becbVBVyK7C1ZB6jXleF05VipPPj1ztvCSvTrcFJh0incOIZgv0-wQLRk-DAXTEt_8mPI8levdHnUOcFdcgTN6Iwmz8PsOPHpZtR67Pf3s1beIVyreg-J1IHm4PuT6EO-03skENnNWKATqzr_A" rel="nofollow external noopener noreferrer" target="_blank">Testifying in 1941 before the Senate Banking Committee</a>, <a href="https://en.wikipedia.org/wiki/Edwin_W._Kemmerer" rel="nofollow external noopener noreferrer" target="_blank">Edwin Kemmerer</a>, the famous “Money Doctor” and gold‐​standard champion, was only slightly less melodramatic. The Thomas Amendment, he said,</p> <blockquote><p>gives to the President and his appointees a legal authority over the nation’s currency that is almost complete. A Stalin or a Hitler could hardly have more. The things that the President has legal authority to do to the currency directly and their necessary implications could give us a gold standard, a silver standard, a bimetallic standard, a paper money standard or a commodity dollar standard. They could give us serious deflation or a runaway inflation.</p> </blockquote> <p>It’s doubtful, though, that FDR ever intended to take full advantage of the powers the Thomas Amendment gave him. Although he certainly welcomed and would soon make use of the power to devalue the dollar, he was neither a greenbackist nor a silverite. As the late <a href="https://www.jstor.org/stable/pdf/1917787.pdf?seq=1" rel="nofollow external noopener noreferrer" target="_blank">Elmus Wicker (1971, pp. 866–7</a>) explains, much as he may have looked forward to raising gold’s price, FDR</p> <blockquote><p>did not view with favor the expedient of simply adding to stock of money to achieve the desired price level. He objected to outright money creation as ‘inflationary’ because [it] had historical connotations of reckless spending by government, extreme difficulty in funding the public debt, and a general wage and price spiral.</p> </blockquote> <p>According to Wicker and most other historians, FDR went along with the Thomas Amendment’s “inflationary” provisions to kill another amendment, proposed by Montana Senator <a href="https://en.wikipedia.org/wiki/Burton_K._Wheeler" rel="nofollow external noopener noreferrer" target="_blank">Burton Wheeler</a>, that would have authorized additions to the money stock whether FDR approved of them or not. Fearing Congress might override his veto of the Farm bill so amended, he accepted Thomas’s alternative, which merely gave him the option of calling for outright money creation.<a href="#_ftn4" id="_ftnref4" name="_ftnref4">[4]</a></p> <p>Whatever FDR’s true intentions, the Thomas Amendment made it possible for him to compel the Fed to create more of its own money by threatening to have the Treasury issue greenbacks or silver money instead. Yet he wielded that threat but once when, in September 1933, he said he’d issue greenbacks if the Fed didn’t roll‐​over $50 million in maturing securities. FDR also went on to authorize Treasury silver purchases. But he did so not to encourage monetary expansion but to placate the powerful silver lobby and those senators and representatives beholden to it. For that reason it made no difference to him that the Treasury retired enough national banknotes to offset most of the new silver currency it issued.<a href="#_ftn5" id="_ftnref5" name="_ftnref5">[5]</a> In short, despite the Thomas Amendment, FDR did very little to encourage money growth beyond what gold inflows alone would accomplish.</p> <h4>The Gold Reserve Act</h4> <p>Two other New Deal measures further strengthened the administration’s grip upon monetary policy. This time the administration was to take full advantage of the changes. But it would do so, not for the sake of further boosting money growth, but to put an end to that growth, with dire consequences I’ll treat in full in later segments.</p> <p>Fed economist <a href="https://www.federalreservehistory.org/essays/gold_reserve_act" rel="nofollow external noopener noreferrer" target="_blank">Gary Richardson and his coauthors</a> have called the first of these measures, the Gold Reserve Act of 1934, “the culmination of Roosevelt’s controversial gold program.” Having ordered Americans to surrender most of their monetary gold holdings to the Fed in April 1933, FDR now secured Congress’ permission (1) to have the Fed transfer its gold to the U.S. Treasury in exchange for Treasury “gold certificates,” and (2) to alter the dollar’s gold value by proclamation, which he did on January 31st, the day after signing the new law, by raising gold’s official price from $20.67 per ounce to $35 per ounce. The dollar was thus deprived of 41 percent of its former gold content.</p> <p>Although Richardson et al. suggest that the government compensated the Federal Reserve “at a rate of $35 per ounce,” that’s not so. As <a href="https://www.federalreserve.gov/faqs/does-the-federal-reserve-own-or-hold-gold.htm" rel="nofollow external noopener noreferrer" target="_blank">a different Fed publication</a> points out, because the Treasury took possession of the Fed’s gold before FDR announced gold’s new price, it paid for it at the old statutory price of $20.67 per ounce. The Fed’s nominal “gold” reserves therefore stayed unchanged, except that they now consisted not of actual gold but of Treasury gold certificates.</p> <p>It’s here that the green line in the FRED chart above becomes relevant. To save you some scrolling here’s that chart again:</p> <p><strong>Figure 4.</strong> <strong>Growth within the Great Expansion (Same as Figure 3)</strong></p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="a33db312-4c58-45d7-9006-2931290b26c6" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-07/3.png?itok=_itmFkaD 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-07/3.png?itok=q6FxPpSy 1.5x" width="700" height="282" src="/sites/cato.org/files/styles/pubs/public/2020-07/3.png?itok=_itmFkaD" alt="Growth within the Great Depression" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">National Bureau of Economic Research, retrieved from FRED, Federal Reserve Bank of St. Louis </div> </figcaption></figure><p>National Bureau of Economic Research, retrieved from FRED, Federal Reserve Bank of St. Louis</p> <p>Because the nominal “gold profit” from the devaluation went not to the Fed but to the Treasury, it didn’t result in any immediate increase in the Fed’s assets, bank reserves, or the money stock. The way in which devaluation was handled thus demonstrated, in an especially neat fashion, FDR’s desire and willingness to try and raise prices generally by raising the price of gold, but <em>not </em>by encouraging growth in the money stock.</p> <p>As for what the Treasury did with its gold profit, $2 billion of it went to establish an “Exchange Stabilization Fund.” According to <a href="https://www.presidency.ucsb.edu/documents/proclamation-2072-fixing-the-weight-the-gold-dollar" rel="nofollow external noopener noreferrer" target="_blank">Roosevelt’s proclamation announcing the dollar’s devaluation</a>, that fund would serve “to stabilize domestic prices and to protect the foreign commerce against the adverse effect of depreciated foreign currencies.” But Fed officials saw it rather differently: according to <a href="https://fraser.stlouisfed.org/archival-collection/records-federal-reserve-system-1344/memo-governor-black-539755/fulltext" rel="nofollow external noopener noreferrer" target="_blank">an internal Fed memo sent to Fed Board governor Eugene Black</a>, it would allow the Treasury Secretary “to assume complete control of general credit conditions and to negate any credit policies that the Federal Reserve might adopt.” Precisely what use the Treasury made of this newly acquired control is something I’ll take up in the next installment in this series. Suffice it to say that there was nothing “Keynesian” about it.</p> <h4>Marriner Eccles and the 1935 Banking Act</h4> <p>While the Farm and Gold Reserve Acts awarded FDR money creating powers he could employ without the Fed’s cooperation, or appeal to compel it to cooperate, by appointing Marriner Eccles as the Fed’s new governor in November 1934 and letting him draft the Banking Act of 1935, FDR got himself a Fed that would sing his tune.</p> <p>Unlike Eugene Black, who was himself a Roosevelt appointee who stepped down after clashing with him when he made the Fed banks surrender their gold, Eccles was said (by the <em>New York Evening Post </em>) to have “views on monetary policy…even more liberal than those already embraced by the New Deal.” Henry Morganthau, who was then FDR’s secretary of the Treasury, recommended Eccles to FDR for this reason and so that the Treasury could count on a highly cooperative Fed.</p> <p>But Eccles agreed to take Black’s place only on one condition: FDR had to let him author a radical Fed overhaul that would substantially increase both his own and other politically‐​appointed officials’ influence upon Fed policy, while reducing that of the governors of the 12 Reserve banks.</p> <p>Eccles’s proposal became the Banking Act of 1935, which Roosevelt signed that August. The Act replaced the former Federal Reserve Board with the present seven‐​member presidentially‐​appointed “Board of Governors.” It also changed the composition of the FOMC, which had been established by the Banking Act of 1933 to coordinate the Fed’s open‐​market operations. That committee’s voting members had originally consisted solely of the “governors” (as they were then styled) of the 12 regional Fed banks. The new law established the one in place today, with the “presidents” of only five Fed banks (New York’s and four others chosen on a rotating basis) serving on the committee at any one time, and doing so along with the seven members of the Board of Governors.</p> <p>Besides allowing the Board of Governors to make up a majority of the FOMC, the new law also allowed it to set Fed bank discount rates and reserve requirements. The Act’s ultimate goal, <a href="https://www.amazon.com/Power-Independence-Federal-Reserve/dp/1536618195" rel="nofollow external noopener noreferrer" target="_blank">according to Peter Conti‐​Brown</a> (p. 32), was nothing less than that of subsuming monetary policy under administration policy. “It is no surprise, then,” says Brown,</p> <blockquote><p>that the Eccles Fed of the 1930s saw less of a need to declare formal independence from government, as the Banking Act of 1935 had done in a declaration of independence from private bankers. Even during a brief and painful interlude of further recession in 1937–38, the Fed’s policy during the 1930s was fully congenial to the administration’s.</p> </blockquote> <p>In <a href="https://www.dallasfed.org/-/media/documents/institute/wpapers/2014/0205.pdf" rel="nofollow external noopener noreferrer" target="_blank">their 2014 paper</a>, “Navigating Constraints: The Evolution of Federal Reserve Monetary Policy, 1935–59,” Fed economists Mark Carlson and David Wheelock reach a more or less identical conclusion. “New Deal legislation,” they write, “limited the Fed’s ability to conduct an independent monetary policy. The Fed was forced to cooperate with the Treasury in the 1930s, and fully ceded monetary policy to Treasury financing requirements during World War II.”</p> <p>***</p> <p>To sum up: if ever an administration had control over Fed policy, and monetary policy more generally, FDR’s was it. It follows that, if monetary policy did less than it should have to end the Great Depression, the Roosevelt administration must bear a good share of the blame.</p> <p>But everything is relative: until the last months of 1936, the Roosevelt administration’s monetary policy errors were errors of omission only: unlike Hoover, who <a href="https://www.jec.senate.gov/public/_cache/files/9b6c87ca-582c-4654-aaa3-08bf396cf7e2/hoover-s-lethal-economic-policy-mix---oct-2008.pdf" rel="nofollow external noopener noreferrer" target="_blank">acquiesced to Fed policies that contributed to the Great Contraction</a>, FDR and his Treasury team merely failed to encourage the Fed to contribute more to money growth than it did, or to contribute more to that growth themselves. Alas, this ceased to be so toward the end of 1936, when actions by both the Fed and the Treasury resulted in a second severe monetary contraction that would reverse many of the gains achieved over the course of the preceding four years.</p> <p>It’s also true that, if New Deal policies failed to encourage monetary expansion beyond what gold inflows alone provided for, those policies deserve much of the credit for those gold inflows. Just <em>how much</em> credit they deserve will be the main topic of this series’ next installment.</p> <p><strong>Continue Reading<em> The New Deal and Recovery:</em></strong></p> <ul><li><a href="https://www.cato.org/blog/new-deal-recovery-new-series">Intro</a></li> <li><a href="https://www.cato.org/blog/new-deal-recovery-part-1-record" rel="nofollow noopener noreferrer">Part 1: The Record</a></li> <li><a href="https://www.cato.org/blog/new-deal-recovery-part-2-inventing-new-deal" rel="nofollow noopener noreferrer">Part 2: Inventing the New Deal</a></li> <li><a href="https://www.cato.org/blog/new-deal-recovery-part-3-fiscal-stimulus-myth" rel="nofollow noopener noreferrer">Part 3: The Fiscal Stimulus Myth</a></li> <li>Part 4: FDR’s Fed</li> </ul><p>__________________</p> <p><a href="#_ftnref1" id="_ftn1" name="_ftn1">[1]</a> The Fed’s 1937 purchases were part of its “flexible portfolio policy”—an early version of <a href="https://www.frbsf.org/economic-research/publications/economic-letter/2011/april/operation-twist-effect-large-scale-asset-purchases/" rel="nofollow external noopener noreferrer" target="_blank">“Operation Twist”</a>—aimed not at promoting money growth but at arresting the decline in Treasury bond prices that began in late 1936. To prop those prices up, the Fed actually bought $200 million in Treasury bonds. But it simultaneously sold $150 million in shorter‐​term Treasury notes and bills. For further details see <a href="https://www.jstor.org/stable/1812740?seq=1" rel="nofollow external noopener noreferrer" target="_blank">Chandler (1949)</a>.</p> <p><a href="#_ftnref2" id="_ftn2" name="_ftn2">[2]</a> See <a href="https://deepblue.lib.umich.edu/bitstream/handle/2027.42/67492/10.1177_002200949903400302.pdf?sequence=2" rel="nofollow external noopener noreferrer" target="_blank">Renshaw</a> (1999, especially pp. 349–50). According to this very well‐​informed article, the decisive change occurred while Roosevelt was at Warm Springs in March 1938. Here he “was finally converted to the idea of a package of federal spending to act counter‐​cyclically on the now seriously depressed economy.” It was also subsequent to this meeting that the administration’s monetary policy, which “had been crucial in deepening” the recession, was “abruptly reversed.”</p> <p><a href="#_ftnref3" id="_ftn3" name="_ftn3">[3]</a> Federal Reserve Bank Notes resembled national bank notes, and could be issued on precisely the same terms, though by individual Federal Reserve banks rather than national banks. They were first used during WWI, but had been withdrawn afterwards.</p> <p><a href="#_ftnref4" id="_ftn4" name="_ftn4">[4]</a> <a href="https://www.amazon.com/Money-Makers-Roosevelt-Depression-Prosperous/dp/0465049699" rel="nofollow external noopener noreferrer" target="_blank">Eric Rauchway</a> (2015, pp. 65–6) rejects this interpretation, which rests upon the testimony of original brain trust members Raymond Moley and Paul Warburg. “Roosevelt,” he says, “operated so deftly that even people close to him believed his hand had been forced.” In fact, Rauchway says, Roosevelt “told [George] Warren to keep pushing” for the Thomas Amendment’s inflationary provisions so he’d have “the tools…he wanted” to manage the dollar. But according to Warren’s theory, to which FDR fully subscribed by this time, the only tool Roosevelt needed was the authority to alter gold’s price. There is no reason to suppose, therefore, that he welcomed, much less encouraged Warren or anyone else to “push for,” the Thomas Amendment’s other provisions.</p> <p><a href="#_ftnref5" id="_ftn5" name="_ftn5">[5]</a> Although Treasury silver purchases added $1.22 billion to Fed member bank reserves between late 1933 and the end of 1938, most of these purchases resulted not from the Thomas Amendment but from the Silver Purchase Act of 1934. In any case their effect on the money stock was largely offset by the Treasury’s concurrent retirement of $900 million in national bank notes. The Treasury’s net contribution to bank reserves was just $320 million, a very small share of the total increase of about $6 billion, most of which was due to gold inflows.</p> Mon, 06 Jul 2020 16:55:04 -0400 George Selgin https://www.cato.org/blog/new-deal-recovery-part-4-fdrs-fed Seila Law v. Consumer Financial Protection Bureau https://www.cato.org/multimedia/cato-daily-podcast/seila-law-v-consumer-financial-protection-bureau Diego Zuluaga, William Yeatman, Caleb O. Brown <div class="mb-3 spacer--nomargin--last-child text-default"> <p>It wasn’t one of the blockbuster Supreme Court cases of the term, but it will shape how power is vested in federal agencies. Cato’s Diego Zuluaga and Will Yeatman comment on <em>Seila Law v. CFPB</em>.</p> </div> Mon, 06 Jul 2020 15:45:47 -0400 Diego Zuluaga, William Yeatman, Caleb O. Brown https://www.cato.org/multimedia/cato-daily-podcast/seila-law-v-consumer-financial-protection-bureau If Housing Affordability Is a National Priority, Then Why Does the Government Tax Almost Everything You Need to Build a Home? https://www.cato.org/blog/housing-affordability-national-priority-then-why-does-government-tax-almost-everything-you Scott Lincicome <p>A few weeks ago, Cato hosted <a href="https://www.cato.org/events/build-or-build-out-solving-housing-crisis">an event</a> on rising home prices and the resulting housing crises in many US cities. It’s an issue that has enjoyed much media attention and widespread calls for reform – even the 2019 <a href="https://www.whitehouse.gov/briefings-statements/president-donald-j-trump-tearing-red-tape-order-build-affordable-housing/">creation</a> of a White House Council on Eliminating Barriers to Affordable Housing Development “to identify and remove obstacles that impede the development of new affordable housing.” <span> </span>Most of the Cato event was—much like the broader public discussion on US housing reform—spent debating the merits and effects of single‐​family zoning and other land use regulations. Less discussed, however, were the <a href="https://www.cato.org/sites/cato.org/files/documents/powerpoints/lincicome-build-or-build.pdf">many ways</a> in which federal, state and local regulations inflate construction costs, which—as the White House press release notes—often drive home prices (and affordability) in many US localities.</p> <p>Among those regulations (yet unlikely to be mentioned by this administration!) are US import restrictions on almost everything you need to build a house, from the foundation to the roof and in between:</p> <p> <div data-embed-button="embed" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="c6df7b66-ee70-41d5-b537-5230b0de526d" class="align-center embedded-entity" data-langcode="en"> <div class="embed embed--infogram js-embed js-embed--infogram"> <div class="infogram-embed" data-id="9e3d00cf-b30a-44cb-83dd-5a8506b80635" data-type="interactive" data-title="Trade and Housing"></div> </div> </div> </p><p>As the chart above shows, these import barriers primarily take the form of tariffs on imports, especially from China, implemented pursuant to various US trade laws.<span> </span>Duty rates can range from a few percent to well over 100 percent – an effective ban on the product at issue.</p> <p>Some of these measures and their economic harms for US consumers—in this case, American home-builders/buyers—have been widely‐​reported (<em>e.g.</em>, President Trump’s “Section 232” tariffs on steel and aluminum or “Section 301” tariffs on Chinese imports).<span> </span>On the other hand, others—especially those implemented under US “trade remedy” (antidumping, countervailing duty or safeguard) laws—are less known, even though they can result in much higher duty rates (often using rather <a href="https://www.cato.org/blog/anti-trade-barbarians-gate">dubious</a> <a href="https://www.cato.org/publications/commentary/congress-must-fix-americas-unconstitutional-trade-laws">methodologies</a>) and can have similar economic effects.</p> <p>Speaking of those effects, numerous studies show that these tariffs (1) are <a href="https://www.nber.org/digest/may19/w25672.shtml">mostly</a> <a href="https://www.nber.org/papers/w26610">borne</a> by US consumers, not foreign governments or exporters; (2) increase <a href="https://www.wsj.com/articles/consumers-bore-cost-for-u-s-tariffs-on-washing-machines-paper-finds-11555936276#:~:text=President%20Trump&#039;s%20tariffs%20on%20imported,of%20washing%20machines%20by%2012%25.">domestic prices</a>—regardless of <a href="https://www.washingtonpost.com/business/2019/05/07/trumps-steel-tariffs-cost-us-consumers-every-job-created-experts-say/">origin</a>—for the goods subject to the tariffs (indeed, eliminating low‐​priced imports’ “adverse” effects is often the whole point); and (3) in the case of essential housing inputs <a href="https://www.cato.org/publications/trade-policy-analysis/nailing-homeowner-economic-impact-trade-protection-softwood-lumber-industry">like lumber</a>, can inflate construction costs and end up pushing tens of thousands of Americans out of the housing market altogether. (They also <a href="https://www.latimes.com/politics/story/2019-10-29/steel-industry-faces-a-bleaker-future-than-when-trump-moved-to-rescue-it">aren’t very good</a> at <a href="https://www.cato.org/publications/policy-analysis/doomed-repeat-it-long-history-americas-protectionist-failures">saving</a> the protected US workers/​industries, either, but that’s a story for another time.)</p> <p>At a time when affordable housing has become a <a href="https://www.whitehouse.gov/briefings-statements/president-donald-j-trump-tearing-red-tape-order-build-affordable-housing/">national priority</a>, you’d think that US law (or at least the Trump administration’s implementation thereof) might allow the agencies administering the long list of “housing taxes” above to prioritize the consumer harms that they impose or the broader national economic interests that they might undermine.<span> </span>Unfortunately, you’d mostly be wrong.<span> </span>The blanket Section 232 and Section 301 tariffs allow US importers to obtain narrow exclusions, but the process is costly, opaque and usually unsuccessful (especially when a domestic competitor opposes the exclusion). Our <a href="https://www.cato.org/blog/us-antidumping-regime-restrains-us-export-growth">AD/CVD laws</a>, meanwhile, expressly prohibit agencies from considering duties’ consumer harms, and – unlike other jurisdictions – lack any test for choosing the “public interest” over domestic industry pleas for import protection.</p> <p>As a result, these housing taxes will likely remain in place for years to come, regardless of the affordability crises to which they contribute.</p> Mon, 06 Jul 2020 13:43:51 -0400 Scott Lincicome https://www.cato.org/blog/housing-affordability-national-priority-then-why-does-government-tax-almost-everything-you Cato Journal article, “A Review of the Regional Greenhouse Gas Initiative,” is cited on Pennsylvania Cable Network’s PMA Perspective https://www.cato.org/multimedia/media-highlights-tv/cato-journal-article-review-regional-greenhouse-gas-initiative-1 Sun, 05 Jul 2020 10:30:18 -0400 Cato Institute https://www.cato.org/multimedia/media-highlights-tv/cato-journal-article-review-regional-greenhouse-gas-initiative-1 Congress Is about to Kick Small Businesses While They’re Down https://www.cato.org/publications/commentary/congress-about-kick-small-businesses-while-theyre-down Diego Zuluaga <div class="lead mb-3 spacer--nomargin--last-child text-default"> <p>Most members of Congress, regardless of party, agree that small businesses are crucial to American prosperity. This rare consensus was behind the decision to authorize $659 billion worth of forgivable loans through Small Business Administration’s&nbsp;<a href="https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program" target="_blank">Paycheck Protection Program</a>&nbsp;in a&nbsp;bid to limit business failures and layoffs as a&nbsp;result of the COVID-19 pandemic.</p> </div> , <div class="mb-3 spacer--nomargin--last-child text-default"> <p>So far, the PPP seems to have achieved its short‐​term goal of keeping small businesses alive. Almost 75 percent of small businesses with employees&nbsp;<a href="https://www.alt-m.org/2020/06/18/paycheck-protection-program-who-lent-to-whom-and-where/" target="_blank">got a&nbsp;loan</a>&nbsp;by early June and were thus able to keep their workers on the payroll. But the crisis is not yet over, with many businesses still far from healthy. And now Congress seems poised to sneak an amendment that has nothing to do with COVID-19 into legislation on which it will vote this week. By imposing a&nbsp;new burden that could cost each small business thousands of dollars to comply with, Congress may push many over the brink just as they’re starting over.</p> </div> , <aside class="aside--right aside--large aside pb-lg-0 pt-lg-2"> <div class="pullquote pullquote--default"> <div class="pullquote__content h2"> <p>By imposing a&nbsp;new burden that could cost each small business thousands of dollars to comply with, Congress may push many over the brink just as they’re starting over. </p> </div> </div> </aside> , <div class="mb-3 spacer--nomargin--last-child text-default"> <p>The amendment in question would require most small businesses with fewer than 20 employees and less than $5 million in annual sales — <a href="https://www.heritage.org/government-regulation/report/the-corporate-transparency-act-and-the-illicit-cash-act" target="_blank" rel="noopener">about 12 million firms</a> — to file information about their owners with the federal government. It is the product of heavy lobbying by bankers, who since 2018 have had to&nbsp;<a href="https://www.fincen.gov/resources/statutes-and-regulations/cdd-final-rule#:~:text=The%20CDD%20Rule%20requires%20these,when%20those%20companies%20open%20accounts." target="_blank">collect this information</a>&nbsp;on behalf of their business customers and include it in their reports to FinCEN, the Treasury’s financial crimes watchdog. But extending banks’ reporting burden to other businesses is unlikely to benefit the public. Instead, by subjecting these businesses to extra costs they can ill‐​afford, the amendment is likely to do far more harm than good.</p> <p>Bankers calling for the change argue that extending the obligation to small businesses would improve the accuracy of reporting and reduce total compliance costs. It’s true that bank regulations ostensibly aimed at uncovering financial crime are extremely costly, accounting for&nbsp;<a href="https://www.communitybanking.org/~/media/files/compliance%20costs%20economies%20of%20scale%20and%20compliance%20performance.pdf" target="_blank">more than 25 percent</a>&nbsp;of community bank compliance expenses. But the amendment wouldn’t reduce the reporting burden on banks. Instead it states that it will help “confirm beneficial ownership information … to facilitate [banks’] compliance” with existing requirements. The bankers evidently hope that this will make their own lives easier. But they offer no proof that it will.</p> <p>History suggests that the burden of financial crime reporting on the private sector, instead of ever declining, tends to increase and encompass a&nbsp;wider array of firms over time. Normally, one might expect small‐​business advocates in Congress to worry about the impact of such a&nbsp;large body of regulations on U.S. economic vibrancy. Yet because their goal is to fend off genuine threats to national security, such as terrorism and money‐​laundering, questioning the usefulness of any government efforts against these threats can make one look weak on crime. But good intentions are no guarantee of efficacy: while reports of suspicious financial activity have&nbsp;<a href="https://home.treasury.gov/system/files/266/12.-FINCEN-FY-2020-CJ.pdf" target="_blank">grown 42 percent</a>&nbsp;in six years, the annual number of prosecutions has&nbsp;<a href="https://www.heritage.org/markets-and-finance/report/financial-privacy-free-society#:~:text=Privacy%2C%20both%20financial%20and%20personal,involvement%2C%20surveillance%2C%20and%20control." target="_blank">stayed the same or declined</a>, and assessments of how valuable such reports are to law enforcement are hard to come by.</p> <p>At any rate, Congress can increase the information available to FinCEN in a&nbsp;less burdensome way by requiring the IRS to share beneficial ownership information it regularly collects. Nor would this set a&nbsp;precedent, since the tax code already mandates&nbsp;<a href="https://www.irs.gov/government-entities/governmental-liaisons/irs-information-sharing-programs" target="_blank">information‐​sharing</a>&nbsp;for other government programs such as federal student loans. Creating yet another reporting obligation on hard‐​pressed small businesses amounts to an unjustifiable overreach. If FinCEN’s&nbsp;<a href="https://www.fincen.gov/sites/default/files/shared/CDD_RIA.pdf" target="_blank">estimate</a>&nbsp;of the compliance burden on banks from current reporting rules is anything to go by, this new obligation could cost the average small business anywhere between $125 and more than $1,000. And that’s without the $500‐​per‐​day fine for non‐​compliance, however unwitting.</p> <p>Then there’s the privacy risk. Although the amendment says that FinCEN’s beneficial ownership database would only be accessible to law enforcement, it also offers the European regime as a&nbsp;model. Yet European authorities now&nbsp;<a href="https://ec.europa.eu/newsroom/just/document.cfm?action=display&amp;doc_id=48935" target="_blank">require</a>beneficial ownership databases to be public. The United Kingdom, for example, has had a&nbsp;public database since 2016, but&nbsp;<a href="https://www.mondaq.com/uk/shareholders/732364/the-beneficial-owners-register-of-uk-companies-a-consideration-of-problem-areas-arising-from-the-legislation" target="_blank">experts</a>&nbsp;regard the information it contains as largely useless,&nbsp;<a href="http://researchbriefings.parliament.uk/ResearchBriefing/Summary/CBP-8259" target="_blank">riddled with inaccuracies</a>, and ineffective. Law‐​abiding businesses go through the pains of reporting, while those with criminal intent have little incentive to do so. The database’s accessibility also means third parties can use the information for illicit ends, such as extortion and smear campaigns. Does Congress really want to expose small businesses to such abuse?</p> <p>The fight against financial crime by increasingly sophisticated international actors is no doubt a&nbsp;duty of government most of us can agree on. But rushing through legislation of questionable value during a&nbsp;recession, with many businesses struggling to survive, is the wrong way to pursue this fight. Let’s put economic recovery first so America can confront&nbsp;future national security threats from a&nbsp;position of strength.</p> </div> Wed, 01 Jul 2020 09:26:40 -0400 Diego Zuluaga https://www.cato.org/publications/commentary/congress-about-kick-small-businesses-while-theyre-down Steve H. Hanke discusses hyperinflation on Cedice Joven https://www.cato.org/multimedia/media-highlights-tv/steve-h-hanke-discusses-hyperinflation-cedice-joven Mon, 29 Jun 2020 13:55:13 -0400 Steve H. Hanke https://www.cato.org/multimedia/media-highlights-tv/steve-h-hanke-discusses-hyperinflation-cedice-joven The New Deal and Recovery, Part 3: The Fiscal Stimulus Myth https://www.cato.org/blog/new-deal-recovery-part-3-fiscal-stimulus-myth George Selgin <p>“[The COVID-19 crisis] wouldn’t be the first time America has resorted to large‐​scale fiscal stimulus in a peacetime emergency. The New Deal of the 1930s, a response to the Great Depression, is probably the most far‐​reaching example.” (Katia Dmitrieva, “The Times America Went Big and Flooded Economy With Federal Cash,” <a href="https://www.bloombergquint.com/global-economics/the-times-america-went-big-and-flooded-economy-with-federal-cash" rel="nofollow external noopener noreferrer" target="_blank"><em>Bloomberg</em>, March 9, 2020.</a>) </p> <p>*** </p> <p>It may seem perverse of me to begin an appraisal of the New Deal’s bearing on recovery by discussing fiscal policy. After all, FDR came into office in the midst of this country’s worst banking crisis, and this left him little choice but to give immediate attention to monetary policy steps that might end it. Still I want to start with fiscal policy, not because I suppose it belongs first chronologically, but because I’m sure it ranks last in importance. </p> <h4>Fallen Spending, Deflation, and Reflation </h4> <p>The proximate cause of the Great Depression was a dramatic collapse of overall spending, or what economists call “aggregate demand” for goods and services between 1929 and early 1933. In the FRED chart below, that collapse is represented by the green line, showing the nominal value of U.S. Gross Domestic Product (GDP). The red line shows how <em>real</em> GDP fell along with its nominal counterpart, though not as much, and then recovered along with it. I’ve drawn the chart to cover the period from 1929 until July 1942, because the latter date marks the recovery’s completion, when real GDP is supposed to have returned to its underlining, long‐​run trend. </p> <p><strong>Figure 1. United States Real GDP and Nominal GDP, 1929–1942</strong> </p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="dc41d649-463f-4439-9fd1-6dc9bff8af99" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/1.png?itok=JPfpNYTT 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/1.png?itok=0XEcYx7X 1.5x" width="700" height="282" src="/sites/cato.org/files/styles/pubs/public/2020-06/1.png?itok=JPfpNYTT" alt="Real and Nominal GDP, 1929-1942" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Source: U.S. Bureau of Economic Analysis, Gross Domestic Product [GDPA], retrieved from FRED, Federal Reserve Bank of St. Louis; <a href="https://fred.stlouisfed.org/series/GDPA">https://​fred​.stlou​is​fed​.org/​s​e​r​i​e​s​/GDPA</a>, June 28, 2020. </div> </figcaption></figure><p>For all its simplicity, this chart can help us to account for the methods by which the recovery was achieved, as well as for ways in which it might have been hastened. The first and perhaps least obvious of these methods, and also the least reliable, is deflation. When spending declines, the result must be either that fewer goods and services are sold, or that prices decline to allow any given amount of spending to purchase more goods and services, or some combination of both things. </p> <p>It follows that the more completely prices respond to fallen spending, the less sales will suffer. Because falling prices, besides preventing inventories from accumulating, also mean falling input costs, production may also be revived. In the chart, the gap between the red and green lines reflects the extent to which deflation prevented real output from collapsing as much as spending did. It’s therefore conceivable that, had it been possible for prices of all kinds to decline further, the depression would have ended sooner. “Conceivable.” But anything but certain, because deflation would have been of little help either to those struggling to pay debts contracted before it took place, or to their creditors. </p> <p>Instead, those who owed money would still owe as many dollars as ever, while each of the dollars owed would be more valuable than before. Consequently, the greater the extent of indebtedness when demand collapses, the less capable deflation becomes of supplying a way out; and, <a href="https://phare.univ-paris1.fr/fileadmin/PHARE/Irving_Fisher_1933.pdf" rel="nofollow external noopener noreferrer" target="_blank">as Irving Fisher observed in 1933</a>, “the debts of 1929 were the greatest known, both nominally and really, up to that time.” Under such circumstances, said Fisher in proposing his famous “debt‐​deflation” theory of the depression, </p> <blockquote><p>the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to right itself, but is capsizing. </p> </blockquote> <p>In short, deflation was the least reliable, and therefore the least desirable, of possible remedies for depression. It remains true, nonetheless, that so long as spending itself stayed depressed, policies that prevented prices from falling only tended to make matters worse. As we’ll see in later installments to this series, the Roosevelt administration didn’t always appreciate this unpleasant truth. </p> <p>The more sure‐​fire ways to fight a depression consist of means for reviving spending itself, so as to bring equilibrium prices back to their pre‐​depression levels—a procedure Fisher and his contemporaries called “reflation.” Broadly speaking, there are two ways to do this: expansionary monetary policy, and expansionary fiscal policy. The first consists of policies that increase the money stock—the sum of currency and bank deposits available for the public to spend. The second consists of policies that increase total spending by the government, and especially ones that increase that spending less than they increase taxation, which reduces the public’s spending power. “Fiscal stimulus” is just another name for an expansionary spending policy aimed at combating a recession or depression. </p> <h4>The Fiscal Stimulus that Wasn’t </h4> <p>Although almost everyone assumes that fiscal stimulus played a big part in bringing the Great Depression to an end, the truth is that its contribution was insignificant. </p> <p>Old myths die hard. Yet this one still ought to have died ages ago when it was thoroughly exploded by M.I.T. economist E. Cary Brown in his paper, “<a href="https://www.jstor.org/stable/1811908" rel="nofollow external noopener noreferrer" target="_blank">Fiscal Policy in the ‘Thirties: A Reappraisal.</a>” Here Brown reached the now‐​famous conclusion that fiscal policy “seems to have been an unsuccessful recovery device in the ‘thirties—not because it did not work, but because it was not tried.” More specifically, he reported that </p> <blockquote><p>the direct effects on aggregate full‐​employment demand of the fiscal policy undertaken by all three levels of government was clearly relatively stronger in the ‘thirties than in 1929 in only two years—1931 and 1936—with 1931 markedly higher than 1936… The trend of the direct effects of fiscal policy on aggregate full‐​employment demand is definitely downward throughout the ‘thirties. </p> </blockquote> <p>Although the federal government’s fiscal policy was itself “more expansionary throughout the ‘thirties than it was in 1929,” in most years after 1933 it wasn’t sufficiently so to offset reductions in state and local government spending. </p> <p>Brown was hardly alone in concluding that New Deal fiscal policy wasn’t particularly expansionary. He himself quotes <a href="https://en.wikipedia.org/wiki/Alvin_Hansen" rel="nofollow external noopener noreferrer" target="_blank">Alvin Hansen, “the American Keynes,”</a> writing to the same effect in 1941: </p> <blockquote><p>Despite the fairly good showing made in the recovery up to 1937, the fact is that neither before nor since has the administration pursued a really positive expansionist program. </p> </blockquote> <p>Save for only one exception I’m aware of—a rather unconvincing paper by <a href="https://academic.oup.com/cje/article-abstract/38/2/349/1707552" rel="nofollow external noopener noreferrer" target="_blank">Nathan Perry and Matias Vernango</a><a href="#_ftn1" id="_ftnref1" name="_ftnref1">[1]</a>—more recent scholarship concurs with these earlier findings. This includes <a href="https://www.jstor.org/stable/2123226?seq=1" rel="nofollow external noopener noreferrer" target="_blank">Christina Romer’s especially influential 1992 finding</a> that “fiscal policy contributed almost nothing to the recovery” of the 1930s. <a href="https://www.jstor.org/stable/43664570?seq=1" rel="nofollow external noopener noreferrer" target="_blank">Price Fishback (2010)</a> sums the current consensus up thus: </p> <blockquote><p>A nationwide Keynesian fiscal stimulus was never really attempted in the 1930s. During the Hoover Presidency Congress doubled federal spending and ramped up federal lending through the Reconstruction Finance Corporation. The Roosevelt Congresses then spent nearly double the Hoover levels. But both administrations collected enough taxes in a variety of new forms to maintain relatively small deficits throughout the period. Relative to a Keynesian deficit target designed to return to full employment, the deficits were minuscule. </p> </blockquote> <p>If some readers find this conclusion hard to believe, one of Fishback’s charts, comparing the small size of consolidated (federal, state, and local) real government spending and deficits to the Great Depression decline in real GNP relative to its 1929 level, should help them to overcome their skepticism: </p> <p><strong>Figure 2. GNP minus 1929 GNP, and Federal Expenditures, Revenues, and Budget Surplus/​Deficit in Billions of 1958 Dollars, 1929–1939</strong> </p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="90d0d970-a4d9-4d4b-9444-7af280713eed" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/2_0.png?itok=Rpxd-DIw 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/2_0.png?itok=tiI0MwRA 1.5x" width="700" height="355" src="/sites/cato.org/files/styles/pubs/public/2020-06/2_0.png?itok=Rpxd-DIw" alt="GNP minus 1929 GNP, and Federal Expenditures, Revenues, and Budget Surplus/Deficit in Billions of 1958 Dollars, 1929-1939" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Source: Fishback, Price. “U.S. Monetary and Fiscal Policy in the 1930s.” Oxford Review of Economic Policy 26, no. 3 (2010): 385–415. <a href="https://doi.org/10.3386/w16477">https://​doi​.org/​1​0​.​3​3​8​6​/​w​16477</a>. </div> </figcaption></figure><p>And here, for good measure, is another chart, this time from <a href="https://www.cato.org/blog/did-new-deal-help" rel="nofollow external noopener noreferrer" target="_blank">an essay by my Cato colleague Tom Firey</a>, showing just how small total government spending in the thirties was in relation to the size of the U.S. economy: </p> <p><strong>Figure 3. U.S. GDP and Government Spending</strong> </p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="7ae6996b-97ab-48d5-a997-cdf3295ac209" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/3_1.jpg?itok=YVxJUxqb 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/3_1.jpg?itok=JotZa2I8 1.5x" width="544" height="420" src="/sites/cato.org/files/styles/pubs/public/2020-06/3_1.jpg?itok=YVxJUxqb" alt="U.S. GDP and Government Spending" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Source: “Budget of the United States Government: Fiscal Year 2009” Historical Tables, Table 1.1; Bureau of Economic Analysis “National Economic Accounts,” Table 1.1.5. </div> </figcaption></figure><h4>The New Deal’s Fiscal Conservatism </h4> <p>Why, despite the New Deal, didn’t government spending—and federal government spending in particular—grow more than it did? And why was the growth of federal deficit spending even more modest? </p> <p>The answer to both questions is that, despite frequent claims to the contrary, the New Deal did not usher in a Keynesian fiscal revolution, or anything close. Instead, as Julian Keliser (p. 125) remarks in <a href="https://www.jstor.org/stable/27552097" rel="nofollow external noopener noreferrer" target="_blank">his brilliant essay on the subject</a>, “fiscal conservatism…remained normative for most of the New Deal.” FDR himself held fairly orthodox views about fiscal policy, and then made a point of picking Treasury secretaries whose views were even more orthodox. The chairs of almost all the key Senate and House committees, mostly southern Democrats, were also fiscal conservatives, as were some progressive Democratic representatives. Only after 1938, after the government had been blindsided by the 1937–8 depression and the New Deal was drawing to a close, did the Roosevelt administration finally abandon its commitment to limited spending and a balanced budget. </p> <p>In short, FDR really meant it when, during his campaign, he railed against Hoover’s “reckless spending” (“the greatest spending administration in peacetime in all our history”) and budget deficits. Indeed, if either Hoover or FDR can be said to have initiated a break with the past, Hoover probably deserves the credit. Spending doubled under his administration; and after a decade of year after year government surpluses starting in 1920, Hoover presided over the country’s biggest peacetime budget deficit. </p> <h4>New Deal Spending </h4> <p>Among other things, FDR had pledged to cut government spending by “at least 25 percent”; and he might well have done so had it not been for his commitment to offering relief to the unemployed. Owing to that commitment, FDR’s policy might be defined pithily as consisting of a commitment to a balanced budget plus a “relief valve,” that is, a willingness to tolerate deficits provided they were due to efforts to get money to the unemployed. It was mainly owing to FDR’s unwillingness to limit relief spending, and despite his determined efforts to cut spending of other sorts, that federal spending as a whole increased. </p> <p>The first of those determined efforts came soon after FDR’s inauguration when, on March 11th, Congress passed <a href="https://en.wikipedia.org/wiki/Economy_Act_of_March_20,_1933" rel="nofollow external noopener noreferrer" target="_blank">the Economy Act.</a> The bill didn’t quite cut spending as much as FDR had promised to cut it during his campaign, but it did trim the government’s $3.6 billion budget by $500 million by eliminating some government agencies and by cutting government salaries, pensions, and veterans’ benefits. The Act also strengthened FDR’s ability to make further cuts through executive authority. “Too often in recent history,” Roosevelt told Congress in recommending the measure, “liberal governments have been wrecked on the rocks of loose fiscal policy.” Nor was Roosevelt merely pandering to Congress’ powerful fiscal conservatives. According to <a href="https://en.wikipedia.org/wiki/Frank_Freidel" rel="nofollow external noopener noreferrer" target="_blank">Frank Friedel</a>, his first major biographer, far from being “a hypocritical concession” the Economy Act “was an integral part of Roosevelt’s overall New Deal.” </p> <p>In 1936, FDR took another big stab at cutting federal spending, this time by trimming “outlays on relief and public works in a great show of budget balancing” aimed at improving his reelection prospects: as <a href="https://www.jstor.org/stable/40256265?seq=1" rel="nofollow external noopener noreferrer" target="_blank">Bernard Lee</a>, whose words I just quoted, observes (p. 74), and as many may not realize, the very first Gallup poll, taken in September 1935, showed that 60 percent of the American public “thought government expenditures for relief and recovery were ‘too great,’ while only nine percent deemed them ‘too little’.” FDR made his third and last attempt to balance the budget in the spring of 1937, this time by reluctantly cutting relief spending. </p> <p>Notwithstanding these and other attempts at “economy,” New Deal spending was anything but modest by the standards of the time. On the contrary, as a share of GNP, FDR’s spending during the 30s was roughly twice Hoover’s, just as Hoover’s had been roughly twice Coolidge’s. In part, as we’ll see, this happened because Congress eventually managed to pass a Veterans Bonus Bill by overriding a second FDR veto. But it was mostly the result of “emergency” spending on various New Deal relief programs. The 1935 Emergency Relief Appropriations Act, which launched the WPA and PWA (among other programs), alone cost almost $4.88 billion, or almost $1 billion more than <em>total </em>federal expenditures during Hoover’s last year in office! </p> <h4>New Deal Deficits and Taxes </h4> <p>Yet even such prodigies of spending didn’t bring correspondingly impressive deficits. As Fishback reports, “only the deficits of 1934, 1936, and 1939… are much larger than Hoover’s 1932 and 1933 deficits,” and only that of 1936—the administration’s largest—was large enough to have given a substantial boost to aggregate demand. Alas for the theory that FDR was an early pioneer of Keynesian deficit spending, the 1936 deficit resulted from the passage, over his veto, of a $1.8 billion World War I Veterans Bonus Bill that January. <a href="https://www.jstor.org/stable/43821486?seq=1" rel="nofollow external noopener noreferrer" target="_blank">John Hausman</a> puts this singular New Deal instance of fiscal stimulus in perspective by noting that was roughly enough to allow every vet to buy a new Ford V8, and about the same share of GDP (2.1 percent) as President Obama’s 2009-10 Recovery and Reinvestment Act. </p> <p>The prosaic reason for the New Deal’s generally modest deficits is that New Deal tax revenues were also high. But the fundamental reason is that practically no one in government at the time believed in any such thing as “fiscal stimulus.” Instead the prevailing view, <a href="https://www.fdrlibrary.org/budget" rel="nofollow external noopener noreferrer" target="_blank">to which FDR himself subscribed</a>, was that a balanced budget served “to instill confidence in consumers, business, and the markets,” and to thereby “encourage investment and economic expansion.” If FDR tolerated massive relief spending, and any deficits that went with it, it wasn’t because he believed in “Keynesian” economics. It was because he didn’t want people going hungry and also (it must be said) because generous relief expenditures, appropriately directed, helped to <a href="https://www.hoover.org/research/politics-new-deal" rel="nofollow external noopener noreferrer" target="_blank">improve his odds of winning‐​over swing states in the 1936 election</a>. </p> <p>The non‐​Keynesian motivation behind New Deal spending went hand‐​in‐​hand with efforts by FDR and his Treasury team to fund as much of it as possible through increased taxation. Tax‐​funded spending had also been Hoover’s preference. But both presidents faced stiff Congressional opposition that ultimately caused their budget‐​balancing efforts to fail. The main difference between their tax policies consisted of the alternative taxes each president proposed. Hoover had favored, but was unable to get, a national sales tax, and instead ended up depending mainly on excise taxes that, besides failing to generate sufficient revenue to cover his government’s expenditures, fell most heavily on the poor. <a href="https://academic.oup.com/ahr/article-abstract/91/1/208/118840?redirectedFrom=fulltext" rel="nofollow external noopener noreferrer" target="_blank">Most New Deal government revenue also came from regressive excise taxes</a>, including a revived liquor tax. Unlike Hoover, FDR tried to supplement these taxes not with a sales tax but by raising income tax rates and introducing other sorts of new taxes.<a href="#_ftn2" id="_ftnref2" name="_ftnref2">[2]</a> </p> <p>Indeed, because high tax rates tended to retard economic growth, FDR’s attempts to balance the budget by resorting to them sometimes backfired. According to Fishback, this seems to have been the result when, by raising the top marginal income tax rate first to 63 percent and then to 79 percent, the Roosevelt administration encouraged aggressive tax avoidance. Various new taxes likewise “led to relatively small amounts of revenue at the cost of chilling some forms of investment activity,” while certain excise taxes, besides continuing to place a disproportionate burden on the poor, discouraged “growth in the leading technological growth sectors in the economy.”<a href="#_ftn3" id="_ftnref3" name="_ftnref3">[3]</a> </p> <h4>Post‐​New Deal Keynesianism </h4> <p>It was, ironically, partly owing to FDR’s efforts to balance the budget that he was ultimately compelled to embrace deficit spending. For besides making aggressive cuts to relief programs to compensate for the Bonus Bill debacle of 1936, FDR introduced several new taxes, including the notorious <a href="https://en.wikipedia.org/wiki/Undistributed_profits_tax" rel="nofollow external noopener noreferrer" target="_blank">undistributed profits tax</a>. The government also began collecting the new social security tax, authorized by the 1935 Social Security Act, in January 1937. Because the government wouldn’t begin paying social security <em>benefits </em>until 1940, the overall result of the 1937 tax was a considerable reduction in the government’s net contribution to overall spending. Steps were also being taken in the meantime, both by the Treasury and by the Federal Reserve, that all but slammed the brakes on growth in the money stock, dampening spending that much further. The combined results of these developments was the devastating depression of 1937–8 that undid much of the recovery achieved during Roosevelt’s first term. </p> <p>The “Roosevelt Recession,” as Republicans especially liked to refer to it, was to alter FDR’s policies in two ways. First, it marked the winding‐​down of the New Deal, properly understood. 1938 saw the last major piece of New Deal legislation, the Fair Labor Standards Act. Second, it marked the beginning of “Keynesian” fiscal policy, first as a matter of necessity, but soon enough as a matter of genuinely revised beliefs. With FDR’s request, in April 1938, for $3 billion in spending for immediate relief efforts, the idea that deficits might actually serve a countercyclical purpose, which certain economists had been urging for years, at last took hold in the halls of power.<a href="#_ftn4" id="_ftnref4" name="_ftnref4">[4]</a> Even then the conversion was far from complete. The New Dealers were still not ready to see tax cuts as a means for achieving fiscal stimulus. “In the late 1930s,” <a href="https://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=1557&amp;context=lcp" rel="nofollow external noopener noreferrer" target="_blank">Joseph Thorndike (2009, p. 122) observes</a>, “the notion of countercyclical tax cuts…remained in the land of economic theory, not political reality.” <a href="https://www.jstor.org/stable/4538063?seq=1" rel="nofollow external noopener noreferrer" target="_blank">Robert Musgrave</a> puts the point even more strongly, saying that expansionary tax cuts were still “unthinkable” then. According to Thorndike, such cuts only gained acceptance “after the fiscal watershed of World War II.” </p> <p>*** </p> <p>That New Deal fiscal policy contributed little to recovery from the Great Depression, and probably contributed to the setback of 1937–8, doesn’t mean that the New Deal as a whole contributed little to recovery. To assess the New Deal’s overall contribution to the recovery, we have to consider the consequences of other New Deal programs and policies, including those that influenced the behavior of the U.S. money stock. I’ll take up New Deal monetary policy next. </p> <p><strong>Continue Reading<em> The New Deal and Recovery:</em></strong> </p> <ul><li><a href="https://www.cato.org/blog/new-deal-recovery-new-series">Intro</a></li> <li><a href="https://www.cato.org/blog/new-deal-recovery-part-1-record">Part 1: The Record</a></li> <li><a href="https://www.cato.org/blog/new-deal-recovery-part-2-inventing-new-deal">Part 2: Inventing the New Deal</a></li> <li>Part 3: The Fiscal Stimulus Myth</li> </ul><p>___________________ </p> <p><a href="#_ftnref1" id="_ftn1" name="_ftn1">[1]</a> Perry and Vernengo attempt to argue that New Deal fiscal policy mattered more than others have claimed partly on a priori grounds, and partly by questioning extant estimates of the New Deal era fiscal multiplier. But <a href="https://www.jstor.org/stable/40256265?seq=1" rel="nofollow external noopener noreferrer" target="_blank">as Bernard Lee noted in 1982</a> (pp. 69–70), even allowing for a generous multiplier New Deal spending was never sufficient “to support more than a fraction of the vast numbers of jobless and destitute at anything but a minimum level.” As for Perry and Vernengo’s <em>a priori</em> argument, it seems to rest upon a strange dichotomy between growth in the supply or velocity of money and growth in spending. Thus they write that while “recoveries tend to rely both on increasing money supply and increased velocity of circulation,” they “<em>also</em> rely on the expansion of spending (in general a combination of private and public spending)” (my emphasis). That illogical “also” allows them to conclude that an increase in the money stock (or in MV) “is only one of the several elements needed for economic recovery” and that expansionary fiscal policy must, therefore, have played an important part. </p> <p><a href="#_ftnref2" id="_ftn2" name="_ftn2">[2]</a> For more on New Deal tax policy see Mark Leff’s fascinating study, <em>The Limits of Symbolic Reform: The New Deal and Taxation, 1933–1939 </em>(<a href="https://www.cambridge.org/us/academic/subjects/history/american-history-general-interest/limits-symbolic-reform-new-deal-and-taxation-19331939?format=PB&amp;isbn=9780521521246" rel="nofollow external noopener noreferrer" target="_blank">Cambridge University Press, 1984</a>). <a href="https://academic.oup.com/ahr/article-abstract/91/1/208/118840" rel="nofollow external noopener noreferrer" target="_blank">According to Ellis Hawley</a>, “Leff shows that there were really two New Deal tax systems: a ‘revenue work‐ horse,’ featuring regressive levies so masked as to allow coexistence with Populist and redistributionist rhetoric, and a ‘symbolic showpiece,’ raising insignificant amounts of revenue but serving the New Deal politically by undercutting and diverting attacks from both the Left and the Right. One became the hidden substance; the other produced the image that still persists.” </p> <p><a href="#_ftnref3" id="_ftn3" name="_ftn3">[3]</a> Concerning the adverse effects upon the investment of New Deal tax policies, and of high rates of dividend taxation especially, see <a href="https://www.jstor.org/stable/23251990?seq=1" rel="nofollow external noopener noreferrer" target="_blank">Ellen McGrattan’s painstaking 2012 study</a>. According to it, New Deal tax policies can account for the steep declines in tangible investment both between 1933 and 1935 and in 1937, where the second decline was mainly a result of the undistributed profits tax. </p> <p><a href="#_ftnref4" id="_ftn4" name="_ftn4">[4]</a> On this see William J. Barber, <em><a href="https://www.amazon.com/Designs-within-Disorder-Economists-Perspectives/dp/0521034310" rel="nofollow external noopener noreferrer" target="_blank">Designs within Disorder</a>: Franklin D Roosevelt, The Economists, and the Shaping of American Economic Policy, 1933–1945</em> (Cambridge University Press, 1996), p. 83. </p> <p>[<a href="https://www.alt-m.org/2020/06/29/the-new-deal-and-recovery-part-3-the-fiscal-stimulus-myth/">Cross‐​posted from Alt​-​M​.org</a>] </p> Mon, 29 Jun 2020 10:37:51 -0400 George Selgin https://www.cato.org/blog/new-deal-recovery-part-3-fiscal-stimulus-myth Liu: Reining in the SEC’s Enforcement Remedies https://www.cato.org/blog/liu-reining-secs-enforcement-remedies Jennifer J. Schulp <p>Earlier this week, in <a href="https://www.supremecourt.gov/opinions/19pdf/18-1501_8n5a.pdf" rel="nofollow external noopener noreferrer" target="_blank"><em>Liu v. SEC</em></a>, the Supreme Court held that the SEC may seek "disgorgement" from a wrongdoer in a civil action, but only to the extent of the net profits from a violation and the award must benefit the victims. Unlike several other recent <a href="https://www.supremecourt.gov/opinions/16pdf/16-529_i426.pdf" rel="nofollow external noopener noreferrer" target="_blank">Supreme</a> <a href="https://www.supremecourt.gov/opinions/17pdf/17-130_4f14.pdf" rel="nofollow external noopener noreferrer" target="_blank">Court</a> <a href="https://www.supremecourt.gov/opinions/12pdf/11-1274_aplc.pdf" rel="nofollow external noopener noreferrer" target="_blank">decisions</a>, this one may look like a victory for the SEC. But partly because of the many questions it leaves unanswered, and partly because of the limits it places on the SEC's ability to seek disgorgement, the decision will likely result in fewer, and smaller, disgorgement awards in SEC enforcement actions. Whether a win or a loss for the SEC, though, <em>Liu</em> should result in a more principled and consistent application of the SEC's remedial authority. That's a step in the right direction.</p> <p>The <a href="https://www.law.cornell.edu/uscode/text/15/78u" rel="nofollow external noopener noreferrer" target="_blank">Exchange Act</a> grants the SEC enforcement authority over securities law violations, including permitting the SEC to sue in federal court. If the suit is successful, the SEC can be awarded monetary penalties, injunctive relief, or equitable remedies. The specific question presented by the <em>Liu </em>case is whether a "disgorgement" award is a remedy typically available at equity. <a href="https://www.law.cornell.edu/wex/disgorgement" rel="nofollow external noopener noreferrer" target="_blank">Disgorgement</a> generally means requiring a wrongdoer to give up profits he or she made as a result of the wrongful conduct, though as this case shows, the term has a somewhat flexible meaning.</p> <p>The Supreme Court's opinion rests on its understanding of remedies traditionally available in a court of equity (as opposed to a court of law), and whether and under what conditions disgorgement qualifies as such a remedy. As a lawyer, I find such delving into legal analysis of legal traditions fun. But you may be forgiven if you do not. I'll therefore spare you a discussion of the differences between law and equity, and skip to summarizing the Court's decision and its background before addressing its likely effects.</p> <p>This case arose from an SEC suit against a couple who solicited nearly $27 million from foreign investors to build a cancer-treatment center. The couple was found to have defrauded investors, having spent only a fraction of the funds raised for legitimate purposes. They were enjoined from future participation in a foreign investor program, subjected to a monetary penalty at the highest tier authorized, and ordered to disgorge the full amount raised from the investors, minus a small sum left in their project's corporate accounts. The court held the pair jointly and severally liable, meaning that each was responsible for the full amount that the SEC sought.</p> <p>While the <em>Liu</em> case was pending, the Supreme Court decided <a href="https://www.supremecourt.gov/opinions/16pdf/16-529_i426.pdf" rel="nofollow external noopener noreferrer" target="_blank"><em>Kokesh v. SEC</em></a>, which held that disgorgement was a "penalty" for statute of limitations purposes. Generally speaking, equitable remedies are not meant to penalize or punish. And although the Supreme Court explicitly reserved the question of whether the SEC was authorized to seek disgorgement, the Court rested its holding, in part, on findings that disgorgement is assessed, in part, for punitive purposes, and in many cases is not compensatory. <em>Kokesh</em> therefore seemed to sound the death knell for the SEC's disgorgement authority as an authorized equitable remedy.</p> <p>When squarely faced with the question in <em>Liu</em>, though, the Court preserved the SEC's disgorgement authority by rewriting it. Recognizing that "equity courts have routinely deprived wrongdoers of their net profits from unlawful activity," it found that the SEC does have the right to seek disgorgement, but that this right is limited. Specifically, it held that a disgorgement-type remedy is valid when: limited to the net profits from the wrongdoing; wrongly obtained profits are returned to the wronged victims; and awarded against a single wrongdoer only, rather than jointly and severally. When the SEC seeks disgorgement beyond these limits, its practice "is in considerable tension with equity practices."</p> <p>This tension is not just theoretical. The Court pointed to several examples of unwarranted SEC disgorgement awards: disgorging the profits from unlawful trades of a defendant's stockbroker, disgorging benefits conferred on close associates, and disgorging without offsetting business expenses. Another example is when disgorgement wrongfully obtained profits in Foreign Corrupt Practices Act matters where the only offense charged was recordkeeping errors that did not garner profits, as the Cato Institute pointed out in its <a href="https://www.cato.org/sites/cato.org/files/2019-12/Liu%20v%20SEC%20merits.pdf" rel="nofollow external noopener noreferrer" target="_blank">amicus brief</a>.</p> <p>Because the defendants in the <em>Liu </em>case sought to have disgorgement ruled out entirely rather than reformed, the Court sent the case back to the lower courts with "principles that may guide" their consideration of an appropriate disgorgement order. These principles mirror the limitations imposed on equitable remedies: the award must be "appropriate or necessary for the benefit of the investors"; individual liability for wrongful profits; and awards must not exceed net profits. But the Court leaves several unanswered questions, including:</p> <p><em>1.) What does it mean for a remedy to be for the "benefit of investors"? </em>The answer to this question in the <em>Liu </em>decision will shape both what the SEC does with the money collected and when the SEC may seek a disgorgement award. The Court counseled that the equitable nature of disgorgement "generally requires the SEC to return a defendant's gains to the wronged investors for their benefit." While the SEC touts its return of <a href="https://www.sec.gov/files/enforcement-annual-report-2019.pdf" rel="nofollow external noopener noreferrer" target="_blank">$1.2 billion</a> to harmed investors in 2019, that number is a fraction of the $3.2 billion of disgorgement collected that year. To comply with the Court's limitations, the SEC must do more than merely deposit the proceeds in the U.S. Treasury.</p> <p>What more can it do? It seems obvious that where victims are easily identified and easily located, the money should be returned to them. But suppose an investor cannot be located. May the SEC collect the award anyway and put the funds to some other use? The Dodd-Frank Act created an <a href="https://www.law.cornell.edu/uscode/text/15/78u-6" rel="nofollow external noopener noreferrer" target="_blank">"investor protection fund"</a> that can be used for undistributed disgorgement awards. Funds deposited there are used to pay whistleblower awards, among other things. Is that "for the benefit of investors"? What about a fund set up for other purposes, like investor education? Or should disgorged funds be paid into a <a href="https://www.law.cornell.edu/uscode/text/15/7246" rel="nofollow external noopener noreferrer" target="_blank">"fair fund"</a> to compensate other victims? Should any of these uses be considered for the "benefit of investors," may the SEC resort to them <em>instead</em> of returning disgorged funds to known and located victims? And what if the victims have already been compensated through some other remedy. May the SEC still seek disgorgement?</p> <p>When victims are not readily identifiable, a different set of questions arises. The SEC brings suit for a host of violations where an ill-gotten gain may be identifiable, but it is hard, if not impossible, to identify any particular <em>victims</em> of the violation. For example, the SEC routinely seeks disgorgement of profits in insider trading cases. Will the SEC have to forgo such awards in the future?</p> <p>These and other questions are likely to give rise to significant litigation in the coming years depending on how aggressively the SEC seeks to exercise its (limited) disgorgement authority.</p> <p><em>2.) Will the SEC be limited to "Liu disgorgement" in administrative proceedings? </em>The <em>Liu</em> decision deals specifically with the question of the SEC's remedies in civil actions. But the SEC also brings suit in its own administrative tribunals. For administrative actions, the <a href="https://www.law.cornell.edu/uscode/text/15/77h-1" rel="nofollow external noopener noreferrer" target="_blank">statute</a> specifically authorizes the SEC to seek "disgorgement." The Court's opinion, however, does not address whether the limits that it applies to disgorgement as an equitable remedy will apply to disgorgement as an administrative remedy. As Justice Thomas points out in his <a href="https://www.supremecourt.gov/opinions/19pdf/18-1501_8n5a.pdf" rel="nofollow external noopener noreferrer" target="_blank">dissenting opinion</a>, this will "cause confusion in administrative practice," and the result may be that "disgorgement has one meaning when the SEC goes to district court and another when it proceeds in house." Besides confusion, competing definitions of disgorgement may result in a greater shift to administrative cases for certain types of misconduct. Historically, the SEC has enjoyed a significant <a href="https://www.wsj.com/articles/sec-wins-with-in-house-judges-1430965803" rel="nofollow external noopener noreferrer" target="_blank">home-field advantage</a> in its tribunals, but that may <a href="https://www.natlawreview.com/article/who-wins-sec-administrative-proceedings" rel="nofollow external noopener noreferrer" target="_blank">no longer</a> be the case. Competing definitions of disgorgement may also make settlement negotiation more difficult for those cases that do not litigate.</p> <p><em>3.) Is disgorgement still a penalty for statute of limitation purposes? </em>Because the Supreme Court's decision in <em>Kokesh</em> rested, in part, on its findings that disgorgement was punitive and often not compensatory, the lines drawn by the Court in <em>Liu</em> seem to make those findings obsolete. Does that mean, then, that the SEC is no longer bound by the same statute of limitations concerns for disgorgement? The SEC <a href="https://www.sec.gov/files/enforcement-annual-report-2019.pdf" rel="nofollow external noopener noreferrer" target="_blank">recognizes</a> the significant headwinds that the <em>Kokesh</em> decision created for collecting disgorgement, particularly for long-running frauds. The SEC may choose to press this argument to recapture some disgorgement authority, particularly given the other limitations imposed by this decision.</p> <p>All of these open questions may magnify the effects of the <em>Liu </em>decision's certainties—that disgorgement awards will be more limited and harder to prove. This should result in fewer, and smaller, disgorgement awards going forward. There may be a significant impact on the SEC's remedies, where disgorgement has far outpaced monetary penalties for years, accounting for <a href="https://www.sec.gov/files/enforcement-annual-report-2019.pdf" rel="nofollow external noopener noreferrer" target="_blank">75% of monetary relief ordered</a> in 2019.</p> <p>The Court made clear that any disgorgement award will be based on a fact-intensive inquiry into the amount of wrongful gains an individual wrongdoer received. Disgorgement awards must not exceed the unlawful gains made, when both the receipts and payments are taken into account, and courts must consider whether expenses incurred have a value independent of fueling a fraudulent scheme. While not prohibiting joint-and-several liability, the Court cautioned against its use. These limitations will subject the SEC's demands to more scrutiny, even if all of the open questions break in the SEC's favor.</p> <p>The <em>Liu </em>decision should put an end to disgorgement awards that exceed the value of illegally obtained profits. Such awards were not aimed at restoring the status quo. Instead they were punitive, leaving defendants worse off. The SEC has other tools at its disposal to penalize defendants, including monetary penalties. <em>Liu</em>'s limitations on the SEC's discretion will force the SEC to make more clear distinctions between remedies meant to punish and remedies meant to restore the status quo. More clear lines between the two will increase transparency and consistency in the SEC's enforcement efforts, and make it easier to assess the effectiveness of the SEC's remedial tools. <em>Liu </em>will also likely increase the share of disgorgement awards that directly compensate victims of wrongdoing. For those reasons, <em>Liu</em> should be viewed as a win for us all.</p> <p> [<a href="https://www.alt-m.org/2020/06/26/liu-reining-in-the-secs-enforcement-remedies/">Cross-posted from Alt-M.org</a>]</p> <p></p> Fri, 26 Jun 2020 09:51:39 -0400 Jennifer J. Schulp https://www.cato.org/blog/liu-reining-secs-enforcement-remedies A Fed for Next Time: Ideas for a Crisis‐​Ready Central Bank — Panel 4: Preserving Monetary Autonomy https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-4-preserving-monetary Peter Stella, George Selgin, Sebastian Edwards, Victoria Guida <div class="mb-3 spacer--nomargin--last-child text-default"> <p>In just a&nbsp;dozen years, the Federal Reserve has faced two severe crises. And twice it has responded by leaning heavily on emergency lending powers it seldom used before by improvising temporary lending programs and taking part in fiscal policy.</p> <p>In the meantime, the Fed’s nonemergency lending facilities have hardly changed, and may well prove insufficient when the Fed faces its next crisis.</p> <p>The implication of this is both obvious and ominous: while we still count on the Fed to deal with crises, we no longer know how it will deal with them. Instead of being predictable, the Fed’s crisis‐​prevention methods have become unpredictable–and controversial–adding to, instead of allaying, economic scrutiny.</p> <p>Can we do better? Can we improve the Fed’s systematic response to crises, making that response both more effective and more predictable? Can we thereby limit the Fed’s entanglement in politics? What can the Fed do to promote these ends? What might Congress do?</p> </div> Thu, 25 Jun 2020 10:08:20 -0400 Peter Stella, George Selgin, Sebastian Edwards, Victoria Guida https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-4-preserving-monetary A Fed for Next Time: Ideas for a Crisis‐​Ready Central Bank — Panel 3: Modernizing Liquidity Provision https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-3-modernizing-liquidity David Andolfatto, William Nelson, Jeremy Kronick, Jeff Cox <div class="mb-3 spacer--nomargin--last-child text-default"> <p>In just a&nbsp;dozen years, the Federal Reserve has faced two severe crises. And twice it has responded by leaning heavily on emergency lending powers it seldom used before by improvising temporary lending programs and taking part in fiscal policy.</p> <p>In the meantime, the Fed’s nonemergency lending facilities have hardly changed, and may well prove insufficient when the Fed faces its next crisis.</p> <p>The implication of this is both obvious and ominous: while we still count on the Fed to deal with crises, we no longer know how it will deal with them. Instead of being predictable, the Fed’s crisis‐​prevention methods have become unpredictable–and controversial–adding to, instead of allaying, economic scrutiny.</p> <p>Can we do better? Can we improve the Fed’s systematic response to crises, making that response both more effective and more predictable? Can we thereby limit the Fed’s entanglement in politics? What can the Fed do to promote these ends? What might Congress do?</p> </div> Tue, 23 Jun 2020 12:04:46 -0400 David Andolfatto, William Nelson, Jeremy Kronick, Jeff Cox https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-3-modernizing-liquidity Paycheck Protection Program: Who Lent to Whom, and Where? https://www.cato.org/blog/paycheck-protection-program-who-lent-whom-where Diego Zuluaga <p>It’s been 11 weeks since Congress passed the CARES Act, which, among its many other provisions, established the <a href="https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program" rel="nofollow external noopener noreferrer" target="_blank">Paycheck Protection Program</a> (PPP). Nearly three‐​quarters of U.S. small businesses have so far availed themselves of this program. But it turns out that fewer small businesses got a PPP loan in the states hardest‐​hit by the Covid‐​19 pandemic than elsewhere. And whereas it seemed early on that small banks had done a better job than larger reaching the smallest businesses, the most recent public data contradict that initial finding. </p> <p>The PPP consists of government‐​guaranteed Small Business Administration (SBA) loans, of which the SBA will forgive any part that businesses use to pay wages, rent, and utilities. The SBA <a href="https://content.sba.gov/sites/default/files/2020-06/PPP_Report_20200612.pdf" rel="nofollow external noopener noreferrer" target="_blank">reports</a> that banks and other authorized lenders have made $512 billion worth of PPP loans so far, out of the total $659 billion Congress appropriated.<a href="#_ftn1" name="_ftnref1" id="_ftnref1">[1]</a> The total number of loans was 4,576,388, for an average loan amount of $111,900. </p> <p>Whether the PPP achieved its main objective of preventing small businesses from firing their staff and closing their doors permanently will take some months to determine. If the same proportion of PPP borrowers and non‐​borrowers ends up shutting down, then the PPP will have been a waste—albeit not completely, as enabling firms to keep workers on their payroll will have reduced claims for unemployment insurance, if only temporarily. But failed businesses will still dissolve, destroying the intangible capital that the PPP was meant to protect. If, on the other hand, a significantly larger proportion of borrowers than non‐​borrowers survives, and assuming both sets of firms are similar, the PPP will have succeeded. </p> <p><strong>Table 1. Percentage of Small Businesses in Receipt of a PPP Loan, by State (as of June 6)</strong> </p> <p><a href="https://cdn.alt-m.org/wp-content/uploads/2020/06/Screen-Shot-2020-06-17-at-3.30.17-PM.png" rel="nofollow noopener noreferrer"><img alt="" height="1379" src="https://cdn.alt-m.org/wp-content/uploads/2020/06/Screen-Shot-2020-06-17-at-3.30.17-PM.png" width="2083" /></a> </p> <p>Source: Small Business Administration, 2020; Census Bureau, 2017. </p> <p>Answering other questions about the program’s efficacy, such as what the extent of borrower <a href="https://www.jdsupra.com/legalnews/first-paycheck-protection-program-fraud-14263/" rel="nofollow external noopener noreferrer" target="_blank">fraud</a> was, will require data that the SBA hasn’t yet published. But the agency’s regular <a href="https://www.sba.gov/funding-programs/loans/coronavirus-relief-options/paycheck-protection-program" rel="nofollow external noopener noreferrer" target="_blank">reports</a><a href="#_ftn2" name="_ftnref2" id="_ftnref2">[2]</a> on the PPP already offer insights into the program’s reach, its distribution across small businesses, and the types of lenders that have primarily catered to borrowers of different sizes. Although many small businesses nationwide (72.6 percent) have received PPP funding, the share varies considerably from state to state, with 57.3 percent of Delaware small businesses borrowing from the PPP, compared with 96.5 percent in Mississippi. In general, Southern and Midwestern states have had particularly high rates of PPP loan penetration, while Eastern states and those in the Pacific Northwest have had lower rates. </p> <p>States with high loan penetration rates in the PPP’s first round, which closed on April 16 after heavy demand, tend to also have higher overall penetration rates. This pattern raises the question of whether fewer small businesses took PPP loans in laggard states because the second round of funds came too late. While the PPP’s nationwide penetration rate is consistent with an April <a href="https://www.nber.org/papers/w26989.pdf" rel="nofollow external noopener noreferrer" target="_blank">survey</a> that found 70 percent of small businesses anticipated applying, the pandemic first hit New England, Washington state, and California, which have lower loan penetration rates than the U.S. as a whole. Some of these states’ small businesses, lacking any options for short‐​term funding, may have shut down for good. But it’s not yet possible to tell. </p> <p>The size of the average PPP loan has gradually declined, with loans under $150,000 taking up just 17 percent of the total amount in the first round, but 45 percent subsequently. As of June 12, loans under the $150,000 threshold accounted for 26.6 percent of the total amount for both rounds. Smaller loans’ growing weight partly reflects the public <a href="https://www.wsj.com/articles/mnuchin-warns-larger-companies-against-seeking-coronavirus-funds-meant-for-small-businesses-11588083665" rel="nofollow external noopener noreferrer" target="_blank">browbeating</a> of large firms that followed the first round, when it came to light that some firms got PPP loans, crowding out smaller applicants, when they might have raised capital elsewhere. This criticism led some of the largest recipients to <a href="https://www.nbcnews.com/business/business-news/which-companies-are-returning-their-ppp-loan-here-s-list-n1194566" rel="nofollow external noopener noreferrer" target="_blank">return</a> their loans. It may also have discouraged other eligible large firms from taking advantage of the program in the second round. </p> <p>Responding to news <a href="https://www.nytimes.com/2020/04/22/business/sba-loans-ppp-coronavirus.html" rel="nofollow external noopener noreferrer" target="_blank">reports</a> that large banks had favored their large commercial clients over other PPP applicants, Congress, in authorizing $310 billion of additional PPP funding, set aside $60 billion for small banks, credit unions, and community lenders to allocate. Specifically, Congress earmarked $30 billion for banks with between $10 billion and $50 billion in assets, and another $30 billion for banks and other lenders with assets of less than $10 billion. These congressional set‐​asides were based on the conventional wisdom that small banks lend more to the smallest businesses. But the truth, as <a href="https://www.alt-m.org/2020/05/11/who-lends-to-small-businesses/" rel="nofollow noopener noreferrer">I’ve</a> shown elsewhere, is that large banks’ average business loans actually tend to be of smaller size than those made by small banks perhaps because large banks issue most of the business credit cards on which many of the smallest businesses rely. </p> <p>Does the pattern of PPP lending also belie the conventional wisdom? An early <a href="https://libertystreeteconomics.newyorkfed.org/2020/05/where-have-the-paycheck-protection-loans-gone-so-far.html" rel="nofollow external noopener noreferrer" target="_blank">study</a> by economists at the New York Fed seemed to suggest that it didn’t: states where small banks account for a large share of retail deposits tended to have high rates of PPP loan penetration in the program’s first round.<a href="#_ftn3" name="_ftnref3" id="_ftnref3">[3]</a> (These states also happen to be <a href="https://www.nytimes.com/interactive/2020/us/coronavirus-stay-at-home-order.html" rel="nofollow external noopener noreferrer" target="_blank">among the few</a> that were never under statewide stay‐​at‐​home orders.) But the finding may be spurious, because small banks are more common in agricultural states with sparse populations, and other Fed <a href="https://www.newyorkfed.org/smallbusiness/small-business-credit-survey-2018" rel="nofollow external noopener noreferrer" target="_blank">research</a> suggests that firms in rural areas are more likely to have established bank credit relationships. It follows that rural firms may have found it easier than most to get PPP loans in the early days of the program. As it happens, small‐​bank market shares no longer seem to predict PPP loan penetration (Figure 1). </p> <p><strong>Figure 1. PPP Loan Penetration and Small Banks’ Market Share, by State (as of June 6)</strong> </p> <p><a href="https://cdn.alt-m.org/wp-content/uploads/2020/06/ppp-e1592483003722.png" rel="nofollow noopener noreferrer"><img alt="" height="402" src="https://cdn.alt-m.org/wp-content/uploads/2020/06/ppp-e1592483003722.png" width="720" /></a> </p> <p>Source: Author’s calculations using FDIC, SBA, and Census Bureau data. </p> <p>Despite the congressional set‐​aside, the PPP market share of banks with under $50 billion in assets actually declined after the first round, from 70 percent to 50 percent of the total amount. Small banks did make somewhat smaller PPP loans, on average, than larger banks: the average loan by lenders with less than $10 billion in assets was $103,500 as of June 6, compared with $141,700 for lenders with between $10 billion and $50 billion, and $119,800 among those with more than $50 billion. But there are considerable differences among the largest banks. J.P. Morgan Chase, America’s largest bank by assets, is also the top PPP lender, with an average loan of $111,041. But three other megabanks (Bank of America, Wells Fargo, and U.S. Bank) that also feature among the top 10 had much smaller average loans (Table 2). Also of note is Cross River Bank’s outstanding performance, which, as the small size of its average loan hints, owes much to the $3 billion bank’s <a href="https://www.nytimes.com/2020/06/10/business/economy/fintechs-loan-small-business.html" rel="nofollow external noopener noreferrer" target="_blank">strong relationships</a> with fintechs. </p> <p><strong>Table 2. Top 15 PPP Lenders (as of June 12)</strong> </p> <p><a href="https://cdn.alt-m.org/wp-content/uploads/2020/06/Screen-Shot-2020-06-17-at-3.33.18-PM.png" rel="nofollow noopener noreferrer"><img alt="Paycheck Protection Program" height="1063" src="https://cdn.alt-m.org/wp-content/uploads/2020/06/Screen-Shot-2020-06-17-at-3.33.18-PM.png" width="2057" /></a> </p> <p>Source: Small Business Administration, 2020. </p> <p>In summary, banks with under $10 billion in assets made slightly smaller loans, on average, than their counterparts with more than $50 billion. But banks in‐​between those thresholds, despite their inclusion in the congressional set‐​aside, made the largest average loans of all. And some of the nation’s largest banks had much smaller average loans than small banks. The PPP experience therefore still doesn’t validate the cliché that it is small banks that mostly lend to the smallest businesses. Instead, it seems that fintechs focus on the smallest loans (under $50,000), with small banks catering to somewhat larger firms (asking for a PPP loan between $50,000 and $150,000), while larger banks serve larger businesses, and megabanks serve all. </p> <p>It’s too early to determine whether the PPP has met its own objective of helping small businesses survive the economic ramifications of the Covid‐​19 pandemic. But the SBA’s reports point to two developments that policymakers should keep in mind as they evaluate the program’s success: small businesses in the hardest‐​hit states got a less‐​than‐​proportionate share of PPP loans, and small banks didn’t lend more, or lend to the smallest businesses, after Congress set aside funds ostensibly for that purpose. </p> <p>****** </p> <p><a href="#_ftnref1" name="_ftn1" id="_ftn1">[1]</a> Of that total, Congress appropriated $349 billion under the CARES Act and $310 billion under the Enhancement Act passed one month later. </p> <p><a href="#_ftnref2" name="_ftn2" id="_ftn2">[2]</a> This post uses data from the SBA’s June 6 and June 12 reports. While there were some slight changes in the numbers from one report to the other, none of the patterns identified here is substantially different. </p> <p><a href="#_ftnref3" name="_ftn3" id="_ftn3">[3]</a> The New York Fed researchers used $1 billion as the asset threshold for a small bank, whereas the more common threshold (and the one used in this post) is $10 billion. </p> <p>I thank Nick Anthony for his excellent research assistance. </p> <p>[<a href="https://www.alt-m.org/2020/06/18/paycheck-protection-program-who-lent-to-whom-and-where/">Cross‐​posted from Alt​-​M​.org</a>] </p> Mon, 22 Jun 2020 16:58:05 -0400 Diego Zuluaga https://www.cato.org/blog/paycheck-protection-program-who-lent-whom-where Fed Policy: A Shadow Review—New Issue of the Cato Journal https://www.cato.org/blog/fed-policy-shadow-review-new-issue-cato-journal Amanda Griffiths <p>Cato's <a href="https://www.cato.org/events/37th-annual-monetary-conference" rel="nofollow external noopener noreferrer" target="_blank">Annual Monetary Conference</a> last November hosted a "shadow review" of the Federal Reserve's own self-review, dedicated to examining "whether the U.S. monetary policy framework can be improved to meet future challenges." The articles in the spring/summer 2020 issue of the <em>Cato Journal</em>, drawn from that conference, are now <a href="https://www.cato.org/cato-journal/spring/summer-2020" rel="nofollow external noopener noreferrer" target="_blank">available online</a>.</p> <p>With inflation then consistent with the Fed's 2 percent target and unemployment at remarkable lows, the Fed likely didn't expect that the "future challenges" it planned to address would come so soon, or be so extreme. Today, thanks to the federal response to the Covid-19 pandemic shuttering businesses across the country, the Fed has once again reduced its policy rate almost to zero, while renewing its large-scale asset purchases and undertaking an unprecedented program of emergency lending that has all but erased the conventional boundary line separating monetary from fiscal policy. These developments make a reexamination of the Fed's policy framework seem even more important than they were last fall.</p> <p>In his <a href="https://www.cato.org/cato-journal/spring/summer-2020/editors-note" rel="nofollow external noopener noreferrer" target="_blank">Editor's Note</a>, Cato Vice President for Monetary Studies James A. Dorn writes that today, "central banks have… greater discretion and lending authority than ever before. Monetary policy has morphed into fiscal policy. The Fed is in uncharted waters and a review of policies aimed at the 2008 financial crisis is inadequate. A major assessment of central banking and alternative money regimes is overdue." Several participants in last fall's event have updated their articles to reflect these developments.</p> <p>In the spirit of fostering dialogue and debate about what we can learn from past policy errors and how to apply those lessons going forward, the <em><a href="https://www.cato.org/cato-journal/about" rel="nofollow external noopener noreferrer" target="_blank">Cato Journal </a></em>is proud to present the articles summarized below. (To access the full text of an article, click on its title.)</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/federal-reserves-review-its-monetary-policy-strategy-tools-communication" rel="nofollow external noopener noreferrer" target="_blank">The Federal Reserve's Review of Its Monetary Policy Strategy, Tools, and Communication Practices</a>," </strong>Richard H. Clarida, Vice Chair of the Board of Governors of the Federal Reserve System</p> <p>Since the 2008 crisis, the global economy has changed in two critical ways, Clarida says. First, the natural rate of interest has fallen, and remained, well below its precrisis baseline. That makes it harder for central bankers to conduct effective countercyclical policy (which often means lowering their policy interest rate) during economic recessions. With the Fed's primary policy strategy increasingly in doubt, the Board of Governors is considering new tools it can use at the zero lower bound.</p> <p>Second, the short-run Phillips curve, measuring the relationship between inflation and unemployment, is flattening. In and of itself, that's not necessarily a bad thing—but it does mean that Fed policymakers should take exceptional care to keep inflation at their self-assigned, 2 percent target, which they work to maintain together with maximum employment.</p> <p>Given these changes, Clarida outlines three questions that the Fed needs to address in its review. First, given its mandate to promote price stability and maximum employment, should the Fed reconsider its current practice of "forgiving" past inflation shortfalls or surpluses, without attempting to compensate for them? While it's possible for the Fed to adopt "makeup" strategies to correct for inflation inconsistencies, this can work only if the public trusts central bankers to stick to them, which may be asking a lot. Second, does the Fed need different tools to reliably fulfill its dual mandate? While Clarida does not say whether the Fed might retire any of its existing policy tools, he does say that Fed leaders are thinking about adding new ones. Finally, how can the Federal Open Market Committee (FOMC) improve the way it communicates with the public? While it does so more often, and in more ways, than it once did, Clarida suggests that there is still room for improvement.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/independence-accountability-inflation-targeting" rel="nofollow external noopener noreferrer" target="_blank">Independence and Accountability via Inflation Targeting,</a>" </strong>Peter N. Ireland, Murray and Monti Professor of Economics at Boston College and Member of the Shadow Open Market Committee</p> <p>Holding central bankers accountable for their decisions is vital to insulating them from partisan pressures. Yet, according to Ireland, accountability has proven difficult to achieve in practice. He illustrates this using examples from the Fed's own history: in the 1970s, "despite the occasional appearance of a statistical Phillips curve relationship between inflation and unemployment… [political efforts] to exploit that Phillips curve led… not to lower unemployment at the cost of higher inflation but instead to the worst of both worlds." Only "by focusing first on keeping inflation low," and not on propping up employment numbers, did future Fed chairs restore the American economy and its labor force. "Unemployment fluctuates no matter what," Ireland explains, "but keeping inflation low and stable can promote the Fed's full employment objective."</p> <p>Ireland recommends that the Federal Reserve replace its current mandate with "a new, streamlined mandate… to focus on stabilizing inflation around its own self-declared 2 percent target." A numeric inflation target remains a key "institutional safeguard" for keeping Fed policymakers accountable to the public—while insulating them from political pressures.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/look-back-consensus-statement" rel="nofollow external noopener noreferrer" target="_blank">A Look Back at the Consensus Statement</a>,"</strong> Jeffrey M. Lacker, former President of the Federal Reserve Bank of Richmond and Distinguished Professor of Economics at Virginia Commonwealth University</p> <p>The Federal Reserve only formalized the terms of its dual mandate in 2012, with the release of its "Statement on Longer-Run Goals and Monetary Policy Strategy" (often abbreviated as its "consensus statement"). Lacker discusses two factors that may have limited the statement's efficacy. First, the FOMC advertised the consensus statement as a mere formalization of existing policy, meaning it produced only a minimal change in the public's inflation expectations. Second, it neglects to specify a numeric employment target—or even a concrete metric for its goal of "maximum employment."</p> <p>Drawing from these lessons, Lacker makes recommendations for the Fed's current policy review. He commends the statement for beginning to rectify some of the more "problematic" elements of the Fed's dual mandate—namely, that "it injects distributional politics directly into monetary policy" by specifying a numeric inflation target. Yet the Fed must now decide whether, or how, to compensate when it misses that target. It must also resolve ongoing questions surrounding its employment mandate.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/ngdp-targeting-public" rel="nofollow external noopener noreferrer" target="_blank">NGDP Targeting and the Public</a>," </strong>Carola Binder, Assistant Professor of Economics at Haverford College</p> <p>When the Federal Open Market Committee (FOMC) first considered replacing its existing inflation-targeting regime with nominal gross domestic product (NGDP) targeting, the idea didn't get much of a hearing. Several years removed from that initial discussion, Binder gives NGDP level targeting a second look, arguing it compares favorably to inflation targeting when it comes to weathering new threats to central bank credibility and independence. The global trend toward populism does not bode well for central banks, which, being "unpopular by design," are frequently the lightning rods of populist discourse: Binder's data show that regimes classified as "populist" or "nationalist" put greater political pressure on central banks—and higher pressure is also correlated with higher rates of inflation.</p> <p>The Fed's "twin deficits" of credibility and trust make it all the more vulnerable to political interference. Partly to blame is that the FOMC conducts monetary policy via inflation targeting, which it has a harder time explaining to the public. Switching to NGDP level targeting, Binder says, would make the Fed's actions "easier to communicate, more popular, and less prone to political interference than a flexible inflation target or dual mandate." It would also "allow the Fed to frame its policy decisions in terms of income rather than inflation"—something that households and politicians can see and feel directly, which makes it easier to grasp. Nor would the switch cause any major policy disruption: in fact, had the Fed switched to NGDP level targeting in 2012, it would seem all the more successful today, given the steady growth rate NGDP has maintained since the last recession. What's more, the low inflation and unemployment rates that we had seen from 2017 until quite recently would look like a policy victory, rather than an anomaly "casting existential doubt on the Fed's model of the economy" (which assumes that inflation and unemployment are inversely correlated).</p> <p>The Fed can protect its independence and enhance its credibility by replacing its dual mandate with a "single, explicit, numerical" NGDP level target, Binder says. This will make it easier for the public to gauge the Federal Reserve's credibility, easier for Fed officials to explain their decisions, and harder for politicians to subject the Federal Reserve to partisan interference.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/federal-reserve-policy-world-low-interest-rates" rel="nofollow external noopener noreferrer" target="_blank">Federal Reserve Policy in a World of Low Interest Rates,</a>" </strong>Eric R. Sims, Professor of Economics, University of Notre Dame and NBER Research Associate, and Jing Cynthia Wu, Associate Professor of Economics, University of Notre Dame and NBER Faculty Research Fellow</p> <p>Since the last crisis, interest rates around the world have found a new normal: nearly zero percent. That's typical even for flourishing economies—and that might signal trouble for central bankers whose main monetary policy strategy is interest rate targeting. Because that strategy generally means keeping the central bank's policy interest rate in line with the natural market rate of interest, a natural rate of zero jeopardizes the central bank's ability to conduct accommodative monetary policy—which often means lowering their policy rate—in the event of a recession. Sims and Wu ask whether this new reality of near-zero interest rates requires a new policy framework to match—one that can better address the increased risk of natural rates hitting the zero lower bound.</p> <p>While some suggest that the next recession might warrant sub-zero interest rates, Sims and Wu show that cutting rates below zero is not effective at stimulating recessed economies. Yet the converse strategy—gradually transitioning to a higher policy rate regime before the next recession hits—is equally fraught, and unlikely to do much good. Instead of shifting policy rates, they suggest that the Fed continue using two of its most powerful postcrisis tools, quantitative easing and forward guidance, to combat economic stagnation when natural interest rates broach their zero lower bound.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/operating-regimes-fed-independence" rel="nofollow external noopener noreferrer" target="_blank">Operating Regimes and Fed Independence,</a>" </strong>Charles I. Plosser, former President and CEO, Federal Reserve Bank of Philadelphia</p> <p>The Fed's postcrisis operating regime makes it more vulnerable to partisan pressures, Plosser writes, by allowing the size of the Fed's balance sheet, and therefore the overall volume of reserves, to have little—if any—bearing on its monetary policy decisions. As long as large excess reserves remain a standing feature of the Fed's operating regime, there is no limit to how large its balance sheet can become. This makes Fed policy a prime target for congressional meddling, with elected lawmakers coveting the central bank's abundant reserves for their own purposes. Indeed, lawmakers have already succeeded in funneling Fed money toward their pet projects: the crisis era bailouts, FAST act, and the Consumer Financial Protection Bureau were all funded by Congress exploiting the Fed's "power" to detach its balance sheet from the stance of monetary policy. Plosser writes that it is imperative that the Fed revise its current operating regime in order to protect its independence from congressional whims.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/how-qe-changed-shape-us-yield-curve" rel="nofollow external noopener noreferrer" target="_blank">How QE Changed the Shape of the U.S. Yield Curve,</a>" </strong>Manmohan Singh, Senior Financial Economist, International Monetary Fund, and Rohit Goel, Financial Sector Expert, International Monetary Fund</p> <p>Lending firms often re-use long-term securities as collateral for short-term loans, which they use to purchase additional long-term, interest-earning assets. Borrowing firms get that collateral back immediately upon repaying those loans—meaning that the same long-term securities can get "recycled" through short-term lending markets again and again. Re-using high-quality bonds as short-term collateral is a process "akin to the money creation that takes place when banks take deposits and make loans," Singh and Goel write; and it "change[s] the effective supply and demand dynamics at the long-end [of the yield curve], which then feeds back into short-term rates." Their article is the first to analyze how that relationship has changed since the 2008 crisis. Before 2008, short-term policy rates "drove" interest rate behavior at the right end of the yield curve, so that "market expectations about the future path of the overnight federal funds rate were reflected in 10-year yields and beyond." Postcrisis, however, transactions using long-term securities as short-term collateral are fewer, and the influence these transactions have on short-term market rates are weaker.</p> <p>Quantitative easing (QE) may play a role in that. An abundance of high-quality collateral "lubricates" the money markets. When, during a round of QE, a central bank buys up this long-term collateral and transforms it into so many permanent, static holdings on its balance sheet, its market availability declines, money markets dry out, and short-term interest rates rise. New regulations compound these effects, especially leverage ratios limiting how much collateral banks can hold, relative to reserves, at any given time.</p> <p>Post-pandemic, Singh and Goel write, central banks should reduce the size of their balance sheets, and by extension, their role in lending markets. Unwinding central bank balance sheets, while freeing up more space for the assets commercial banks can hold on theirs, "is likely to improve transmission to the short-end money market rates." Regulatory changes should also keep "central bank reserves and U.S. Treasuries… as equal as possible," granting dealer banks more freedom to exchange some of their leverage (in the form of reserves) for collateral (in the form of U.S. Treasuries). That, in turn, will bolster the velocity and money-creating power of that collateral. This is especially important now, since "Covid-19 related bailouts will keep central banks' footprint even larger for even longer, unless regulations are softened to allow dealer banks more balance sheet capacity."</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/monetary-policy-operating-frameworks-are-reforms-heading-right-direction" rel="nofollow external noopener noreferrer" target="_blank">Monetary Policy Operating Frameworks: Are Reforms Heading in the Right Direction?</a>" </strong>Andrew Filardo, Head of Monetary Policy, Bank for International Settlements and Visiting Fellow, Hoover Institution</p> <p>Filardo examines the repeated, and unexpected, interest rate spikes that rattled financial markets during the final months of 2018 and September 2019. Many blamed these episodes on the Fed's gradual balance sheet unwind, which added risk to the market and subtracted reserves. Yet Filardo counters that these spikes were instead "symptoms of deeper pathologies." In particular, he attributes them to flaws in how "monetary policy operations have been adapted to the new financial regulatory environment."</p> <p>Contrary to claims that the Fed's postcrisis, "floor-based" operating system offers the best chance of stabilizing the money markets, Filardo argues it actually <em>weakens </em>incentives for financial institutions to lend to, and monitor, one another. With the Fed pumping large quantities of reserves into the market whenever money becomes scarce, private institutions rely on one another less for overnight lending. That makes them less likely to monitor one another's risk-taking behavior. If the Fed increases its lending activities, it could further erode market trust and stability. Filardo recommends two reforms for returning responsibility to the hands of private financial institutions. First, the Fed should abandon its current floor system and return to its precrisis corridor system. Second, it should adopt Filardo's own "sequestered reserve rule," requiring financial institutions and regulators to negotiate an "appropriate preannounced level of reserves necessary to satisfy liquidity regulations." That ratio would curb institutions from hoarding excess reserves and encourage them to use reserves, alongside other high-quality liquid assets, in their day-to-day operations.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/upgrading-feds-operating-framework" rel="nofollow external noopener noreferrer" target="_blank">Upgrading the Fed's Operating Framework</a>," </strong>David Beckworth, Director of the Monetary Policy Program at the George Mason University Mercatus Center</p> <p>Beckworth reviews some of the major macroeconomic lessons of the last decade, examining monetary policy strategy experiments from around the globe—ranging from interest rate policy adjustments, to quantitative easing cycles, to policies aimed at expanding the monetary base. Ultimately, his survey leads him to suggest three measures for making the Fed more resilient to future crises. Along with adapting its operating framework for both positive and negative interest rate scenarios, switching from interest rate targeting to NGDP level targeting will help the Fed "provide meaningful forward guidance." To enhance the credibility of the Fed's operating framework, Beckworth also recommends that the Fed set up a standing fiscal facility for making "helicopter money" drops—with the stipulation that this facility be used only when the natural rate of interest breaches the zero lower bound. While he concedes that such a facility would allow monetary policymakers to engage in fiscal policy operations, he adds that its terms should be clearly outlined to keep the Fed's ability to marry fiscal and monetary policy constrained, rules-based, and limited in both duration and scope.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/central-banking-rule-law" rel="nofollow external noopener noreferrer" target="_blank">Central Banking and the Rule of Law</a>," </strong>Paul Tucker, former Deputy Governor, Bank of England</p> <p>How can central banks can restore their legitimacy and integrity when their incentives to compromise both are so high? Tucker approaches this question from the standpoint of political and constitutional theory, rather than economics, which lends a unique perspective to his analysis. "[M]ost discussions, and especially justifications, of central bank independence are expressed entirely in the language of economics," he says; and economics, "positing a benign sovereign, sets out to achieve a flourishing society in which well-being is maximized." Political theory, on the other hand, "alert to the possibility of a malign sovereign, aims to avoid tyranny."</p> <p>In constitutional democracies, Tucker says, central banks should not be exempt from "the values of democracy, constitutionalism… and of the rule of law." To that end, central bankers should design a transparent, rules-based, "money-credit constitution" for measuring their compliance with policy mandates. They should also be required to explain publicly any departures that constitution's terms. Central bankers should also keep their balance sheets "as simple and small as possible"; avoid making drastic discretionary policy changes; resist lending to insolvent firms; and develop transparent contingency plans for would-be extraordinary circumstances that may require them to temporarily increase their financial-market footprints.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/how-natural-language-processing-will-improve-central-bank-accountability" rel="nofollow external noopener noreferrer" target="_blank">How Natural Language Processing Will Improve Central Bank Accountability and Policy</a>," </strong>Charles W. Calomiris, Henry Kaufman Professor of Financial Institutions, Columbia Business School, and Harry Mamaysky, Director of the Program for Financial Studies, Columbia Business School</p> <p>However else central banking may change, central bank transparency is likely to improve, rather than worsen, in the near future. That's thanks to innovations in natural language processing (NLP) software, which can detect speech and language patterns associated with obfuscation or manipulation. While Fed bankers have a tendency to withhold the truth from the public, it's rarely out of malice. Instead, by making central bankers shoulder so many responsibilities—and therefore expose themselves to more blame—during economic difficulties, discretionary and unsystematic policy frameworks encourages them to dissemble. What's more, the lack of a definitive set of goals and metrics by which the public can hold them to account makes it easier for central bankers to dodge questions or provide meaningless answers about their policy decisions.</p> <p>NLP can begin to address these challenges—with techniques that highlight evasive, long-winded explanations, or technology that reveals vague, meaningless, or redundant language in Fed policy statements. Calomiris and Mamaysky identify three ways that they foresee NLP improving central bank communications. First, NLP can help measure "how nonsystematic and nontransparent policy is" or reveal when central bankers "are failing to disclose their true beliefs about a policy." Second, NLP acts as a "mind reader," clarifying "which economic phenomena central bank policies are actually responding to." It also works as an "information leveler," reducing "the information asymmetry between central bankers and the public about the state of the economy." The authors predict that as NLP technology becomes more advanced, Fed policy will become more transparent (and systematic) in turn, with central bankers facing new incentives "to recognize and address observable shortcomings."</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/how-politics-shapes-federal-reserve-communications" rel="nofollow external noopener noreferrer" target="_blank">How Politics Shapes Federal Reserve Communications,</a>" </strong>Sarah Binder, Professor of Political Science, GWU and Senior Fellow, Brookings Institution, and Mark Spindel, Founder and Chief Investment Officer, Potomac River Capital, LLC</p> <p>Binder and Spindel reflect on the political origins—and consequences—of the double bind the Fed faces in its communication strategy. While transparency is vital for stabilizing market expectations and keeping central bankers accountable, it also makes it easier for politicians to blame the Fed when the economy sours. Now, conflicting and often impossible demands from Congress and the President make it nearly impossible for Fed officials to communicate openly. The authors discuss how our increasingly polarized political climate harms Fed transparency and independence, especially when it comes to inflation targeting and balance sheet operations.</p> <p>One of the most politically troubling economic trends facing the Fed is the weakening relationship between inflation and unemployment. The idea that inflation and unemployment are inversely correlated has been a bedrock of Fed policy for decades, and is even the basis of the Fed's dual mandate. Now, however, "setting market expectations of future policy" through forward guidance "is near impossible in light of the Fed's uncertainties." At the same time, the Fed faces aggressive political jawboning from President Trump. Between the President's "procyclical pressure for more dovish policy… compounded by already low rates and an enfeebled Phillips curve," the Fed has dispensed with most of its communications strategies and "limited itself to meeting-by-meeting policy choices."</p> <p>Nor are these choices themselves free from political pressure. When it comes to managing inflation expectations, former Federal Reserve officials have refused to consider higher inflation targets, not for economic reasons as much as out of fear that Congress might object. Similarly, the Fed's balance sheet policies are at once a topic of congressional criticism and exploitation: though Republican and Democrat lawmakers have each questioned the Fed's paying interest on excess reserves, they have also both "tapped Federal Reserve profits (a partial by-product of large balance sheet policies) to help fund political priorities."</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/pitfalls-makeup-strategies-mitigating-effective-lower-bound" rel="nofollow external noopener noreferrer" target="_blank">Pitfalls of Makeup Strategies for Mitigating the Effective Lower Bound</a>," </strong>Andrew T. Levin, Professor of Economics, Dartmouth College, and Arunima Sinha, Assistant Professor of Economics, Fordham University</p> <p>Levin and Sihna discuss three factors that make "makeup strategies" prone to failure. First is the challenge of "expectations formation": the public may not trust the Fed to carry through on a given makeup strategy; and unless people expect the Fed to change its own policy, they are unlikely to change their own patterns of spending and saving. Second is "imperfect credibility": the less credible a central bank is, the less capable it will be of influencing market behavior. Even a well-functioning and trustworthy central bank is not entirely credible—throwing the outcome of even the soundest make-up strategy in doubt. Third is "model uncertainty": all economic policies rely, to some degree, on economic modeling; and make-up strategies are no exception. Yet models are not markets, and cannot mirror reality perfectly. At best, models can merely help policymakers form educated guesses about how their strategies will pan out.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/envisioning-monetary-freedom" rel="nofollow external noopener noreferrer" target="_blank">Envisioning Monetary Freedom</a>," </strong>George Selgin, Director of the Cato Institute's Center for Monetary and Financial Alternatives</p> <p>Selgin's contribution addresses the question: what might a free market monetary system of the not-too-distant future be like? He begins by noting that, "if monetary freedom means anything, it means that people are free to choose what sort of money they will keep on hand, or accept from others, in exchange for their labor, goods, or services. And enjoying such freedom… means that government regulations neither compel people to use any particular sort of currency nor prevent entrepreneurs making alternatives to the dollar." What sort of monetary arrangements would these conditions give rise to? Among the changes Selgin contemplates are the fate of the U.S. dollar, new incentives for borrowers and lenders, and currency competition and valuation. The dollar will likely prevail in the short-term, he writes, with either a "convertibility rule" or a "quantity rule" regulating the total amount in circulation.</p> <p>As for regulatory incentives, Selgin imagines a world where "both explicit and implicit deposit insurance," are done away with, followed by "all bank regulations [aside from those that] enforce voluntary contracts" between borrowers and lenders. (That includes all government bailout guarantees.) Future financial transactions will be mostly digital and "made using convertible [cash] substitutes, supplied by banks or other companies," tracked and executed by "an intricate clearing and settlement system," he says. He also discusses "converting today's Federal Reserve banks into so many private clearing houses," and allowing commercial banks the option to transact with them or a variety of competing clearing house systems.</p> <p>Just how dramatic the changes will be between today's monetary system and that of a future, freer society, Selgin says, will depend not only on <em>what </em>changes are made—but <em>how </em>we make them.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/feds-precrisis-monetary-policy-framework-well-suited-free-society" rel="nofollow external noopener noreferrer" target="_blank">The Fed's Precrisis Monetary Framework is Well-Suited for a Free Society</a>," </strong>Bill Nelson, Executive Vice President and Chief Economist, Bank Policy Institute</p> <p>Before the 2007–09 financial crisis, the Fed's primary means of regulating the money supply were purchasing U.S. Treasuries and conducting short-term sales of government securities. These limited functions meant it seldom intervened in day-to-day market transactions. Banks borrowed and lent among one another, and the Fed served only as their lender of last resort. Postcrisis, the Fed has augmented its earlier operating framework dramatically. Nelson discusses the consequences of these changes and makes recommendations for reform. He addresses the Fed's decision to house unlimited Treasury deposits at Federal Reserve banks as well as the Fed's QE3 (or "QE Infinity" program), which continued well past its promised conclusion date. Extending QE postponed, and then altered, the Fed's earlier plans to renormalize its balance sheet. Rather than sell back the assets it had purchased from market dealers, as it first intended, the Fed opted instead to allow those assets to roll off as they mature.</p> <p>Nelson argues that returning to the Fed's pre-2008 operating framework will help the economy run far more smoothly going forward. He outlines the steps the Fed should take to shrink its balance sheet and reinstate its "scarce reserves" regime. First, it should tame fluctuations in its own reserve balance (which shifts wildly owing to ups and downs in the Treasury General Account, or TGA) by relying on frequent repo operations in the short run, and by shifting more of the TGA's reserves to the private sector in the long run. Second, it should dispel the popular misconception that TGA deposits are counted among the Fed's own assets. It should also enact policies that encourage banks to rely on collateralized daylight overdrafts and use the Fed's discount window judiciously—not as a first recourse for borrowing. It should also unwind its own asset portfolio as soon as possible.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/four-principles-base-money-regime" rel="nofollow external noopener noreferrer" target="_blank">Four Principles for a Base Money Regime</a>," </strong>William J. Luther, Assistant Professor of Economics, Florida Atlantic University and Director, AIER Sound Money Project</p> <p>Four properties define the optimal base money regime, writes Luther. The first is a stable inflation rate. While economists continue to debate whether the optimal inflation rate is slightly negative or slightly positive, it is certainly close to zero, Luther says—likely somewhere "between –4 percent and 4 percent." The second is demand-elasticity: changes in the total quantity of base money should depend, not on central bankers' discretion, but rather market demand. Luther adds the caveat that a "demand-elastic" regime does not mean adjusting the base money supply upon every shock in the real supply, "since real shocks tend to be concentrated on a particular subset of markets." The third is a uniform global currency. Not only does a uniform currency facilitate exchange in myriad direct and indirect ways; it also increases the benefits of exchange. "A common currency area prevents a regionally specific money-supply mechanism," Luther writes. "However, the financial system routes funds to those demanding them and remaining differences in regional price levels are relative-price differences. Taken together, this implies that the optimal currency area is the maximum currency area"—which is to say, global. The fourth is incentive-compatibility: those charged with creating and maintaining the monetary regime must not only be legally required, but incentive-bound, to uphold the rules by which it operates. While Luther notes that no monetary regime anywhere in the world possesses all four of these attributes, he says that taken together, they can serve as a guidepost for comparing, and improving upon, the ones in existence today.</p> <p><strong>"<a href="https://www.cato.org/cato-journal/spring/summer-2020/money-stability-free-societies" rel="nofollow external noopener noreferrer" target="_blank">Money, Stability, and Free Societies</a>," </strong>Steve H. Hanke, Professor of Applied Economics, Johns Hopkins University</p> <p>The greatest threat that financial crises pose to free societies, Hanke writes, is not the supply shock that comes with it, but the civil liberty constraints that come after it. He outlines three strategies for improving global monetary stability overall, and in turn reducing the immediate and long-term threats financial crises pose to our prosperity. The first is to formalize a loose, yet official, exchange rate between the U.S. dollar and the euro. Hanke recommends that this rate be somewhere between $1.20 and $1.40 per euro. The second is to replace at least 100 central banks around the world with currency boards, which Hanke considers more stable, since unlike a central bank, a currency board is entirely non-discretionary and "cannot engage in the fiduciary issue of money." Its sole function is rather "to exchange the domestic currency it issues for an anchor currency at a fixed rate," meaning that "the quantity of domestic currency in circulation is determined by market forces." Because currency boards have "a [fixed] exchange rate policy… but no monetary policy," their economies consistently perform better than central banks' in areas like financial stability, lower inflation, debt reduction, and market productivity. Hanke's third recommendation is that governments greenlight private currency board systems, including digital currency boards like Libra. Like most businesses, central banks tend to regard these competitors as threats to their own market primacy. Unlike most businesses, however, central banks can effectively bar their competitors from entry via institutional strictures. Hanke argues against this: "The competitive forces that will be unleashed by the private alternatives would be a great stabilizer and enhance economic freedom and free societies."</p> <p>[<a href="https://www.alt-m.org/2020/06/20/fed-policy-a-shadow-review-new-issue-of-the-cato-journal/">Cross-posted from Alt-M.org</a>]</p> <p></p> Mon, 22 Jun 2020 16:53:39 -0400 Amanda Griffiths https://www.cato.org/blog/fed-policy-shadow-review-new-issue-cato-journal Should the U.S. Government Create a Token‐​Based Digital Dollar? https://www.cato.org/blog/should-us-government-create-token-based-digital-dollar Lawrence H. White <p>Proposals for "central bank digital currency" (CBDC) come in two basic types: account-based and token-based. I have been critical of proposals for an account-based system. Until recently, there didn't seem to be much active interest in a token-based system. But now comes a significant token-based proposal in <a href="https://www.digitaldollarproject.org/exploring-a-us-cbdc" rel="nofollow external noopener noreferrer" target="_blank">a new white paper by the Digital Dollar Project</a>. Would a token-based system be any better than an account-based system? It might, but it all depends on the design details. Let me explain.</p> <p>An account-based CBDC would mean that households and businesses have retail checking accounts directly on the Federal Reserve System's balance sheet. A detailed proposal for such a "FedAccounts" system by three legal scholars (Morgan Ricks, John Crawford, and Lev Menand) is available <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3192162" rel="nofollow external noopener noreferrer" target="_blank">here</a>. (I recently exchanged views with Ricks in an <a href="https://www.cato.org/events/digital-dollars-whom-should-we-trust" rel="nofollow external noopener noreferrer" target="_blank">online event</a> hosted by the Cato Center for Monetary and Financial Alternatives.) It is implausible that a FedAccounts system, run by a bureaucracy with no experience in retail payments, unguided by profit and loss, will provide <a href="https://www.alt-m.org/2019/02/11/efficient-central-bank-digital-currency-is-a-fantasy/" rel="nofollow noopener noreferrer">better or more efficient service</a> than systems offered by banks and other competitive private firms. But it isn't implausible that <a href="https://www.wsj.com/articles/does-the-u-s-need-a-national-digital-currency-11582513201" rel="nofollow external noopener noreferrer" target="_blank">threats to privacy</a> would arise from a system that gives a government agency real-time access to all deposit transfers.</p> <p>A token-based CBDC would mean that households and businesses hold circulating digital Fed liabilities in digital wallets (think mobile phone apps), the way they hold Bitcoin or Tether<a href="#_ftn1" name="_ftnref1" id="_ftnref1">[1]</a>, or the way they hold Federal Reserve Notes in analog wallets. This model has been labeled "FedCoin." The Federal Reserve System would know the dollar quantity of FedCoin in circulation, but in principle, as with physical notes and coins, it needn't know which users hold how many of these digital dollars. One prominent supporter of the FedCoin concept since 2015 has been Federal Reserve economist <a href="https://andolfatto.blogspot.com/2015/02/fedcoin-on-desirability-of-government.html" rel="nofollow external noopener noreferrer" target="_blank">David Andolfatto</a>. An early sketch of the concept was provided in 2014 by blogger <a href="https://jpkoning.blogspot.com/2014/10/fedcoin.html" rel="nofollow external noopener noreferrer" target="_blank">J. P. Koning</a>.</p> <p>In May 2020 a group calling itself "The Digital Dollar Project" released a report entitled "Exploring a US CBDC." Although it deliberately leaves many important details to be determined later, the report deserves our scrutiny as an updated and prominent proposal for a token-based system. The report expands on an earlier <a href="https://www.wsj.com/articles/we-sent-a-man-to-the-moon-we-can-send-the-dollar-to-cyberspace-11571179923" rel="nofollow external noopener noreferrer" target="_blank">WSJ op-ed</a> by two of the Project's principals, J. Christopher Giancarlo and Daniel Gorfine. Giancarlo once headed the Commodity Futures Trading Commission while Gorfine was the CFTC's chief innovation officer. The named authors of the report include Giancarlo and Gorfine, plus Charles H. Giancarlo (CEO, Pure Storage) and David B. Treat (Accenture) as additional Project directors, together with eight more contributors from Accenture.</p> <p>From the user's point of view, the Digital Dollar Project's "champion model" is akin to a well-backed dollar stablecoin, that is, a transferable digital token pegged to $1.00 per unit by its issuing entity. (<a href="https://en.wikipedia.org/wiki/Tether_(cryptocurrency)" rel="nofollow external noopener noreferrer" target="_blank">Tether</a> is by far the leading US-dollar-linked stablecoin with more than $9 billion currently in circulation. <a href="https://cryptoslate.com/cryptos/stablecoin/" rel="nofollow external noopener noreferrer" target="_blank">Here</a> is a list of the many other available stablecoins.) But there are some differences between the Project's model and the typical stablecoin: the model's coin issuer is not a private entity, the fix to the dollar is free of default risk, and the exchange-rate variation around the $1.00 peg is zero. The issuer is to be the same US government agency currently responsible for supplying fiat US dollars in paper and ledger-entry form: the Federal Reserve System.</p> <p>Rather than buy FedCoins on an exchange, a user would get them from banks the way she gets fresh Federal Reserve Notes, redeeming her deposit dollars for them. She would hold FedCoin balances in a digital wallet, perhaps an app on her cell phone, and spend them online or in person, or transfer them to her friend, using the phone app.</p> <p>The Fed would stand ready to interchange FedCoins (which the report calls "Digital Dollars," but FedCoins is less ambiguous) 1:1 with existing types of base money, Federal Reserve Notes (which are not to be abolished), and commercial banks' reserve balances on the books of the Fed. In this way FedCoins are to be a form of fiat money, part of the US dollar monetary base. They are to have "the same legal status as physical bank notes," which I interpret to mean that they are to be legal tender like Federal Reserve Notes. That is, they cannot be refused in the discharge of any dollar-denominated debts. Commercial banks will be as happy to accept them on deposit, and to pay them back out, as they are to accept and pay out Federal Reserve Notes.</p> <p>Because Federal Reserve Notes are not to be abolished, the Digital Dollar Project proposal does not eliminate the "zero lower bound" on the Fed's nominal interest rate target posed by the storage of zero-yielding currency, and thus does not enable negative interest rate policy. The Report describes its champion model as "monetary policy neutral." I consider that a <a href="https://www.alt-m.org/2019/03/28/the-zero-lower-bound-is-no-reason-to-punish-currency-users/" rel="nofollow noopener noreferrer">welcome feature</a> and not a bug in the proposal, but NIRP enthusiasts who want to abolish cash will consider it a shortcoming. Whether FedCoins are to bear interest is left an open question.</p> <p>The Report is generally fuzzy or flexible on technical details. FedCoin payments are to be "recorded on new transactional infrastructure, potentially informed by distributed ledger technology." What, pray tell, is this "new transactional infrastructure"? How is it "informed" by distributed ledger technology?</p> <p>In a confusing sentence (p. 9), the authors of the report declare that "a US CBDC would serve to upgrade the infrastructure of money (the ultimate public good) and act as a catalyst for private sector and market innovation." Dollar bills or FedCoins are clearly not public goods: they are rival in use and readily excludable, as the authors recognize (p. 10). So presumably it is "the infrastructure of money" that is supposed to be a public good. But the infrastructure of "payment rails," like the infrastructure of literal train rails, itself exhibits rivalness in use and excludability. Payment rails (like credit card systems, check clearing systems, or real-time payment networks) are congestible, gated, and have historically been privately provided. It's arguable that a unit of account role of money exhibits non-rivalness and non-excludability, but the Project is not proposing to upgrade the unit of account.</p> <p>It is easy to agree with one policy implication (p. 8): "We accordingly do not view a digital dollar as antithetical to the development of private sector payments and stable coin initiatives, many of which seek to tokenize commercial bank money."</p> <p>The report (p. 6) offers only very fuzzy reassurance against the surveillance of FedCoin transactions:</p> <blockquote><p>The digital dollar will support a balance between individual privacy rights and necessary compliance and regulatory processes, decided upon by policymakers and ultimately reflecting the jurisprudence around the Fourth Amendment.</p> </blockquote> <p>The Fourth Amendment to the US Constitution secures "persons, houses, papers, and effects, against unreasonable searches and seizures." Its application to financial privacy depends on whether financial data counts as "papers" or "effects," and on the standard for what is "unreasonable." The currently dominant 4A jurisprudence regarding the privacy of transactions involving ordinary bank deposits, unfortunately, is that there isn't any, based on the "third party doctrine." As Jennifer Lynch of the Electronic Frontier Foundation <a href="https://www.scotusblog.com/2017/08/symposium-will-fourth-amendment-protect-21st-century-data-court-confronts-third-party-doctrine/#:~:text=This%20principle%20holds%20that%20information,third%20party%20to%20keep%20the" rel="nofollow external noopener noreferrer" target="_blank">has explained</a>:</p> <blockquote><p>This principle holds that information you voluntarily share with someone else — whether that "someone else" is your bank (such as deposit and withdrawal information) or the phone company (the numbers you dial on your phone) — isn't protected by the Fourth Amendment because you can't expect that third party to keep the information secret. By sharing that information with a third party, you have assumed the risk that it will be shared with others.</p> </blockquote> <p>A very basic design choice, then, is whether FedCoin transfers will share information with a third party (like the Fed), in the manner of deposit transfers, or won't, in the manner of purchases using paper currency. Under the third-party doctrine, however, sharing with the Fed means in effect sharing with any federal agency that wants the information—whether the Justice Department, the FBI, or any other bureaucracy. So much for privacy.</p> <p>To the extent that FedCoin payments provide information to the Fed (namely, the payment's size, sender, and recipient), there will be no barrier to government surveillance unless one is specifically enacted into law. Information would not always be provided to the Fed if some payments were allowed to be anonymous or pseudonymous as with paper currency. For example, the German GeldKarte, a stored-value card system introduced in the 1990s, initially allowed for anonymous cards to be purchased with cash. Prepaid gift card balances today can be spent anonymously, even online, but only once. If a stored-value or prepaid card could accept additional funds peer-to-peer, without recording the identity of the sender, it could preserve privacy in transactions much like paper currency.</p> <p>Digital Dollar wallets <em>could</em> preserve privacy in a similar way. But the Project report proposes that FedCoin wallets "could be readily registered through a regulated hosting intermediary performing requisite Know Your Customer/Anti-Money Laundering (KYC/AML) checks," which seems intended to rule out anonymous payments. A footnote (p. 13, fn. b) simply punts on whether privacy-preserving alternatives are to be permitted: "The decision to permit un-hosted wallets is a separate policy and design choice subject to separate analysis and consideration." The authors do rightly caution (p. 20) that while "full surveillance and traceability may achieve broad goals of law enforcement," such traceability "would reduce its attractiveness and inhibit adoption by even the most law-abiding users."</p> <p>Even with registered wallets, spending <em>could</em> be kept private by excluding identifying information about sender and recipient from the ledger, in the manner of cryptocurrency privacy coins like <a href="https://z.cash/" rel="nofollow external noopener noreferrer" target="_blank">Zcash</a> and <a href="https://beam.mw/features" rel="nofollow external noopener noreferrer" target="_blank">Beam</a> with revelation only by user choice ("opt-in auditability") or court order. Following current US reporting requirements for large currency payments, privacy could be the default for all transactions under $10,000. Matthew Green and Peter Van Valkenburgh have <a href="https://coincenter.org/entry/without-privacy-do-we-really-want-a-digital-dollar" rel="nofollow external noopener noreferrer" target="_blank">recently discussed</a> the technical issues connected with designing digital dollars that are "<em>private by design</em> such that (as is the case with physical cash) even the issuing authority can't engage in surveillance of transactions system-wide." And they pose the crucial policy question: "Without privacy, do we really want a digital dollar?" The Digital Dollar Project report deliberately takes no real stand on privacy design issues. It rather announces a process: "The Project intends to convene stakeholder working groups to develop these design features and recommendations." First embrace our effort to get a FedCoin, it suggests, and then you can help us hash out the details.</p> <p>What is the proposed advantage of FedCoin over existing ways of making payments? The report (p. 11) says that "a digital dollar would offer a new choice for digital transactions, instantaneous peer-to-peer payments, and in-person transactions" with "potentially lower costs." But such commercial services as Venmo and Cash App, and stablecoins like Tether, already offer convenient dollar payments and peer-to-peer transfers at little cost to consumers. As for speed, most US checking accounts are already in banks that are members of The Clearing House's <a href="https://www.theclearinghouse.org/payment-systems/rtp/institution" rel="nofollow external noopener noreferrer" target="_blank">RTP® system</a>, which has offered real-time payments since 2017. Meanwhile the Fed forecasts that its own <a href="https://www.americanbanker.com/opinion/we-shouldnt-have-to-wait-for-fednow-to-have-faster-payments" rel="nofollow external noopener noreferrer" target="_blank">FedNow system</a> will be ready in <a href="https://www.americanbanker.com/news/fed-plans-to-launch-real-time-payment-service-by-2024" rel="nofollow external noopener noreferrer" target="_blank">2024</a>. Only a Pollyanna can expect the Fed to offer innovative payment service at lower cost, whether account-based or token-based, when it has been consistently behind the private sector to date.</p> <p>The report recognizes that the US <em>private sector</em> has been a leader in payments tech. It nonetheless hopes for the Fed to become an innovator someday soon—after many rounds of public policy discussions involving stakeholders from many interest groups. That is hardly a recipe for getting ahead of the curve. Permissionless innovation by private cooperatives and enterprises promises better results.</p> <p>Some of the Digital Dollar Project's enthusiasm for improving the Federal Reserve's product offerings seems nervous, derived from a fear of the US government losing power. Should the US fall technologically behind in digital payments, they fear, it will be less able to continue projecting US government power globally. They write (p. 32): "If payment systems could bypass Western banks heavily linked economically and geopolitically to US dollar reserves, the effectiveness of economic sanctions as a central and unifying tool of our foreign policy would be at serious risk." This is a poor argument for creating a CBDC given that US economic sanctions are being <a href="https://www.cato.org/publications/policy-analysis/ineffective-immoral-politically-convenient-americas-overreliance" rel="nofollow external noopener noreferrer" target="_blank">overused</a>. A Fed initiative to reinforce the use of sanctions should be regretted rather than applauded. Furthermore, without a credible commitment not to invalidate or freeze FedCoins held abroad, akin to the Fed's commitment never to invalidate Federal Reserve Notes in circulation, the foreign demand to hold FedCoins (touted earlier in the report as a benefit) will be limited.</p> <p>The US dollar will remain the world's primary reserve currency due to strong network economies—there will be no reason to switch—so long as the Fed keeps dollar inflation rates as low as those of potential competitor currencies.</p> <h4><strong>Conclusion</strong></h4> <p>A FedCoin retail payment system is likely to be less inefficient than a FedAccount system, because it does not require an ill-equipped Federal Reserve System bureaucracy to provide as much retail customer service. Still, it requires the Fed to step outside its expertise, and into the realm of private enterprise, to launch and maintain a retail digital wallet system. FedCoin <em>may</em> also be less invasive of privacy, but that depends entirely on the relative designs of the two systems, yet to be specified. The Digital Dollar Project's "champion model," although deliberately underspecified at this point (in hopes of broadening its appeal), provides a useful framework for further discussion of the standards necessary to ensure that a CBDC system does not make the money-using public worse off. At a minimum a FedCoin system should not bring constraints on private innovation in digital payments for the sake of its own market share, nor should it reduce financial privacy. So long as its use is entirely voluntary, there is not much to object to other than the likely waste of taxpayer money to subsidize the costs of creating and operating it.</p> <p>******</p> <p><a href="#_ftnref1" name="_ftn1" id="_ftn1">[1]</a> Bitcoin is of course denominated in its own unit of account, BTC, and its dollar price varies freely (while its volume in circulation is predetermined).</p> <p>[<a href="https://www.alt-m.org/2020/06/19/should-the-u-s-government-create-a-token-based-digital-dollar/">Cross-posted from Alt-M.org</a>]</p> <p></p> Mon, 22 Jun 2020 16:50:38 -0400 Lawrence H. White https://www.cato.org/blog/should-us-government-create-token-based-digital-dollar Steve H. Hanke discusses the Iranian rial on BBC Persian https://www.cato.org/multimedia/media-highlights-tv/steve-h-hanke-discusses-iranian-rial-bbc-persian Sun, 21 Jun 2020 11:58:52 -0400 Steve H. Hanke https://www.cato.org/multimedia/media-highlights-tv/steve-h-hanke-discusses-iranian-rial-bbc-persian Veronique de Rugy discusses the Export‐​Import Bank on The John Batchelor Show https://www.cato.org/multimedia/media-highlights-radio/veronique-de-rugy-discusses-export-import-bank-john-batchelor Thu, 18 Jun 2020 11:32:15 -0400 Veronique de Rugy https://www.cato.org/multimedia/media-highlights-radio/veronique-de-rugy-discusses-export-import-bank-john-batchelor A Fed for Next Time: Ideas for a Crisis‐​Ready Central Bank — Panel 2: Defining Fiscal Stimulus Duties https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-2-defining-fiscal-stimulus Peter Conti-Brown, Elga Bartsch, Joseph Mason, Chris Condon <div class="mb-3 spacer--nomargin--last-child text-default"> <p><strong>Full event: <a href="https://www.cato.org/events/fed-next-time-ideas-crisis-ready-central-bank">A&nbsp;Fed for Next Time: Ideas for a&nbsp;Crisis‐​Ready Central Bank</a></strong></p> <p>In just a&nbsp;dozen years, the Federal Reserve has faced two severe crises. And twice it has responded by leaning heavily on emergency lending powers it seldom used before by improvising temporary lending programs and taking part in fiscal policy.</p> <p>In the meantime, the Fed’s nonemergency lending facilities have hardly changed, and may well prove insufficient when the Fed faces its next crisis.</p> <p>The implication of this is both obvious and ominous: while we still count on the Fed to deal with crises, we no longer know how it will deal with them. Instead of being predictable, the Fed’s crisis‐​prevention methods have become unpredictable–and controversial–adding to, instead of allaying, economic scrutiny.</p> <p>Can we do better? Can we improve the Fed’s systematic response to crises, making that response both more effective and more predictable? Can we thereby limit the Fed’s entanglement in politics? What can the Fed do to promote these ends? What might Congress do?</p> <p>For some expert answers, please join us for a&nbsp;joint Cato Institute–Mercatus Center at George Mason University virtual conference series, <em>A&nbsp;Fed for Next Time: Ideas for a&nbsp;Crisis‐​Ready Central Bank</em>, hosted by George Selgin and David Beckworth.</p> </div> Thu, 18 Jun 2020 11:09:03 -0400 Peter Conti-Brown, Elga Bartsch, Joseph Mason, Chris Condon https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-2-defining-fiscal-stimulus A Fed for Next Time: Ideas for a Crisis‐​Ready Central Bank — Panel 1: Reforming Credit Policy https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-1-reforming-credit-policy Sir Paul Tucker, Kathryn Judge, Lev Menand, Jeanna Smialek <div class="mb-3 spacer--nomargin--last-child text-default"> <p><strong>Full event: <a href="https://www.cato.org/events/fed-next-time-ideas-crisis-ready-central-bank">A&nbsp;Fed for Next Time: Ideas for a&nbsp;Crisis‐​Ready Central Bank</a></strong></p> <p>In just a&nbsp;dozen years, the Federal Reserve has faced two severe crises. And twice it has responded by leaning heavily on emergency lending powers it seldom used before by improvising temporary lending programs and taking part in fiscal policy.</p> <p>In the meantime, the Fed’s nonemergency lending facilities have hardly changed, and may well prove insufficient when the Fed faces its next crisis.</p> <p>The implication of this is both obvious and ominous: while we still count on the Fed to deal with crises, we no longer know how it will deal with them. Instead of being predictable, the Fed’s crisis‐​prevention methods have become unpredictable–and controversial–adding to, instead of allaying, economic scrutiny.</p> <p>Can we do better? Can we improve the Fed’s systematic response to crises, making that response both more effective and more predictable? Can we thereby limit the Fed’s entanglement in politics? What can the Fed do to promote these ends? What might Congress do?</p> <p>For some expert answers, please join us for a&nbsp;joint Cato Institute–Mercatus Center at George Mason University virtual conference series, <em>A&nbsp;Fed for Next Time: Ideas for a&nbsp;Crisis‐​Ready Central Bank</em>, hosted by George Selgin and David Beckworth.</p> </div> Tue, 16 Jun 2020 22:00:00 -0400 Sir Paul Tucker, Kathryn Judge, Lev Menand, Jeanna Smialek https://www.cato.org/multimedia/events/fed-next-time-ideas-crisis-ready-central-bank-panel-1-reforming-credit-policy It’s Time for Private Cryptocurrency Boards https://www.cato.org/publications/commentary/its-time-private-cryptocurrency-boards Steve H. Hanke <div class="lead mb-3 spacer--nomargin--last-child text-default"> <p>With the onset of the coronavirus pandemic, currencies around the world took a&nbsp;deep dive. To name but a&nbsp;few casualties: Argentina, Brazil, Colombia, Iran, Lebanon, Mexico, Nigeria, Russia, South Africa, Syria, Turkey, Venezuela, and Zimbabwe. Not only have the currencies in these countries plunged, but the burden of their foreign debts has soared. Exchange‐​rate instability is a&nbsp;curse.</p> </div> , <div class="mb-3 spacer--nomargin--last-child text-default"> <p>Indeed, currency instability, banking crises, soaring inflation, sovereign‐​debt defaults, and economic booms and busts all have a&nbsp;common source: exchange‐​rate instability. The ills induced by exchange‐​rate instability bring with them calls for policy changes. Karl Schiller, the German Finance Minister from 1966 until 1972, understood this simple fact. Schiller’s mantra was clear and uncompromising: “Stability is not everything, but without stability, everything is nothing.” Well, Schiller’s mantra is my mantra.</p> <p>I offer a&nbsp;regime change that would enhance stability in the international monetary sphere: private currency boards. Just what is a&nbsp;currency board?</p> <p>A currency board issues notes and coins convertible on demand into a&nbsp;foreign anchor currency at a&nbsp;fixed rate of exchange. As reserves, it holds low‐​risk, interest‐​bearing bonds denominated in the anchor currency and typically some gold. The reserve levels (both floors and ceilings) are set by law and are equal to 100 percent, or slightly more, of its monetary liabilities (notes, coins, and, if permitted, deposits). A&nbsp;currency board generates profits (seigniorage) from the difference between the interest it earns on its reserve assets and the expense of maintaining its liabilities. By design, a&nbsp;currency board has no discretionary monetary powers and cannot engage in the fiduciary issue of money. It has an exchange‐​rate policy (the exchange rate is fixed) but no monetary policy. A&nbsp;currency board’s operations are passive and automatic: Its sole function is to exchange the domestic currency it issues for an anchor currency at a&nbsp;fixed rate. Consequently, the quantity of domestic currency in circulation is determined by market forces; namely, the demand for domestic currency.</p> <p>A currency board cannot issue credit. It cannot act as a&nbsp;lender of last resort or extend credit to the banking system. Nor can it make loans to the fiscal authorities and state‐​owned enterprises. Consequently, such a&nbsp;regime imposes discipline on the economy through a&nbsp;hard budget constraint. As a&nbsp;result, when compared to countries that employ central banking, currency‐​board countries have lower fiscal deficits, lower debt‐​to‐​GDP ratios, lower inflation rates, and more rapid growth.</p> <p>Historically, currency boards have existed in about 70 countries, and none have failed — including the North Russian currency board installed on November 11, 1918, during the civil war that followed the Bolshevik revolution. Its architect was none other than John Maynard Keynes, who was a&nbsp;British Treasury official at the time. Today, the most notable currency board is Hong Kong’s. What all currency boards — past and present — have in common is that they are public institutions. But, there is no requirement that currency boards be publicly owned.</p> </div> , <div class="mb-3 spacer--nomargin--last-child text-default"> <p>For many years, my long‐​time collaborator Kurt Schuler and I&nbsp;have advocated private currency boards. In our <a href="https://sites.krieger.jhu.edu/iae/files/2017/06/Currency_Boards_for_Developing_Countries-1.pdf" rel="noopener noreferrer" target="_blank">draft law</a> for such a&nbsp;regime, we proposed that its home offices and reserves be located in Switzerland and that it be governed under Swiss law. With the advent of cryptocurrencies, the prospect of our idea, or something similar to it, is close to becoming a&nbsp;reality. Indeed, the <a href="https://libra.org/en-US/wp-content/uploads/sites/23/2019/06/LibraWhitePaper_en_US.pdf" rel="noopener noreferrer" target="_blank">white paper</a> issued by the Libra Association in 2019 explicitly states that the Libra cryptocurrency would resemble a&nbsp;currency board. While that is correct in broad terms, Libra stumbled out of the gate and is not yet a&nbsp;reality.</p> <p>Central banks are clearly feeling the competitive threat posed by the prospect of private currency boards, like Libra. Indeed, a&nbsp;<a href="https://www.omfif.org/ibm19/" rel="noopener noreferrer" target="_blank">2019 report</a> on digital currencies by the Official Monetary and Financial Institutions Forum in London and IBM presents results from a&nbsp;survey of 23 central banks. Half of the respondents indicated that they perceived the widespread use of decentralized, private, digital currencies as a&nbsp;real threat. As the central bankers put it, private currencies would potentially “disturb the global financial system and undermine the sovereignty of monetary authorities.” This is nonsense. What central banking authorities are actually worried about is competition from private, stable currencies.</p> <p>The prospect of private currency boards — which are either backed by stable fiat currencies or gold — is a&nbsp;promising one. The competitive forces unleashed by private currencies would be a&nbsp;great stabilizer.</p> </div> Tue, 16 Jun 2020 14:48:24 -0400 Steve H. Hanke https://www.cato.org/publications/commentary/its-time-private-cryptocurrency-boards The Great Bulgarian Waiting Room Farce https://www.cato.org/publications/commentary/great-bulgarian-waiting-room-farce Steve H. Hanke <div class="mb-3 spacer--nomargin--last-child text-default"> <p>Bulgaria’s attempt to enter the ERM II waiting room is a&nbsp;farce. The first act of this three‐​act play begins with the mere thought of abandoning Bulgaria’s currency board and the lev. The currency board killed Bulgaria’s terrible hyperinflation of 1997, and it stabilized the economy and paved the way for Bulgaria’s entry into the EU and NATO. It has worked automatically and perfectly, just as I&nbsp;designed it to work. The Bulgarian public knows this and supports the currency board.</p> <p>But, Prime Minister Boyko Borisov and his echo chamber, Finance Minister Vladislav Goranov, want to do away with one of the few Bulgarian institutions that works perfectly well and is widely respected by Bulgarians, as well as foreigners. This is a&nbsp;farce.</p> <p>The second act of this farce involves the European Central Bank’s precondition that the First Investment Bank had to be recapitalized before Bulgaria could enter the Single Supervisory Mechanism and the ERM II waiting room. In my view, this discriminatory precondition imposed by Bulgaria’s masters in the European Union was illegal– another farce.</p> <p>The play’s grand finale started when the coronavirus pandemic struck. While the Bulgarian public was looking the other way, Prime Minister Borisov changed course. He argued that Bulgaria was missing out on EU funding because Sofia was not a&nbsp;member of the eurozone. This is total nonsense. Then, in a&nbsp;desperate attempt to recapitalize the First Investment Bank, the Bulgarian Development Bank, a&nbsp;state‐​owned bank, purchased the rights to FIB shares at double their market price. Only time will tell how this questionable maneuver will be viewed by the EU’s Directorate‐​General for Competition and whether Bulgaria’s government will move a&nbsp;step closer to what most Bulgarians fear: the loss of their beloved lev. This last act is, of course, the greatest farce of all.</p> </div> Tue, 16 Jun 2020 14:43:59 -0400 Steve H. Hanke https://www.cato.org/publications/commentary/great-bulgarian-waiting-room-farce The New Deal and Recovery, Part 1: The Record https://www.cato.org/blog/new-deal-recovery-part-1-record George Selgin <p>“Under the New Deal, the US economy grew at rapid rates, even for an economy in recovery.” (Eric Rauchway, <em>The Money Makers</em>, p. 100.)</p> <p>Before I start telling you what “the New Deal” did and didn’t do, I had better make clear what I mean by the phrase, if only to assure you that my meaning is perfectly conventional. Like <a href="https://en.wikipedia.org/wiki/New_Deal" rel="nofollow external noopener noreferrer" target="_blank">Wikipedia</a>, when I say “the New Deal,” I mean the “series of programs, public work projects, financial reforms, and regulations enacted by President Franklin D. Roosevelt in the United States between 1933 and 1939.” I point this out because some claims made about the New Deal’s contribution to recovery refer to certain parts of it only, rather than to <a href="https://www.econlib.org/archives/2007/01/what_was_the_ne_1.html" rel="nofollow external noopener noreferrer" target="_blank">the whole thing</a>.</p> <h4>Relief, Recovery, and Reform</h4> <p>Readers looking for a comprehensive list of New Deal undertakings are encouraged to consult that Wikipedia entry, for there were too many for me to list here, let alone describe in any detail. During <a href="http://www.digitalhistory.uh.edu/disp_textbook.cfm?smtid=2&amp;psid=3439" rel="nofollow external noopener noreferrer" target="_blank">its famous “first 100 days”</a> alone, the Roosevelt administration passed 15 major pieces of legislation and created roughly as many new Federal agencies; and these early efforts were to be followed by many others. Although, as we’ll see, many of these efforts had Hoover‐​administration precedents, and some were merely repackaged versions of Hoover‐​era schemes, the scale and overall scope of New Deal undertakings was such as to constitute a sea‐​change in the federal government’s role—one that has endured ever since.</p> <p>But not all of these New Deal efforts were aimed at promoting economic recovery. Instead, as any high‐​school American history text will tell you, the New Deal had three distinct aims—the “three R’s” of relief, recovery, and reform. It doesn’t follow that every New Deal effort can be neatly assigned to just one “R”: many can be said to have been intended to serve, if not to have served, multiple ends. Any relief program that meant more spending, for example, could also serve to promote recovery, particularly if it was financed by borrowing.</p> <p>But programs that brought relief, as many New Deal programs did, didn’t necessarily promote recovery. FDR himself understood this. “Emergency relief under way and planned,” he wrote in <em>Looking Forward </em>(1933, p. 224) “will succeed only in the vital work of maintaining life. But it corrects nothing.” The same was true of New Deal programs whose chief aim was reform. Indeed, as we’ll see, some New Deal reforms undermined what might otherwise have been a far more successful New Deal recovery program.</p> <p>As for New Deal policies and programs that had recovery among their chief aims, these were all supposed to help restore the general level of prices to its pre‐​depression level. Like many people at the time, FDR viewed the decline in prices since 1929 not just as a symptom but as a <em>cause</em> of the depression. As we’ll see, this reasoning was far from being altogether sound. Nevertheless, taken together with the Brain Trust’s aversion to “greenbackism” and <a href="https://www.jstor.org/stable/1917787" rel="nofollow external noopener noreferrer" target="_blank">various other populist proposals for money creation</a>, it readily accounts for all of the New Deal’s otherwise diverse recovery gambits, including the abandonment of the gold standard; the RFC‐​financed gold‐​purchase program; the establishment of the Agricultural Adjustment and National Recovery Administrations (AAA and NRA); and the dollar’s eventual, official devaluation.</p> <h4>The Course of Unemployment</h4> <p>Did these and other New Deal programs succeed in pulling the U.S. economy out of the Great Depression? To begin to answer that question, we first need to examine the bare facts concerning the depression and recovery. Those terms refer, most obviously, to the sharp decline in output starting in 1929 and its eventual return at least to its pre‐​depression level, if not to a higher level consistent with some pre‐​depression trend. But they also refer to the equally‐​sharp post‐​1929 increase in unemployment and the subsequent return to what most consider “full” employment.</p> <p>That the US economy suffered its most severe depression in the opening years of the 1930s is notorious. That it recovered rapidly for several years starting in mid‐​1933 is less well known, but no less indisputable. But the story of the Great Depression is far from a simple tale of depression followed by a speedy recovery. Consider the progress of unemployment, as seen in this chart <a href="https://utopiayouarestandinginit.com/2015/06/17/how-great-was-the-great-depression-unemployment-the-official-and-darby-estimates-of-us-unemployment-in-the-1930s/" rel="nofollow external noopener noreferrer" target="_blank">snatched from Jim Rose’s blog</a>:</p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="cbae2f19-9545-4cae-a87a-542993cd3584" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/Unemployment%5B1%5D.png?itok=qZyO_6Li 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/Unemployment%5B1%5D.png?itok=5lYbq674 1.5x" width="480" height="288" src="/sites/cato.org/files/styles/pubs/public/2020-06/Unemployment%5B1%5D.png?itok=qZyO_6Li" alt="Selgin chart" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Source: Rose, J. “How great was the Great Depression unemployment? The official and Darby estimates of US unemployment in the 1930s.” June 17, 2015. Utopia You Are Standing In It (blog). Accessed June 6, 2020. Utopi​aY​ourAre​StandingInIt​.com </div> </figcaption></figure><p>Ignore the orange line for now (I’ll come to it): the blue one is the standard, BLS unemployment measure which, I maintain, is best for gauging the progress of the recovery. And that progress was neither steady nor ever close to complete. From 3.2 percent in 1929—which was by no means an exceptionally low rate by the standards of that decade—unemployment rose to a peak of just under 25 percent in 1933. By 1936 it had fallen to just below 17 percent. But then it rose again, to 19 percent, after which it fell to 14.6 percent. To put these figures in perspective, the <em>peak</em> unemployment rate during the severe but relatively short‐​lived 1920–21 recession, and the highest since the 1890s, was 11.7 percent. Even at its lowest level, the Great Depression unemployment rate was almost 3 percentage points higher.</p> <p>Now, about that orange line. That shows a different measure of unemployment proposed some years ago in <a href="https://www.jstor.org/stable/1830168?seq=1" rel="nofollow external noopener noreferrer" target="_blank">a 1976 <em>JPE </em>article by Michael Darby</a>. What makes it different is that Darby counted all the persons working in New Deal work relief programs as “employed,” whereas the standard measure considers them unemployed. As you can see, although Darby’s numbers still don’t show unemployment dropping much below double‐​digits (the lowest level, for 1937, is 9.1 percent), they make the New Deal look a lot more successful than the standard numbers do.</p> <p>Now, if all this were just a matter of classification, it wouldn’t signify much. After all, what we care about in gauging recovery isn’t simply whether people are working but whether the economy is capable of coming up with reasonably permanent jobs for them. But Darby’s position isn’t simply a matter of terminology: he claims that relief work served, not to give employment to workers who would otherwise have been unemployed, but to give better‐​paying or otherwise more attractive jobs to workers who could have found other jobs had they tried. According to that hypothesis, Darby’s numbers show the true pace of recovery.</p> <p>But it’s a hard hypothesis to swallow. As Jonathan Kesselman and N.E. Savin note in <a href="https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1465-7295.1978.tb00282.x" rel="nofollow external noopener noreferrer" target="_blank">their 1978 response to Darby</a>, although it’s true that relief work was sometimes more appealing than private alternatives, it doesn’t follow that those alternatives were readily available. What’s more, they offer plenty of good reasons for thinking it wasn’t, starting with the most obvious, to wit: that millions of “Darby‐​unemployed” persons indistinguishable in any obvious way from those on work relief were still unemployed. If there were plenty of private jobs to be had, why wouldn’t they snap them up? Based on this and other salient facts, and a painstaking econometric test of Darby’s hypothesis, Kesselman and Savin conclude that, had workers employed by New Deal programs been thrown onto the labor market, few if any would have found gainful employment elsewhere. It follows that the BLS’s “uncorrected” unemployment numbers, intended to measure the lack of what Stanley Lebergott, their compiler, called “regular” work, supply a more accurate picture of the progress of recovery than Darby’s corrected series.</p> <p>Darby’s intention, by the way, wasn’t to show that the New Deal was more successful than conventional statistics suggest. It was to claim that the New Classical view that unemployment is generally voluntary held even for the Great Depression: once the shock of the Great [monetary] Contraction had run its course, Darby claims, unemployment was bound to fall rapidly to its “natural” level as a matter of course, New Deal or no New Deal. New Deal programs merely served to obscure this naturally rapid recovery by supplying workers with more attractive jobs than the ones private employers would have been able to give them. I don’t buy this argument against the New Deal for a minute, both because I think some New Deal steps aided recovery (mainly by encouraging a revival of spending) and because I think others hindered it. But I also don’t find Darby’s numbers helpful in any other way for assessing the New Deal’s success.</p> <h4>The Course of Output</h4> <p>To switch now to looking at the course of real output, the picture here seems at first glance to put the New Deal in a much more favorable light. Here, for example, is what happened to real GDP:</p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="c4f9935a-abf1-4a8a-bae3-a501914c31bb" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/Output%5B1%5D.png?itok=dhYm8Gv9 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/Output%5B1%5D.png?itok=4LpkeXXQ 1.5x" width="700" height="282" src="/sites/cato.org/files/styles/pubs/public/2020-06/Output%5B1%5D.png?itok=dhYm8Gv9" alt="Selgin chart 2" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Source: U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPCA], retrieved from FRED, Federal Reserve Bank of St. Louis; <a href="https://fred.stlouisfed.org/series/GDPCA">https://​fred​.stlou​is​fed​.org/​s​e​r​i​e​s​/​GDPCA</a>, June 15, 2020. </div> </figcaption></figure><p>Evidently, real output had returned to its pre‐​depression level by 1936 and, despite a serious setback in 1937–8, ultimately surpassed it.</p> <p>But here again the statistics must be handled with care. Healthy economies grow; so a mere return of output to its starting level, or a little above it, after a decade is itself no great achievement. A better measure of the speed of recovery is the time it takes for output to return to its pre‐​crisis trend line, and in this instance that didn’t happen until 1942<em>,</em> after the New Deal had been cast aside for the sake of mobilization, setting‐​off what <a href="https://www.researchgate.net/publication/24126115_Price_and_Production_Controls_in_World_War_II" rel="nofollow external noopener noreferrer" target="_blank">Hugh Rockoff</a> calls a munitions‐​based “gold rush.”</p> <p>More fundamentally, what matters isn’t the absolute level of output, but how the progress of actual output compares to that of <em>potential</em> output. That unemployment was persistently high itself tells us that output could have improved considerably more than it did. “The Depression years,” <a href="https://scholarcommons.scu.edu/cgi/viewcontent.cgi?article=1097&amp;context=econ" rel="nofollow external noopener noreferrer" target="_blank">Alexander Field reports</a>, “were disastrous from the standpoint of capacity utilization. …Double digit unemployment for more than a decade represented a terrible waste of human and other resources.” And it wasn’t just labor that was wasted: machines and all sorts of other inputs were also left idle. “The private sector capital stock,” Field says, also remained “in the aggregate, basically unchanged.”</p> <p>So how could output have recovered as it did? The answer, Field says, is that, despite the depression, the 1930s witnessed remarkable improvements in total factor productivity (TFP)—that is, the amount of real output the U.S. economy was able to squeeze out of any given amount of land, labor, and capital:</p> <blockquote><p>Since private sector input growth was effectively absent, all of the growth in output was on account of TFP advance. And since there was virtually no capital deepening, almost all of the growth in output per hour (labour productivity) can also be attributed to TFP growth.</p> </blockquote> <p>Just why did productivity grow so rapidly during the 30s? While the New Deal may well have contributed to the gains, according to Field its contribution—mainly through the Public Work Authority’s construction of streets and highways—was quite limited. Instead, he says, the coincidence of depression and TFP gains was mostly serendipitous: the harvest was mainly a result, not of anything that happened in the 30s, but of seeds sown by inventors and investors during the previous two decades.</p> <p>To summarize: if we want to properly gauge the progress of economic recovery after any collapse, we can’t simply look at the number of persons employed, or the amount of stuff being produced. We have to ask, “how close is the economy to making full use of its valuable resources, including its labor force? How close is it to achieving its full potential?” And if we ask that question of the U.S. economy in 1939, as the New Deal neared its end, the answer must be, “Not very close at all.”</p> <h4>The International Picture</h4> <p>Another way in which to judge the progress of the U.S. recovery is by comparing it with those of other nations. The Great Depression was an <em>international</em> depression, after all. Were the New Deal conducive to recovery, one might expect the U.S. recovery to have matched if not surpassed that of other afflicted nations. Yet, as the chart below, from Barry Eichengreen’s <a href="https://www.amazon.com/Golden-Fetters-Depression-1919-1939-Development/dp/0195101138" rel="nofollow external noopener noreferrer" target="_blank"><em>Golden Fetters</em></a>, shows, despite the rapid productivity growth it enjoyed, by 1937 the United States’ index of industrial production was still below its 1929 level, having grown relatively slowly, and in fits and spurts, since 1932. In contrast the indexes of several other European nations increased steadily, surpassing their pre‐​depression levels. France alone lagged even further behind than the U.S.</p> <p> </p><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="55219dba-ddbf-43b0-adfc-ee2c396261f0" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/eichengreen-international%5B1%5D.png?itok=dG0uhEs0 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/eichengreen-international%5B1%5D.png?itok=Qmr6xoqF 1.5x" width="700" height="476" src="/sites/cato.org/files/styles/pubs/public/2020-06/eichengreen-international%5B1%5D.png?itok=dG0uhEs0" alt="Selgin chart 3" typeof="Image" class="component-image" /></div> <p>Eichengreen’s chart only goes up to 1937. Here’s another chart, from <a href="https://commons.wikimedia.org/wiki/File:PIB_1929-1939.gif" rel="nofollow external noopener noreferrer" target="_blank">a French Wikipedia article</a> (hence the French labels: note that “E-U” stands for “<span>États‐​Unis</span>,” not “European Union”). This one shows the progress of real GDP (<a href="https://en.wikipedia.org/wiki/Maddison_Project" rel="nofollow external noopener noreferrer" target="_blank">the data are Angus Maddison’s</a>) through 1939. It also differs by excluding the data for Germany and adding those for the U.S.S.R. (ditto) and Italy. According to it, by the end of New Deal, the U.S. was tied with France for last place.</p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="9ff431f7-06a7-4f00-9675-662735c7e93c" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/International-Recovery%5B1%5D.gif?itok=bfCTl7Hb 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/International-Recovery%5B1%5D.gif?itok=BoJMiZuI 1.5x" width="596" height="410" src="/sites/cato.org/files/styles/pubs/public/2020-06/International-Recovery%5B1%5D.gif?itok=bfCTl7Hb" alt="Selgin chart 4" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Source: Berlin, K. “Evolution du PIB 1929–1939.” Wikipedia. September 13, 2006. Accessed June 15, 2020. <a href="https://commons.wikimedia.org/wiki/File:PIB_1929-1939.gif">https://​com​mons​.wiki​me​dia​.org/​w​i​k​i​/​F​i​l​e​:​P​I​B​_​1​9​2​9​-​1​9​3​9.gif</a> </div> </figcaption></figure><p>Finally, here’s a third chart, <a href="https://www.obserwatorfinansowy.pl/in-english/the-economy-of-the-second-polish-republic-collapsed-because-of-dogmatic-policies/" rel="nofollow external noopener noreferrer" target="_blank">made by Piotr Arak</a> also using Angus Maddison’s data, showing the progress of per‐​capita real GDP, relative to pre‐​WWI levels, in the U.S. and six other nations, including several Central European nations that were especially hard‐​hit by the depression, between 1929 and 1938:</p> <figure role="group" class="filter-caption"><div data-embed-button="image" data-entity-embed-display="view_mode:media.blog_post" data-entity-type="media" data-entity-uuid="19fb2e37-6056-4aa3-b083-abb3913dcbe2" data-langcode="en" class="embedded-entity"> <img srcset="/sites/cato.org/files/styles/pubs/public/2020-06/Wealth-of-European-Countries%5B1%5D.jpg?itok=ux2vMgSg 1x, /sites/cato.org/files/styles/pubs_2x/public/2020-06/Wealth-of-European-Countries%5B1%5D.jpg?itok=x24_Mfpl 1.5x" width="700" height="336" src="/sites/cato.org/files/styles/pubs/public/2020-06/Wealth-of-European-Countries%5B1%5D.jpg?itok=ux2vMgSg" alt="Selgin chart 5" typeof="Image" class="component-image" /></div> <br /><figcaption><div class="figure-caption text-sans-alternate">Source: Arak, P. “The economy of the Second Polish Republic collapsed because of dogmatic policies.” Obserwator Finansowy. February 27, 2019. Accessed June 15, 2020. <a href="https://www.obserwatorfinansowy.pl">https://​www​.obser​wa​tor​fi​nan​sowy​.pl</a> </div> </figcaption></figure><p>According to this chart, the average U.S. citizen was 30 percent better off in 1929 than in 1913—a postwar gain second only to Czechoslovakia’s, where per‐​capita income had risen by 45 percent. By 1938, however, the average American was only 21 percent richer than in 1913, making the United States’ record the worst of the bunch.</p> <p>***</p> <p>Perhaps, after seeing me run through these statistics, you’re expecting me to add, “<em>ergo</em>, the New Deal was a flop.” But I know better than that. To make the case that the New Deal failed, I need to convince you, not only that it didn’t bring recovery, but that a different set of policies might well have done so. And that’s why this series is only just getting started.</p> <p>[<a href="https://www.alt-m.org/2020/06/16/the-record/">Cross‐​posted from Alt​-​M​.org</a>]</p> Tue, 16 Jun 2020 09:02:53 -0400 George Selgin https://www.cato.org/blog/new-deal-recovery-part-1-record Incorporating Scenario Analysis into the Federal Reserve’s Policy Strategy & Communications https://www.cato.org/publications/working-paper/incorporating-scenario-analysis-federal-reserves-policy-strategy Michael D. Bordo, Andrew T. Levin, Mickey D. Levy <div class="mb-3 spacer--nomargin--last-child text-default"> <p>The U.S. economy currently faces a&nbsp;truly extraordinary degree of uncertainty as a&nbsp;consequence of the COVID-19 pandemic. Consequently, the Federal Reserve should begin highlighting alternative scenarios that illustrate key risks to the economic outlook, and those scenarios should inform the Fed’s policy strategy and public communications. We present a&nbsp;set of illustrative scenarios, including a&nbsp;<em>baseline scenario</em> with a&nbsp;rapid but incomplete recovery this year (an upward‐​tilting checkmark), a&nbsp;<em>benign scenario</em> in which an effective cure or vaccine becomes available and facilitates a&nbsp;nearly complete recovery by mid‐​2021, and a&nbsp;severely adverse scenario involving persistently high unemployment and disinflationary pressures. Insights into these scenarios can be drawn from key historical episodes, including the Spanish flu, the Great Depression, the end of World War II, and the global financial crisis. We conclude by identifying key challenges that the Federal Reserve will need to address in adjusting its monetary policy and emergency credit facilities under these three alternative scenarios.</p> </div> Wed, 10 Jun 2020 15:49:26 -0400 Michael D. Bordo, Andrew T. Levin, Mickey D. Levy https://www.cato.org/publications/working-paper/incorporating-scenario-analysis-federal-reserves-policy-strategy How the Federal Reserve Literally Makes Money https://www.cato.org/publications/commentary/how-federal-reserve-literally-makes-money William J. Luther <div class="lead mb-3 spacer--nomargin--last-child text-default"> <p>The Federal Reserve has vowed to provide up to&nbsp;<a href="https://www.brookings.edu/research/fed-response-to-covid19/" target="_blank">US$2.3 trillion</a>&nbsp;in lending to support households, employers, financial markets and state and local governments struggling as a&nbsp;result of the coronavirus and corresponding stay‐​at‐​home orders.</p> </div> , <div class="mb-3 spacer--nomargin--last-child text-default"> <p>Let that number sink in: $2,300,000,000,000.</p> <p>I have a&nbsp;<a href="https://scholar.google.com/citations?user=DeAMImUAAAAJ&amp;hl=en&amp;oi=ao" target="_blank">Ph.D. in economics</a>, direct the&nbsp;<a href="https://www.aier.org/pertinent_category/sound-money-project/" target="_blank">Sound Money Project</a>&nbsp;at the American Institute for Economic Research and write regularly on Federal Reserve policy. And, yet, it is difficult for me to wrap my head around a&nbsp;number that large. If you were to stack 2.3 trillion $1 bills, it&nbsp;<a href="https://www.ehd.org/science_technology_largenumbers.php" target="_blank">would reach over halfway to the Moon</a>.</p> <p>Put simply, it is a&nbsp;lot of money. Where does it all come from?</p> </div> , <aside class="aside--right aside--large aside pb-lg-0 pt-lg-2"> <div class="pullquote pullquote--default"> <div class="pullquote__content h2"> <p>Congress gave the Fed the ability to create money from thin air. The Fed should wield this enormous power wisely. </p> </div> </div> </aside> , <div class="mb-3 spacer--nomargin--last-child text-default"> <p>Unlike the trillions of dollars the&nbsp;<a href="https://www.congress.gov/bill/116th-congress/senate-bill/3548/text?q=product+actualizaci%C3%B3n" target="_blank">Treasury is spending to save the economy</a>&nbsp;by bailing out companies or beefing up unemployment checks,&nbsp;<a href="https://www.mercatus.org/bridge/podcasts/04272020/george-selgin-fed-treasury-relationship-new-lending-facilities-covid-19" target="_blank">very little of the Fed’s money</a>&nbsp;actually comes from taxpayers or sales of government bonds. Most of it, in fact, emerges right out of thin air. And that has costs.</p> <p><strong>Printing green</strong></p> <p>It is common to hear people say the Fed prints money.</p> <p>That’s not technically correct. The Bureau of Engraving and Printing, an agency of the U.S. Treasury,&nbsp;<a href="https://www.newyorkfed.org/aboutthefed/fedpoint/fed01.html" target="_blank">does the printing</a>. The Fed, for its part, purchases cash from the bureau at cost and then puts it in circulation.</p> <p>Although you may have heard some economists talk about the Fed figuratively&nbsp;<a href="https://www.investopedia.com/terms/h/helicopter-drop.asp" target="_blank">dropping cash from helicopters</a>, its method of distribution isn’t quite as colorful. Instead, it gives banks cash in exchange for old, worn‐​out notes or digital balances held by the banks at the Fed. In this way, the Fed can help banks accommodate changes in demand for banknotes, like those in advance of&nbsp;<a href="http://jpkoning.blogspot.com/2018/12/christmas-and-cash.html" target="_blank">major holidays</a>&nbsp;or after&nbsp;<a href="https://www.aier.org/article/cash-is-king-covid19/" target="_blank">natural disasters</a>.</p> <p>These exchanges are dollar‐​for‐​dollar swaps. The Fed does not typically increase the&nbsp;<a href="https://fred.stlouisfed.org/series/BOGMBASEW" target="_blank">monetary base</a> — the total amount of currency in circulation and reserves held by banks at the central bank — when it distributes new banknotes.</p> <p><strong>Magicking green</strong></p> <p>To put more money into circulation, the Fed typically purchases financial assets — in much the same way that it plans to spend that $2.3 trillion.</p> <p>To understand how, one must first recognize that the Fed is a&nbsp;bankers’ bank. That is, banks hold deposits at the Fed much like you or I&nbsp;might hold deposits in a&nbsp;checking account at Chase or Bank of America. That means when the Fed purchases a&nbsp;government bond from a&nbsp;bank or makes a&nbsp;loan to a&nbsp;bank, it does not have to — and usually doesn’t — pay with cash. Instead, the Fed just credits the selling or borrowing bank’s account.</p> <p>The Fed does not print money to buy assets because it does not have to. It can create money with a&nbsp;mere keystroke.</p> <p>So as the Fed buys Treasuries, mortgage‐​backed securities, corporate debt and other assets&nbsp;<a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20200409a.htm" target="_blank">over the coming weeks and months</a>, money will rarely change hands. It will just move from one account to another.</p> <p><strong>Costs of magical money</strong></p> <p>While the Fed can create money&nbsp;<a href="http://andolfatto.blogspot.com/2011/03/out-of-thin-air.html" target="_blank">out of thin air</a>, that does not mean it does so without cost. Indeed, there are two potential costs of creating money that one should keep in mind.</p> <p>The first results from inflation, which denotes a&nbsp;general increase in prices and, correspondingly, a&nbsp;fall in the purchasing power of money. Money is a&nbsp;highly liquid — easily exchangeable — asset we use to make purchases. When the Fed creates more money than we want to hold on to, we exchange the excess money for less liquid assets, including goods and services. Prices are driven up in the process. When the Fed does this routinely, expected inflation gets built into long‐​term contracts, like mortgages and employment agreements. Businesses incur costs from having to&nbsp;<a href="https://www.investopedia.com/terms/m/menu-costs.asp" target="_blank">change prices more frequently</a>, while consumers have to&nbsp;<a href="https://fraser.stlouisfed.org/title/inside-vault-6107/spring-1999-586615" target="_blank">make more frequent trips to the bank or ATM</a>.</p> <p>The other cost is a&nbsp;consequence of reallocating credit.</p> <p>Suppose the Fed makes a&nbsp;loan to the “Bank of Fast and Loose Lending.” If the bank wasn’t able to secure alternative funding, this suggests that other private financial institutions deemed its lending practices too risky. In making the loan, the Fed has only created more money. It has not created more real resources that can be bought with money. And so, by giving the Bank of Fast and Loose Lending a&nbsp;lifeline, the Fed enables it to take scarce real resources away from other productive ventures in the economy.</p> <p>The&nbsp;<a href="https://www.annualreviews.org/pb-assets/journal-assets/annual-review-financial-economics/volume-10/ARFE_Bailouts-1541624486297.pdf" target="_blank">cost to society</a>&nbsp;is the difference between the value of those real resources as employed by the Bank of Fast and Loose Lending and the value of those real resources as employed in the productive ventures forgone.</p> <p><strong>Uncharted waters</strong></p> <p>In recent years, the Fed has shown itself to be quite adept at keeping inflation low, even when making large‐​scale asset purchases.</p> <p>The central bank purchased nearly&nbsp;<a href="https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm" target="_blank">$3.6 trillion</a>&nbsp;worth of assets from September 2008 to January 2015, yet annual inflation averaged roughly&nbsp;<a href="https://fred.stlouisfed.org/series/PCEPI" target="_blank">1.5% over the period</a> — well below its&nbsp;<a href="https://www.federalreserve.gov/faqs/money_12848.htm" target="_blank">2% target</a>.</p> <p>I’m less sanguine about the Fed’s ability to keep the costs of reallocating credit low. Congress has&nbsp;<a href="https://www.aier.org/article/powell-admits-that-the-feds-actions-vastly-exceed-its-mandate/" target="_blank">traditionally limited</a>&nbsp;the Fed to making loans to banks and other financial market institutions. But now it is&nbsp;<a href="https://www.aier.org/article/fed-lending-programs-might-be-legal-but-theyre-still-bad-policies/" target="_blank">tasking the Fed</a>&nbsp;with providing direct assistance to&nbsp;<a href="https://www.aier.org/article/fed-lending-programs-might-be-legal-but-theyre-still-bad-policies/" target="_blank">nonbank businesses and municipalities</a> — areas where the Fed lacks experience.</p> <p>It is difficult to predict how well the Fed will manage its new lending facilities. But its limited experience making loans to small businesses –&nbsp;<a href="https://www.alt-m.org/2020/03/30/when-the-fed-tried-to-save-main-street/" target="_blank">in the 1930s, for example</a> — does little to alleviate the concerns of myself and others.</p> <p>Congress gave the Fed the ability to create money from thin air. The Fed should wield this enormous power wisely.</p> </div> Wed, 10 Jun 2020 09:06:59 -0400 William J. Luther https://www.cato.org/publications/commentary/how-federal-reserve-literally-makes-money Let Investors Decide, Part II https://www.cato.org/blog/let-investors-decide-part-ii Jennifer J. Schulp <p><a href="https://www.cato.org/blog/let-investors-decide-part-1">In my last post</a>, I argued that the SEC's "accredited investor" definition, which prevents investors who make less than $200,000 a year or who are worth less than $1 million from investing in private securities offerings, should be eliminated from our securities laws. Under its current definition, the SEC conflates less-wealthy investors with ones who lack good judgment, reserving considerable investment opportunities only for the well-to-do.</p> <p>After years of considering options for revising the definition, including scrapping the concept altogether, the SEC has instead proposed nothing more than a modest change. The new <a href="https://www.sec.gov/rules/proposed/2019/33-10734.pdf" rel="nofollow external noopener noreferrer" target="_blank">proposal</a> somewhat expands the group of investors it considers to have "the knowledge and expertise to participate in our private capital markets" by including people who hold certain professional credentials, such as broker-dealer and investment adviser representatives, as well as some private fund employees seeking to invest in their employers' own funds. The proposed definition thus adds a small subset of financial industry insiders to the set of well-to-do investors it already permits to participate in private securities offerings.</p> <p>This limited expansion does little to remedy <a href="https://www.alt-m.org/2020/06/01/let-investors-decide-part-1/" rel="nofollow noopener noreferrer">the harms caused</a> by the current rule, which reserves private securities offerings for a small minority of individual investors. The vast majority of investors remain shut out of offerings made under <a href="https://www.law.cornell.edu/cfr/text/17/230.506" rel="nofollow external noopener noreferrer" target="_blank">Rule 506 of Regulation D</a>, which permits an issuer to raise an unlimited amount of capital without registering the offering, so long as that issuer complies with the rule's requirements for investor solicitation and eligibility, among other things.</p> <p>But the proposed definition at least moves the SEC in the right direction: by expanding access to private securities offerings regardless of whether investors are wealthy enough to sustain a loss, the SEC has narrowed its investor protection focus to whether an investor can assess a prospective investment. Given this refined focus, the SEC can and should do better than its current proposal.</p> <p>To be specific, if the SEC wants to open investment in private securities offerings to those who can assess a prospective investment, it should take the following three steps:</p> <p>(1) <em>Consider as "accredited" any investor who is being advised by an investment adviser or broker-dealer</em>. The SEC's proposed amendments assume, by their very nature, that investment adviser and broker-dealer representatives are sophisticated enough to make their own investments in private offerings. Their clients should be able to leverage that same expertise to invest. Many of these interactions will be subject to fiduciary duties or the best interest standard, depending on the representative's relationship with the client, providing an additional layer of investor protection.</p> <p>A limited number of investors are already allowed to rely on the advice of others to purchase exempt offerings. A <a href="https://www.law.cornell.edu/cfr/text/17/230.506" rel="nofollow external noopener noreferrer" target="_blank">Rule 506(b)</a> offering can be purchased by a limited number of non-accredited investors if they, individually or together with a purchaser representative, have enough knowledge and experience to evaluate the merits and risks of the prospective investment. This allowance has been used sparingly—from 2013 to 2018, <a href="https://www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017.pdf" rel="nofollow external noopener noreferrer" target="_blank">only 6% of Rule 506(b) offerings</a> included at least one non-accredited investor—first, because there's uncertainty as to how to judge an investor's knowledge and experience, and second, because issuers are required to provide additional information to any non-accredited investors who participate in the offering. This allowance is not the panacea that it may seem; these additional burdens on issuers deter participation by non-accredited investors who can assess the investment (alone or with their adviser). And such investors remain shut out entirely from Rule 506(c) offerings that are strictly limited to accredited investors. Adding advised investors to the accredited investor definition would open substantially more opportunities to those who have the ability to judge the prospective investment.</p> <p>Counting advised investors as accredited also gives investors control over their own circumstances. While it may impose additional costs to investing, obtaining an adviser is far easier than obtaining a new credential, some of which are only available to those employed by a broker-dealer or investment adviser. And, of course, obtaining an adviser is far easier than getting rich enough to meet the accredited investor definition's wealth test.</p> <p>(2) <em>Permit investors to self-certify as accredited</em>. Issuers generally are allowed to rely on investors' representations for offerings under Rule 506(b), but offerings under Rule 506(c) require issuers to verify that an investor meets the accredited investor definition. Although the rule provides a list of "non-exclusive" methods to conduct such a verification, as a practical matter, issuers generally follow the rule's proscriptions, which include reviewing the investor's tax returns and bank statements. This verification process is onerous for issuers and investors alike and invasive to investor privacy. It also likely results in the exclusion of investors who do not substantially exceed the accredited investor threshold, both to make the review easier and to avoid the potential consequences of an erroneous verification. Recognizing the burdens of verification and investor privacy concerns, the SEC <a href="https://www.sec.gov/rules/proposed/2020/33-10763.pdf" rel="nofollow external noopener noreferrer" target="_blank">has proposed</a> limited self-certification for investors who are making a new investment with the same issuer. But this tweak to the existing rules does not go far enough.</p> <p>The best solution would be for the SEC to permit an investor to self-certify under a broader, principles-based, definition of accredited investor. Coupled with clear disclosure about the Securities Act protections that she will forgo by participating in private markets, this will allow an investor to choose for herself whether she meets the sophistication criteria required to invest. Other jurisdictions, like the <a href="https://www.sec.gov/corpfin/reportspubs/special-studies/review-definition-of-accredited-investor-12-18-2015.pdf" rel="nofollow external noopener noreferrer" target="_blank">United Kingdom</a>, permit <a href="https://www.handbook.fca.org.uk/handbook/COBS/4/12.html#DES586" rel="nofollow external noopener noreferrer" target="_blank">self-certification</a> of this type for certain sophisticated investors. But even used in conjunction with the SEC's bright-line accreditation definition, self-certification coupled with clear disclosure would be welcome. Self-certification appropriately shifts the burden of compliance to the investor, who bears the risk of the investment. Self-certification also protects an investor's privacy by relieving her of the need to disclose highly personal information about net worth and income.</p> <p>(3) <em>Consider accredited investor status only for offerings under Rule 506 of Regulation D</em>. The accredited investor definition appears in the <a href="https://www.law.cornell.edu/uscode/text/15/77b" rel="nofollow external noopener noreferrer" target="_blank">Securities Act</a> only in sections that are relevant to Rule 506 offerings. Yet the SEC has imported the accredited investor definition to exempt offerings that are based on other statutory authority. For example, the SEC imposes investment limitations on non-accredited investors for offerings made under <a href="https://www.law.cornell.edu/cfr/text/17/230.251" rel="nofollow external noopener noreferrer" target="_blank">Tier 2 of Regulation A</a>, which permits issuers to raise up to $50 million annually subject to certain filing requirements. And while the statute itself imposes investment limitations for crowdfunding offerings based on an investor's income and net worth, the SEC <a href="https://www.sec.gov/rules/proposed/2020/33-10763.pdf" rel="nofollow external noopener noreferrer" target="_blank">is proposing</a> to permit accredited investors to make unlimited investments. The SEC should not expand this investor caste system into other exemptions.</p> <p>Of course, allowing more persons to take part in private offerings doesn't mean that anyone allowed to do so <em>should</em> be taking part in such offerings! As <a href="https://d.docs.live.net/aa1321af17d9974a/Desktop/Accredited%20Investor%20Posts/o%09https:/www.sec.gov/news/public-statement/statement-roisman-2019-12-18-accredited-investor" rel="nofollow external noopener noreferrer" target="_blank">SEC Commissioner Elad Roisman</a> has said, "not every private company will turn out to be a good investment, just as not every public company would be a good investment. But depriving people of investment opportunities based on certain income and wealth thresholds objectively makes little sense." That someone is legally able to buy into a hedge fund or invest in a biotech startup is no reason why they should. But the SEC should not prevent them from doing so, especially provided investors can seek expert advice in evaluating potential investments.</p> <p>Although the SEC's proposal to expand the accredited investor definition is a step in the right direction, it is only a small one. Bigger steps, including but not necessarily limited to those suggested here, are needed to move the needle further in favor of investor choice, even if the SEC is unwilling to eliminate the accredited investor concept all together.</p> <p>[<a href="https://www.alt-m.org/2020/06/10/let-investors-decide-part-ii/">Cross-posted from Alt-M.org</a>]</p> <p></p> Wed, 10 Jun 2020 08:20:54 -0400 Jennifer J. Schulp https://www.cato.org/blog/let-investors-decide-part-ii To Help the Unbanked, Break the Industrial Bank Taboo https://www.cato.org/blog/help-unbanked-break-industrial-bank-taboo Diego Zuluaga <p>According to the FDIC, 8.4 million U.S. households <a href="https://www.fdic.gov/householdsurvey/2017/2017report.pdf" rel="nofollow external noopener noreferrer" target="_blank">lacked</a> a bank account as of 2017, putting America behind other rich countries. Minorities and the young are heavily overrepresented among the unbanked, so addressing this problem is a matter of both financial inclusion and equal opportunity. Fortunately, the FDIC can use its authority over an obscure banking charter to help, and it recently <a href="https://www.americanbanker.com/news/fdic-nears-decision-on-ilc-bids-as-it-floats-new-standards-for-charter" rel="nofollow external noopener noreferrer" target="_blank">proposed</a> to do just that. But if it goes ahead, it can expect stiff opposition from industry incumbents and their champions in Congress. </p> <p>Many blame the unbanked problem on the recent decline in the number of U.S. banks. But that decline has been more than offset by the 24 percent growth of bank branch networks since 1995. Because the share of unbanked households is also often <a href="https://www.fdic.gov/householdsurvey/2017/2017appendix.pdf" rel="nofollow external noopener noreferrer" target="_blank">higher</a> in urban areas, where bank branches are easiest to come by, than elsewhere, proximity to a bank office doesn't seem to be a strong driver of account ownership. Instead, the unbanked themselves generally <a href="https://www.fdic.gov/householdsurvey/2017/2017report.pdf" rel="nofollow external noopener noreferrer" target="_blank">blame</a> their predicament on either the high cost of keeping bank accounts or their distrust of ordinary banks or both. </p> <p>Slimming down the ranks of the unbanked is therefore likely to necessitate a different kind of bank—one that inspires unbanked Americans' confidence without busting their budgets. Many large commercial firms, such as retailers, grocery stores, online marketplaces, and other businesses that the unbanked regularly patronize would seem well-placed to fill such a gap. The hitch is that the 1956 <a href="https://www.law.cornell.edu/uscode/text/12/1843" rel="nofollow external noopener noreferrer" target="_blank">Bank Holding Company Act</a> (BHCA) generally forbids mingling commerce and banking, an American anomaly that subsequent <a href="https://www.govinfo.gov/content/pkg/PLAW-106publ102/pdf/PLAW-106publ102.pdf" rel="nofollow external noopener noreferrer" target="_blank">financial legislation</a> has only helped to entrench. While Congress <a href="https://www.govinfo.gov/content/pkg/PLAW-106publ102/pdf/PLAW-106publ102.pdf" rel="nofollow external noopener noreferrer" target="_blank">got rid</a> of the New Deal-era separation of banking and securities in 1999, it hasn't yet seriously contemplated letting non-financial firms enter the business of banking. </p> <p>There is, however, an exception in current law: a commercial firm can offer certain types of bank accounts by obtaining an <a href="https://www.fdic.gov/regulations/examinations/supervisory/insights/sisum04/industrial_loans.html#drop5" rel="nofollow external noopener noreferrer" target="_blank">industrial bank charter</a> from a state banking regulator and deposit insurance from the FDIC. Only five states currently host industrial banks, and only Utah and Nevada continue to take charter applications from commercial firms, with Utah <a href="https://lassonde.utah.edu/wp/wp-content/uploads/2018/10/ILC_REPORT_BARTH_2018.pdf" rel="nofollow external noopener noreferrer" target="_blank">accounting</a> for 94 percent of industrial bank assets. All sorts of firms, including carmakers BMW and Toyota, the student loan servicer Sallie Mae, and Swiss investment bank UBS, now own industrial banks. </p> <p>Owing to their exemption from the BHCA, industrial banks are a bête noire of many regulators and politicians. The Federal Reserve dislikes them because neither they nor their parent companies are subject to its consolidated supervision. Even Alan Greenspan, as close to a free-market luminary as is ever likely to run the Fed, <a href="https://www.nytimes.com/2006/01/26/business/worldbusiness/26iht-IBRIEF.html" rel="nofollow external noopener noreferrer" target="_blank">asked</a> Congress to get rid of them toward the end of his tenure, causing some to <a href="https://www.wsj.com/articles/SB113893527376964107" rel="nofollow external noopener noreferrer" target="_blank">wonder</a> if he'd gone native. Politicians generally <a href="https://www.americanbanker.com/news/a-wal-mart-owned-bank-would-set-bad-precedent" rel="nofollow external noopener noreferrer" target="_blank">oppose</a> industrial banks because only a few states have them, while community banks, whose lobbying clout remains heavy despite their recent economic <a href="https://www.cato.org/sites/cato.org/files/2019-12/v42n4-6.pdf" rel="nofollow external noopener noreferrer" target="_blank">decline</a>, give no quarter in their persistent <a href="https://www.icba.org/docs/default-source/icba/advocacy-documents/reports/ilc-white-paper.pdf" rel="nofollow external noopener noreferrer" target="_blank">calls</a> to "end the industrial bank loophole." Owing partly to such strong opposition, industrial banks are a small part of the U.S. banking system, accounting for 0.8 percent ($150 billion) of total FDIC-insured assets ($18 trillion). </p> <p>Yet industrial banks' safety and soundness record is actually comparably good: They fail less, hold more capital, and are more profitable <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3197316" rel="nofollow external noopener noreferrer" target="_blank">than ordinary banks</a>. Nor is there much evidence to support the accusation that they're insufficiently regulated. Like ordinary banks, they face <a href="https://www.federalreserve.gov/aboutthefed/section23a.htm" rel="nofollow external noopener noreferrer" target="_blank">strict limits</a> on the amount and terms of their lending to affiliated companies. Just like bank holding companies, industrial bank parent companies must be ready to serve as a <a href="https://www.law.cornell.edu/uscode/text/12/1831o-1" rel="nofollow external noopener noreferrer" target="_blank">"source of strength"</a> in times of stress. But the FDIC imposes additional standards, often requiring that industrial banks hold capital well above the statutory minimum. For example, Square, a payments firm that recently gained FDIC <a href="https://www.fdic.gov/news/news/press/2020/pr20033a.pdf" rel="nofollow external noopener noreferrer" target="_blank">approval</a> for its industrial bank, must not let its capital drop below 20 percent of assets. Ordinary banks, on the other hand, usually get a pass with 9 percent and may temporarily hold just 8 percent under the CARES Act. </p> <p>Yet despite their good prudential record, industrial banks' prospects have become somewhat dimmer in the last two decades. A series of moratoria—first by the FDIC, then by the Dodd-Frank Act—kept a lid on new industrial bank charters until 2013. One event more than any other served to <a href="https://www.wsj.com/articles/SB116118495912296504" rel="nofollow external noopener noreferrer" target="_blank">galvanize</a> industrial bank opponents: Wal-Mart's July 2005 charter application. Nearly 14,000 mostly critical responses pushed the FDIC to enact its moratorium and gave Greenspan an opportunity to advocate pulling the plug on industrial banks altogether. Community bankers <a href="https://www.wsj.com/articles/SB113633902998337121" rel="nofollow external noopener noreferrer" target="_blank">joined</a> the fray, of course, arguing that a Wal-Mart bank would put them out of business, usher in monopoly, and increase risk in the system. In March 2007, the retail giant, exhausted from nearly two years of "manufactured controversy," <a href="https://corporate.walmart.com/newsroom/2007/03/15/wal-mart-withdraws-ilc-charter-application" rel="nofollow external noopener noreferrer" target="_blank">withdrew</a> its application. The Wal-Mart fiasco marked the start of a 15-year-long hiatus in industrial bank approvals, contributing to a dearth of new bank charters of all kinds since the 2008 financial crisis. </p> <p>This March, however, the FDIC released plans that could give the industrial bank model a new lease on life. A notice of proposed rulemaking (NPR) <a href="https://www.fdic.gov/news/news/press/2020/pr20031a.pdf?source=govdelivery&amp;utm_medium=email&amp;utm_source=govdelivery" rel="nofollow external noopener noreferrer" target="_blank">laid out</a> the written commitments that charter applicants must make to gain approval. Paradoxically, the new requirements may actually improve applicants' odds of success: In the past, they were left in the dark about precisely what it took to gain the FDIC's approval, with many withdrawing their applications after years-long delays. By codifying its expectations, the FDIC's <a href="https://www.federalregister.gov/documents/2020/03/31/2020-06153/parent-companies-of-industrial-banks-and-industrial-loan-companies" rel="nofollow external noopener noreferrer" target="_blank">proposed rule</a> should make applicants' prospects less uncertain, thereby encouraging new applications, while increasing the speed and rate of approvals. As if to signal its good faith, the day after introducing its proposal, the FDIC approved <a href="https://www.fdic.gov/news/news/press/2020/pr20033.html" rel="nofollow external noopener noreferrer" target="_blank">Square's</a> application, along with that of the loan servicer <a href="https://www.fdic.gov/news/news/press/2020/pr20034.html" rel="nofollow external noopener noreferrer" target="_blank">Nelnet</a>. </p> <p>But the FDIC's battle has only just begun. While its Chairman Jelena McWilliams deserves praise for tackling an issue that is sure to bring controversy, both new charters were awarded to financial sector parents and were therefore less likely to raise opposition from ordinary banks. The real test will come with applications from commercial firms. Unless the FDIC can eschew political pressure, and focus instead, as it is <a href="https://www.law.cornell.edu/uscode/text/12/1816" rel="nofollow external noopener noreferrer" target="_blank">supposed</a> to, on these applicants' prudential commitments and prospects for serving community needs, their applications may meet the same fate as Wal-Mart's. Much will depend on whether McWilliams keeps the <a href="https://www.fdic.gov/news/news/speeches/spmar1720.pdf" rel="nofollow external noopener noreferrer" target="_blank">vow</a> she made in the NPR's release to "implement the law as it exists today." No doubt reassured by this promise, Japanese e-commerce firm Rakuten last week <a href="https://news.bloomberglaw.com/banking-law/japans-e-commerce-giant-rakuten-refiles-bid-to-form-u-s-bank" rel="nofollow external noopener noreferrer" target="_blank">announced</a> that it will make a second bid to establish an industrial bank, just three months after <a href="https://www.americanbanker.com/news/rakuten-withdraws-ilc-application-plans-to-refile" rel="nofollow external noopener noreferrer" target="_blank">ending</a> its first attempt. </p> <p>The circumstances of Rakuten's bid will make it a crucial test case for the FDIC's new policy. Incumbents <a href="https://www.aba.com/-/media/documents/comment-letter/aba-bpi-oppose-rakuten-ilc-application-083019.pdf" rel="nofollow external noopener noreferrer" target="_blank">large</a> and <a href="https://www.icba.org/news/icba-in-the-news/press-releases/2019/07/29/icba-statement-on-rakuten-ilc-application" rel="nofollow external noopener noreferrer" target="_blank">small</a> yowled when Rakuten first applied for an industrial bank charter in July 2019; and they will no doubt resume their warnings that granting it will open the floodgates to other tech and commercial firms. While these incumbents' motives may be questionable, their concerns are not entirely illegitimate. For example, <a href="https://www.biometricsdirect.com/Biometrics/laws/GLB/GLBText.htm" rel="nofollow external noopener noreferrer" target="_blank">provisions</a> in the current law exempting banks from disclosing their data-sharing with affiliates may have to change if commercial firms take up a bigger role in banking. This is because commercial firms, unlike standalone banks, might conceivably use financial data from their industrial bank to tailor product offerings to their customers, which would contravene the spirit if not the letter of arm's length restrictions on affiliate transactions. </p> <p>But the responsibility for making such a revision belongs to Congress, as part of its larger efforts on data privacy. In the meantime, the FDIC should charter industrial banks in line with its statutory mandate, allowing them to help bank the unbanked and increase the range of options to which consumers have access. After 15 years of moratoria and delays, action to increase entry into banking is long overdue. </p> <p> [<a href="https://www.alt-m.org/2020/06/05/to-help-the-unbanked-break-the-industrial-bank-taboo/">Cross-posted from Alt-M.org</a>] </p> <p></p> Tue, 09 Jun 2020 09:03:12 -0400 Diego Zuluaga https://www.cato.org/blog/help-unbanked-break-industrial-bank-taboo Argentina, the World’s Biggest Deadbeat https://www.cato.org/publications/commentary/argentina-worlds-biggest-deadbeat Steve H. Hanke <div class="lead mb-3 spacer--nomargin--last-child text-default"> <p>On May 22, Argentina failed to meet interest payments on its sovereign debt. With that, the country tipped into default on its $65 billion mountain of foreign debt. If that’s not enough, Argentina’s provinces are addicted to debt and are buried in it, too. The province of Buenos Aires is already in default, and Cordoba, La Rioja, Salta, Rio Negro, and Chubut have also indicated that they plan to restructure their debt as well.</p> </div> , <div class="mb-3 spacer--nomargin--last-child text-default"> <p>This is not the first time that Argentina has stiffed its creditors. No, it’s the ninth time. And it’s not Argentina’s largest default, either. Indeed, Argentina set the world’s default record when it defaulted on $95 billion in external debt in 2001. The bottom line is clear: Argentina is hands down the world’s biggest deadbeat.</p> <p>It hasn’t always been that way. Argentina, with a&nbsp;landmass five times as large as France’s, was, once upon a&nbsp;time, relatively rich. When the Central Bank of Argentina (BCRA) was established in 1935, the nation’s income per capita was roughly the same as that of the United States. By 1946, when Juan Peron first became president of the republic, the per capita income gap between the U.S. and Argentina had widened, with the U.S. putting distance between itself and Argentina.</p> <p>With Peron came Peronism (in many ways a&nbsp;variant of fascism), the pursuit of economic autarky, and a&nbsp;clientelist welfare state, a&nbsp;combination that even a&nbsp;rich country could not afford, and which, even after Peron was driven out of office, left a&nbsp;legacy of economic populism that Argentina has never been able to escape. The result was that the country tumbled down the economic standings. Today, per capita income in the U.S. is over three times as high as Argentina’s.</p> <p>When we speak of the world’s biggest deadbeat, we don’t speak or write about economic development. Instead, it’s economic regression. Argentina is one of those rare countries that were once rich but have become poor.</p> <p>At the heart of Argentina’s calamitous economy is its central bank and the currency it produces. Indeed, the peso is venomous. The instances of the poison delivered by the peso are almost too numerous to count. To list but a&nbsp;few of Argentina’s major peso collapses: 1952, 1958, 1967, 1975, 1985, 1989, 2001, and 2018/19.</p> <p>Major peso devaluations have, of course, been associated with each crisis. And with those devaluations, the burden of Argentina’s debt load explodes, and defaults follow.</p> <p>To put out the fires associated with these defaults, Buenos Aires has regularly rung the alarm at the International Monetary Fund’s (IMF) firehouse. But this has been to no avail. It’s often made things worse, because the IMF always fails to understand that the BCRA and the peso are what ignite and fuel the infernos in Argentina.</p> <p>As Harvard University’s Robert Barro put it, the IMF reminds him of Ray Bradbury’s <em>Fahrenheit 451</em>, “in which the fire department’s mission is to start fires.” Barro’s basis for that conclusion is his own extensive research. His damning evidence finds that:</p> <ul><li>A higher IMF‐​loan participation rate reduces economic growth.</li> <li>IMF lending lowers investment.</li> <li>A greater involvement in IMF programs lowers the level of the rule of law and democracy.</li> </ul><p>And, if that’s not bad enough, countries that participate in IMF programs tend to be recidivists. The IMF programs don’t provide cures but instead create addicts. Just consider Argentina. Since joining the IMF in 1956, it has called in the IMF’s firemen 22 times.</p> <p>When and how will Argentina’s most recent debt fiasco end? On Tuesday, Argentina and its creditors agreed to extend negotiations for another ten days, and further extensions may be in the cards. As for how those negotiations might end, the net present recovery value being offered to creditors by Buenos Aires is 46 cents on the dollar. Smart money thinks that figure might end up closer to 50 cents. That’s what incorrigible deadbeats do; they give creditors haircuts.</p> <p>To end Argentina’s never‐​ending monetary nightmare, the Central Bank of Argentina, along with the peso, should be mothballed and put in a&nbsp;museum. The peso should be replaced with the U.S. dollar. Argentina’s government should do officially what all Argentines do in times of trouble: dollarize.</p> </div> Fri, 05 Jun 2020 10:32:32 -0400 Steve H. Hanke https://www.cato.org/publications/commentary/argentina-worlds-biggest-deadbeat