Latest Cato Research on Finance, Banking &amp; Monetary Policy https://www.cato.org/ en Congress’ Stimulus Oversight Imperative https://www.cato.org/publications/commentary/congress-stimulus-oversight-imperative William Yeatman <div class="lead text-default"> <p>Lawmakers must not back down from President Trump’s threat to ignore congressional oversight of the massive Coronavirus Aid, Relief, and Economic Security Act, or the <a href="https://www.congress.gov/bill/116th-congress/house-bill/748/text">CARES Act</a>.</p> </div> , <div class="text-default"> <p>Such oversight is crucial for two reasons.</p> <p>First, haste makes for waste. The sums involved are mind‐​boggling. Financial agencies, for example, have a&nbsp;<a href="https://www.pillsburylaw.com/en/news-and-insights/CARES-Act-COVID-19-title-iv-loan.html" target="_blank">mandate</a> to quickly leverage almost $500 billion into as much as $4 trillion in loans to big businesses and small governments. Where, as here, the idea is to move as much money as fast as possible, there’s an obvious danger that the public funds could be mismanaged in the rush to push dollars out the door.</p> <p>The second concern is political. Absent Congress’s watchful eye, there’s nothing to stop the Trump administration from playing political games. Imagine, for example, if the Small Business Administration focused its new $350 billion <a href="https://www.pillsburylaw.com/en/news-and-insights/sba-loan-cares-act-covid-19.html" target="_blank">loan program</a> on swing states in the upcoming presidential election.</p> <p>Congressional Democrats, to their credit, <a href="https://www.politico.com/news/2020/03/27/trump-congress-coronavirus-relief-oversight-152560" target="_blank">fought</a> to include novel and important safeguards to protect against these troubling possibilities. Specifically, leadership in the House of Representatives pressed for multiple layers of supervision for public funds unlocked by the CARES Act.</p> <p>The first is to install a&nbsp;special accountability officer, known as an inspector general, at the Treasury Department. Here, the purpose is to provide quality control directly at the executive agency with primary responsibility for “stimulating” the economy.</p> </div> , <div class="pullquote pullquote--default"> <div class="pullquote__content h2"> <p>Lawmakers must not back down from President Trump’s threat to ignore congressional oversight of the massive Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act.</p> </div> </div> , <div class="text-default"> <p>The second layer of supervision is to establish a&nbsp;Pandemic Response Accountability Committee to conduct and coordinate oversight of public funds.</p> <p>Again, these provisions were crucial for winning the CARE Act’s passage in Congress. Nevertheless, only hours after signing the bill into law, Trump repudiated the oversight provisions based on flimsy constitutional claims.</p> <p>In a&nbsp;<a href="https://www.whitehouse.gov/briefings-statements/statement-by-the-president-38/" target="_blank">signing statement</a>, Trump objected to Congress’s having input in the selection of a&nbsp;director for the new Pandemic Response Accountability Committee. Trump said his “administration will treat this provision as hortatory but not mandatory.”</p> <p>The president also announced his administration’s intention to block the new inspector general from reporting directly to Congress whenever the Treasury Department refuses to comply with an investigation.</p> <p>In terms of a&nbsp;justification for rejecting the law he had signed, Trump alluded vaguely to “executive power,” but this is constitutional hand‐​waving. Both the Constitution and common‐​sense permit Congress to oversee public funds allocated (by Congress) to agencies (created and funded by Congress).</p> <p>Simply put, the president’s signing statement amounts to a&nbsp;constitutional slap in the face. Congress bargained for these safeguards. President Trump condoned Congress’s bargain when he signed the CARES Act. Then Trump effectively took back his approval, by announcing that his administration wouldn’t comply with the act’s oversight provisions.</p> <p>Congress needs to stand up for itself — and the Constitution. If Trump follows through on his threat, then lawmakers must push back.</p> <p>How?</p> <p>Lawmakers could play hardball with the budget process. That is, Congress could condition the Treasury Department’s operational funding on compliance with the CARES Act’s oversight provisions. Yet such a&nbsp;counterpunch could prove counter‐​productive, given that such cuts might unduly undermine implementation of the stimulus.</p> <p>There’s a&nbsp;better way. If the Trump administration refuses to oversee the implementation of the CARES Act, then Congress itself should take on the role.</p> <p>Perhaps expecting the president’s recalcitrance, the CARES Act provides Congress with a&nbsp;backup plan. The act creates a&nbsp;Congressional Oversight Commission, comprised of lawmakers selected by party leaders in Congress. The Commission is empowered to obtain information directly from agencies, by subpoena if necessary, and to report to the full Congress.</p> <p>The first big decision is imminent. The Congressional Oversight Commission must staff itself, which is a&nbsp;crucial juncture, If Congress has any self‐​respect, it will invest generously in the Commission’s capacity. Party loyalty must not trump lawmakers’ institutional pride.</p> <p>There’s too much at stake for Congress not to assert itself here. Stewardship of public money should not be thwarted by partisanship.</p> </div> Fri, 03 Apr 2020 14:36:37 -0400 William Yeatman https://www.cato.org/publications/commentary/congress-stimulus-oversight-imperative More on the Challenges of Main Street Lending https://www.cato.org/blog/more-challenges-main-street-lending George Selgin <p>A few days ago, in response to the Fed's March 23rd announcement that it planned to help smaller businesses through a new Main Street Lending Program, I posted <a href="https://www.cato.org/blog/when-fed-tried-save-main-street">an essay here</a> about the Fed's 13(b) business-lending program—a New Deal arrangement that had the same aims. Among other things, I pointed out that, thanks in part to that program's painstaking, slow, and highly selective application approval process, it ultimately made little difference to the businesses it was supposed to help. Yet until World War II came along, it still managed to lose plenty of money, by yielding a net return of<span> </span><em>minus</em><span> </span>3 percent.</p> <p>Since then, Boston Federal Reserve Bank President Eric Rosengren<span> </span><a href="https://www.bloomberg.com/news/articles/2020-04-01/fed-s-rosengren-says-main-street-lending-program-two-weeks-away" rel="nofollow external noopener noreferrer" target="_blank">has told Bloomberg's Mike McKee</a><span> </span>that the Fed's new Main Street facility "is still in the design phase," and that it won't be up-and-running until mid-April. "It's a complicated facility to appropriately scope," he said; and the Fed "needs to make sure that banks and other organizations understand what the nature of the facility is." The Fed seems determined to avoid the fate of the SBA's complementary, $350-billion emergency lending program, which is set to launch tomorrow.<span> </span><a href="https://www.wsj.com/articles/the-rush-for-350-billion-in-small-business-loans-starts-friday-banks-have-questions-11585828455" rel="nofollow external noopener noreferrer" target="_blank">According to today's<span> </span><em>Wall Street Journal</em></a><em>,</em> the fact that that program's details have yet to be ironed-out</p> <blockquote><p>is complicating efforts by lenders to gear up for what is expected to be an onslaught of prospective borrowers at the end of this week. Among what lenders say are the unanswered questions are how much due diligence of borrowers is required and whether they will be able to sell these loans to create liquidity.</p> </blockquote> <p>In this follow-up to my last post, I review some of the logistical challenges the Fed encountered in administering its 13(b) loans. Doing so may help readers to understand some of the issues with which Fed officials are now grappling. And who knows? Perhaps those officials themselves will draw some lessons from it.</p> <h4>Naughty or Nice?</h4> <p>Thanks to Robert Rosa, who was then Research Chief of the Federal Reserve Bank of New York, we have a pretty good picture of the challenges Fed officials faced when they first ventured into the business of lending to small and medium-sized businesses. Rosa spent over a year carefully studying "the dossiers of some 250 of the small concerns" that applied to the New York Fed for 13(b) loans during the Great Depression. He later published his findings<span> </span><a href="https://www.jstor.org/stable/2975520?seq=1" rel="nofollow external noopener noreferrer" target="_blank">in the<span> </span><em>Journal of Finance</em></a>.</p> <p>Those findings mainly concerned the challenges the New York Fed faced, first in evaluating applications it received, and then in managing those loans it chose to grant. To make a long story short, Fed officials and staff discovered the hard way that lending to ordinary businesses, and to smaller ones especially, posed all sorts of problems they'd never had to confront in supplying credit to banks.</p> <p>Perhaps the biggest of those problems was that, despite the depression, many of the firms that applied to the Fed for credit weren't just victims of economic circumstances beyond their control. Instead the applications Rosa reviewed revealed a "complex set of small business problems which are too often waved aside when we think of increased credit availability as the panacea to small business ills." Rather than being the ultimate cause of many applicants' troubles, the depression only served to expose their more deep-seated weaknesses.</p> <blockquote><p>While additional borrowed money often seemed to be the only way out for most of these concerns, the original causes of their distress were not financial in most cases. They had instead, as a rule, worked themselves out of satisfactory credit lines by mistakes or misfortunes in managerial judgment.</p> </blockquote> <p>The trouble wasn't simply that many businesses weren't worthy of the Fed's support. It was that of determining which ones were and which ones weren't. "Even if a concern had none of the difficulties I have just described," Rosa observed, "it would still be a long step further for the loan officer to verify that to his own satisfaction." Many smaller firms couldn't themselves furnish the Fed with detailed reports of the sort that give a sense of their condition and prospects. "These circumstances," Rosa says, made "the job of credit investigation, and the final decision to grant a loan, exceedingly difficult." For the most part the Fed could only satisfy itself of firms' creditworthiness through investigations it undertook itself. Beyond that it had to retain staff who "could go in and set up bookkeeping systems, establish accounting controls, appraise and recommend changes in plant condition, lay-out, quality of machinery and inventory, and so on."</p> <p>All of this didn't come cheap. On the contrary: Rosa found the expenses connected to the New York Fed's 13(b) lending "staggering":</p> <blockquote><p>without any allocation of such fixed costs as office space, light, and heat, the combined expenses of the New York Bank (before losses on granted loans) averaged about $625 per formal loan application. Of this amount, at least $400 can be attributed to the credit investigation process, although that part of the expense ran much higher in some individual cases. Costs ran this high because of the generous use of the industrial engineer, and also because the Bank had no backlog of old names to draw on-all applicants for 13b credit were new names to the Reserve Bank.</p> </blockquote> <p>A labor cost of $625 in 1935 was equivalent to a cost of<span> </span><a href="https://www.measuringworth.com/calculators/uscompare/" rel="nofollow external noopener noreferrer" target="_blank">almost $40,000</a><span> </span>today.</p> <p>Despite the lengths they went to assess applicants' creditworthiness, Fed staff often found themselves flying blind, especially because they lacked information about the general state of a given trade or the industry. In such cases they naturally proceeded cautiously. But in some others, and especially when many jobs were at stake, they gambled on companies they considered likely to fail, hoping that the often doubtful collateral they asked for would limit their losses.</p> <p>Such cases were exceptional, however. On the whole, Rosa writes, the "mundane factors of investigation cost and the need for operating advice seem to me the greatest obstacles in extending adequate loan credits to small business."</p> <h4>In For a Penny…</h4> <p>Nor was the Reserve Bank's hardest work behind it once it chose which loans to make. Instead, it "found right away that actual receipt of the funds did not solve very many of the problems" of most firms it lent to. To begin with, it ended up having to extend or renew a third of the loans it made. But that</p> <blockquote><p>was only a part of the story. Once in, the Bank ordinarily assumed an affirmative responsibility, providing assistance wherever the borrower would accept it. …Wholly apart from any altruistic motives, the Bank was really forced to act to protect its investment.</p> </blockquote> <p>Such assistance could also consume many staff hours. In the case of one three-year loan, Rosa reports, the Bank's industrial engineer had to make<span> </span><em>twenty-seven</em><span> </span>different trips to the firm, lasting from a few days to several weeks, in order to try and help it stay afloat. Yet "the company still went bankrupt, and the Fed booked a sizeable loss."</p> <p>Despite all the challenges he encountered, Rosa resists the conclusion that the results of the Fed's 13(b) lending "were not worth the effort." However, he does offer a warning that it would be unwise for Fed officials today to ignore, to wit: "that credit granting to smaller businesses is likely to involve a great deal more after the funds are advanced than simply checking off repayments. At least for the cases I have seen, credit alone would do very little. Continued managerial advice and assistance is required."</p> <p>Whether the Fed is prepared today, not just to begin lending money to Main Street, but to offer it—or to have its partner banks offer it—"continued managerial advice," remains to be seen. I'm afraid I rather doubt it; but I very much hope that I'm wrong.</p> <p>[<a href="https://www.alt-m.org/2020/04/02/more-on-the-challenges-of-main-street-lending/">Cross-posted from Alt-M.org</a>]</p> <p></p> Fri, 03 Apr 2020 08:41:36 -0400 George Selgin https://www.cato.org/blog/more-challenges-main-street-lending Diego Zuluaga with Caleb O. Brown on liquidity and insolvency in the crisis https://www.cato.org/multimedia/cato-audio/diego-zuluaga-caleb-o-brown-liquidity-insolvency-crisis Wed, 01 Apr 2020 03:00:00 -0400 Diego Zuluaga, Caleb O. Brown https://www.cato.org/multimedia/cato-audio/diego-zuluaga-caleb-o-brown-liquidity-insolvency-crisis Recent Trouble Among Money‐​Market Mutual Funds, and the Way Forward https://www.cato.org/blog/recent-trouble-among-money-market-mutual-funds-way-forward Lawrence H. White <p>Money-market mutual funds (MMMFs) have had a turbulent couple of weeks. On March 18, the Federal Reserve System created a<span> </span><a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20200318a.htm" rel="nofollow external noopener noreferrer" target="_blank">Money Market Mutual Fund Liquidity Facility (MMLF)</a><span> </span>to "assist money market funds in meeting demands for redemptions by households and other investors." What's the source of the trouble?</p> <p>The story begins with an investor flight, driven by fears of coronavirus-related corporate defaults, out of private debt and into safer and more liquid Treasury debt. Prices of US Treasury bonds have been pushed way up, dramatically lowering their yields. Three-month US Treasury bonds, as of March 27, are yielding only 0.04 percent, down from 1.49 percent a month earlier. MMMFs that hold only government bonds have seen record inflows of funds ($286 billion or 7.3 percent growth in the week ending March 25; nearly 12 percent growth if we add the previous week).</p> <p>The flight<span> </span><em>out</em><span> </span>of private bonds, even short-term AAA-rated bonds, includes large outflows from the mutual funds and exchange-traded funds (ETFs) that hold them. "Investment-grade bond funds experienced a record $38 billion outflow in the week through March 25," reports<span> </span><a href="https://www.bloomberg.com/opinion/articles/2020-03-27/coronavirus-sorts-bond-market-into-winners-and-losers" rel="nofollow external noopener noreferrer" target="_blank">Bloomberg News</a>. Some "prime" MMMFs, which mostly hold short-term commercial paper issued by banks, have been hit by outflows of more than 40 percent.</p> <p>These outflows from prime funds should not be thought of as "runs" in the usual sense. Because mutual funds issue no debts, only equity claims, there is no "me-first" reason to hurry to withdraw from fear of insolvency. A mutual fund can't become insolvent by suffering asset losses—total claims can't exceed total assets—when share claims are promptly marked down as soon as, and as much as, portfolio value.</p> <p>Yes, there was a singular MMMF run in 2008. To summarize what I wrote about it<span> </span><a href="https://www.alt-m.org/2016/03/01/money-market-mutual-funds-restrictions-run-proofing-and-regulatory-pretense/" rel="nofollow noopener noreferrer" target="_blank">here</a>, the Reserve Primary Fund suffered losses when the failure of Lehman Brothers drove down the market value of its portfolio. The Fund neither injected capital nor promptly marked down its share price from its conventional $1 price (it did not "break the buck" until two days later). Shareholders saw that redeeming immediately would mean getting $1 per share, but those at the end of the line would get less. So they ran. The Reserve Primary Fund belatedly reduced its redemption price to 97 cents, meaning that the remaining customers took a 3 percent haircut.</p> <p>Runs of this sort on mutual funds can be prevented by doing what Reserve Primary did not do: immediately marking down the "net asset value" (NAV) of shares, the price at which the fund will buy them back, as soon as asset losses occur. Institutional prime funds do that (they have a "floating NAV"), so the heavy withdrawals in recent weeks were not out of me-first solvency concerns. (For any fund that maintains a fixed $1 share price, marking immediately to market<span> </span><em>could</em><span> </span>be replicated by a contractual agreement to reduce each customer's number of $1 shares to match any fall in the portfolio's total value.)</p> <p>Some part of last week's outflows may, however, be thought of as due to runs of a different sort. They were prompted not by fear of insolvency but by fear of a regulatory barrier. After the Reserve Primary Fund failure, new legal restrictions were imposed on MMMFs in 2010 and 2014 that were supposed to prevent such a failure from happening again. One of these restrictions appears to have unintentionally made the problem worse this time around. This could have been predicted—and was in fact predicted. Here is what I wrote four years ago about that restriction, a 30 percent minimum liquidity ratio (cash or Treasuries to total assets), the breaching of which gives a fund the right to restrict redemptions:</p> <blockquote><p>Funds are given the discretion, whether they want it or not (they cannot contractually bind themselves not to use it), "to impose liquidity fees or to suspend redemptions temporarily, also known as 'gate,' if a fund's level of weekly liquid assets falls below a certain threshold." Hanson, Sharfstein, and Sunderam, and many other analysts, rightly reject such "gating rules" as means to diminish runs. Inability to precommit not to impose a gate can be expected to weaken a MMMF. Knowing that a gate might be imposed, especially if another fund has just done so, investors will likely become <em>more</em><span> </span>anxious to redeem now rather than wait and see.</p> </blockquote> <p>Which is what we appear to have just experienced. The liquid asset threshold imposed by the 2014 rules is that 30 percent of a prime fund's assets must be cash or Treasuries. Heavy withdrawals by investors who wanted out of portfolios of corporate debt and into safer Treasuries compelled prime funds to make heavy sales of these liquid assets. As the percentage of liquid assets falls toward the 30% liquid asset requirement, investors rationally fear being trapped behind a "gate," unable to redeem, or able to redeem only by paying a fee. Again, the restriction is that a fund is blocked from contractually committing not to impose fees or a gate.</p> <p>It was not to avoid breaking the buck, but to stay above the 30 percent threshold, that Goldman Sachs purchased $1.4 billion in assets from one of its own funds, and $391 million from another. For the same reason Bank of New York Mellon bought "almost $2.2 billion in securities from one of its prime money funds, the Dreyfus Cash Management fund," reported the<span> </span><em><a href="https://www.wsj.com/articles/goldman-steps-in-to-shore-up-two-money-funds-11585042200" rel="nofollow external noopener noreferrer" target="_blank">Wall Street Journal.</a></em><span> </span>Other funds faced similar trouble.</p> <p>The Federal Reserve thus stepped in not to quell runs of the Reserve Primary Fund sort, but rather to help out funds that were experiencing withdrawals made heavier in part because of the existence of the 30 percent liquidity threshold. The Fed did not want to see the predictable cascade of withdrawals that would follow any fund actually imposing gates or fees. As Cornell Law professor Dan Awrey<span> </span><a href="https://twitter.com/DanAwrey/status/1242844002468143104" rel="nofollow external noopener noreferrer" target="_blank">noted on Twitter</a>, the threshold is "the precise point at which the fund boards were required to consider imposing liquidity fees and redemption gates. The boards clearly stared down the Fed, and the Fed blinked."</p> <p>Federal Reserve support is a breeding ground for moral hazard, whether support takes the form of emergency lending to MMMFs at below-market rates or the form of purchasing assets from MMMFs at above-market prices. (If the Fed were not beating the market, the MMMFs would go to the market). To avoid repeating the current problem, end the recently imposed liquidity threshold requirement. The problem of a Reserve Primary-type failure can be alleviated more elegantly by greater rather than lesser freedom of contract, namely by a floating NAV or, for an MMMF with a fixed $1 share price, allowing a contractual share-reduction mechanism (applied strictly, without "penny-rounding") to replicate the run-proofing property of a floating NAV.</p> <p>[<a href="https://www.alt-m.org/2020/03/31/recent-trouble-among-money-market-mutual-funds-and-the-way-forward/">Cross-posted from Alt-M.org</a>]</p> <p></p> Tue, 31 Mar 2020 15:40:25 -0400 Lawrence H. White https://www.cato.org/blog/recent-trouble-among-money-market-mutual-funds-way-forward When the Fed Tried to Save Main Street https://www.cato.org/blog/when-fed-tried-save-main-street George Selgin <p>Any day now, the Federal Reserve will start making loans to small and medium-sized businesses, breaking new ground with its Section 13(3) lending authority.</p> <p>Yet this won't be the first time the Fed set its sights on Main Street businesses.</p> <p>In this post, I'll first review the origins and outlines of the Fed's latest lending scheme. Then I'll tell the story of its mostly forgotten predecessor: a lending program based on a now-defunct Federal Reserve Act amendment that was also supposed to encourage the Fed to lend to smaller non-bank businesses.</p> <p>I hope the story of that former program may shine a light on some potential pitfalls along the road down which the Fed plans to venture. But even if it doesn't, it seems worth telling.</p> <h4>A Big-Business Bailout?</h4> <p>Of the many emergency facilities the Fed has launched since the start of the Great Corona Crash, none has been more controversial than the <a href="https://www.federalreserve.gov/newsevents/pressreleases/files/monetary20200323b1.pdf" rel="nofollow external noopener noreferrer" target="_blank">Primary Market Corporate Credit Facility (PMCCF)</a>, a Special Purpose Vehicle through which the Fed will support "severely distressed industries." The facility allows the Fed to either lend directly to firms in these industries or to purchase their bonds directly from them, with the aim of keeping them open so they can go on supplying necessary goods and services, and so that their workers can stay employed.</p> <p>Why is the PMCCF controversial? Mainly because it supports only large, <a href="https://www.investopedia.com/terms/i/investmentgrade.asp" rel="nofollow external noopener noreferrer" target="_blank">investment-grade</a> companies, and is being backstopped to the tune of $10 billion by the U.S. Treasury. That's led the setup's (mostly Democratic) critics to assail it as part of a <a href="https://www.washingtonpost.com/business/2020/03/26/senate-stimulus-bill-coronavirus-2-trillion-list-what-is-in-it/" rel="nofollow external noopener noreferrer" target="_blank">"bailout for corporate America"</a> and a Wall Street <a href="https://www.politico.com/news/2020/03/23/democrats-slush-fund-republican-rescue-package-143565" rel="nofollow external noopener noreferrer" target="_blank">"slush fund."</a> West Virginia Senator Joe Manchin spoke for many when, before a procedural vote on Sunday, March 22nd, he declared himself <a href="https://wchstv.com/news/local/manchin-votes-against-procedural-vote-to-advance-stimulus-package" rel="nofollow external noopener noreferrer" target="_blank">"more worried about bailing out main street and keeping small businesses in operation."</a></p> <h4>Main Street's Turn</h4> <p>It didn't take long, though, for the Fed to address Senator Manchin's concerns: on the very next day it announced plans for <a href="https://www.nytimes.com/reuters/2020/03/23/us/23reuters-health-coronavirus-usa-smallbusiness-analysis.html?auth=login-email&amp;login=email" rel="nofollow external noopener noreferrer" target="_blank">a Main Street Lending Program</a> aimed at small and midsize businesses. Fed staff haven't yet worked out all of the plan's details—on March 27th they were still <a href="http://we are working furiously here at the Fed to have this in place and work out the details." rel="nofollow external noopener noreferrer" target="_blank">"working furiously"</a> on them. But <a href="https://www.marketwatch.com/story/heres-how-the-fed-will-support-main-street-2020-03-27" rel="nofollow external noopener noreferrer" target="_blank">Fed officials have said</a> that, instead of lending directly to businesses, the Fed will use banks and credit unions to "funnel short-term financing" from it to them.</p> <p>Thanks to Joseph Brusuelas, chief economist at <a href="https://realeconomy.rsmus.com/fed-takes-robust-action-to-backstop-the-economy-and-financial-markets/" rel="nofollow external noopener noreferrer" target="_blank">RSM US</a> (a <a href="https://www.investopedia.com/terms/m/middle-market.asp" rel="nofollow external noopener noreferrer" target="_blank">"middle market"</a> tax and audit consulting firm), we know a little more than that about the Fed's plan. Using comments from Fed officials (particularly Dallas Fed President Robert Kaplan and Atlanta Fed President Raphael Bostic), Brusuelas has come up with <a href="https://www.marketwatch.com/story/heres-how-the-fed-will-support-main-street-2020-03-27" rel="nofollow external noopener noreferrer" target="_blank">a compelling composite sketch</a> of the Fed's planned arrangement, including its official name: the "Temporary Corporate and Small Business Liquidity Facility," or TCSLF. <a href="https://realeconomy.rsmus.com/fed-takes-robust-action-to-backstop-the-economy-and-financial-markets/" rel="nofollow external noopener noreferrer" target="_blank">According to Brusuelas</a>, the new facility will support businesses with revenues not exceeding $5 billion with up to $1 trillion in loans, backstopped by $85 billion in Treasury-supplied capital. The loans will be for terms up to five years, with quarterly payments, at an interest rate of 2.25 percent.</p> <p>Here, compliments of RSM, is a chart showing how the scheme is expected to work:</p> <p><a href="https://www.alt-m.org/2020/03/30/when-the-fed-tried-to-save-main-street/bankrate-articlle-image/" rel="attachment wp-att-219629 nofollow noopener noreferrer" target="_blank"><img alt="Chart depicting the flow of funds in the new TCSLF system. " height="404" src="https://cdn.alt-m.org/wp-content/uploads/2020/03/Bankrate-Articlle-Image.png" width="718" /></a></p> <p>The TCSLF is meant to complement <a href="https://www.wsj.com/articles/sba-to-oversee-vast-lending-program-under-federal-economic-stimulus-plan-11585167856" rel="nofollow external noopener noreferrer" target="_blank">a $350 billion emergency Small Business Administration loan program</a>, funded entirely by the Treasury, and aimed at companies with no more than 500 employees. Because borrowers under that program may have their loans partially forgiven provided they retain their workers or rehire those who'd been laid off, while the TCSLF offers no similar prospect of loan forgiveness, whether many small businesses eligible for either program will want to also take advantage of the newer facility <a href="https://www.marketwatch.com/story/heres-how-the-fed-will-support-main-street-2020-03-27" rel="nofollow external noopener noreferrer" target="_blank">is far from clear.</a></p> <h4>Section13(3)'s Big Business Bias</h4> <p>Like all Fed lending to non-banks in recent decades, lending by the TCSLF will be authorized by Section 13(3) of the Federal Reserve Act, covering the Fed's "discounts for individuals, partnerships, and corporations." That authority, first granted to the Fed in 1932 (when it was <a href="https://www.minneapolisfed.org/article/2002/lender-of-more-than-last-resort" rel="nofollow external noopener noreferrer" target="_blank">"tucked inside a highway construction bill"</a>), and amended several times since, allows Federal Reserve banks, with the prior approval of the Secretary of the Treasury and an "affirmative vote of not less than five members" of the Board of Governors, to extend credit to non-bank firms "in unusual and exigent circumstances."</p> <p>Importantly, the Fed for some time chose to construe its 13(3) authority as limiting it to discounting the same liquid collateral it had long stood ready to discount for member banks. Because few non-bank corporations possessed such collateral, that decision severely limited the new authority's usefulness. Indeed, <a href="https://www.newyorkfed.org/medialibrary/media/research/epr/2018/epr_2018_political-origins_sastry.pdf" rel="nofollow external noopener noreferrer" target="_blank">the Fed went still further</a>, interpreting its Section 13(3) powers so narrowly as to exclude support for nonmember banks and trust companies! For these reasons, and also because the Fed charged a relatively high rate on 13(3) loans, the Fed's new powers remained little used during the depression. <a href="https://www.minneapolisfed.org/article/2002/lender-of-more-than-last-resort" rel="nofollow external noopener noreferrer" target="_blank">According to David Fettig</a>, the Minneapolis Fed's former V.P. of Public Affairs, during the amendment's first four years, Fed banks made only 123 13(3) loans totaling just $1.5 million.</p> <p>By the depression's end, Section 13(3) appeared to be a dead letter. But it sprang back to life after 1991, thanks to a clause in that year's <a href="https://www.fdic.gov/regulations/laws/rules/8000-2400.html" rel="nofollow external noopener noreferrer" target="_blank">FDIC Improvement Act</a> that struck-out the Section 13(3) language that the Fed had interpreted as calling for discount window collateral. The way was thus cleared at last for substantial 13(3) support to non-bank firms. The irony of this change was not lost on <a href="https://www.cato.org/people/walker-f-todd" rel="nofollow external noopener noreferrer" target="_blank">CMFA Adjunct Scholar Walker Todd</a>, <a href="https://www.clevelandfed.org/en/newsroom-and-events/publications/discontinued-publications/economic-review/1993-economic-review/er-1993q3-fdicias-emergency-liquidity-provisions.aspx" rel="nofollow external noopener noreferrer" target="_blank">who observed in 1993</a> that, although the FDIC Improvement Act was supposed to "reduce the size and scope of the federal financial safety net," by expanding the Fed's 13(3) lending authority, it threatened to do just the opposite.</p> <p>Still it wasn't until the 2008 financial crisis that the Fed proved Walker right by using its new 13(3) powers to rescue Bear Stearns and AIG, and as the basis for several new emergency lending facilities. But because all of that episode's 13(3) lending went to very large firms, the TCSLF will mark the very first use of the Fed's 13(3) authority to support smaller, non-bank businesses.</p> <p>It doesn't follow, however, that the Fed has never lent to such businesses before. On the contrary: it did so for more than three decades, thanks not to its Section 13(3) powers, but to a different Great Depression amendment to the Federal Reserve Act: the now defunct, and almost entirely forgotten, Section 13(b).</p> <h4>Déjà Vu All Over Again</h4> <p>Section 13(b) was inserted into the Federal Reserve Act by the <a href="https://fraser.stlouisfed.org/files/docs/historical/fr_act/pa417_s3487_cong_19340619.pdf" rel="nofollow external noopener noreferrer" target="_blank">Industrial Advances Act of 1934</a>, not quite two years after the Fed gained its 13(3) lending privilege. Part (a) of the new section allowed Reserve Banks to extend credit directly to any "industrial or commercial business" located in their district, by lending to them or buying their obligations, for up to five years, "for the purpose of providing it with working capital." Part (b) in turn allowed Fed banks to offer similar support in partnership with commercial lenders, by purchasing or discounting obligations entered into by them for the purpose of supplying working capital to industrial or commercial business, on the condition that its commercial partner obligated itself for at least 20 percent of any loss.</p> <p>While the Fed banks might make 13(b) business loans in partnership with commercial lenders at any time, they were to resort to the direct lending option only "in exceptional circumstances when it appears…that [a business] is unable to obtain the requisite financial assistance on a reasonable basis from the usual sources." Although no limit was placed on the size of individual 13(b) loans, total 13(b) lending was limited to a sum equal to the Reserve Bank's surplus as of mid-1934 of $141 million, plus roughly the same amount ($139 million) of additional capital contributed by the U.S. Treasury in the guise of a rebate of the Reserve Banks' FDIC subscription.</p> <p>Just as the TSCLF will supplement an expanded SBA lending program, the Fed's 13(b) lending was intended to supplement small business lending by the Reconstruction Finance Corporation (RFC), $300 million of which was authorized by the Industrial Advances Act's Section 5d. The RFC's loans were also to have maturities of up to five years. But unlike 13(b) loans they were subject to a per-applicant limit of $500,000.</p> <p>According to <a href="https://www.jstor.org/stable/1885023" rel="nofollow external noopener noreferrer" target="_blank">James Dolley's 1936 appraisal of the Industrial Advances Act</a>, the measure grew out of what was first "a widespread belief among government officials that commercial banks, thru fear of the Roosevelt Administration or deliberate antagonism to it, were refusing to extend loans to qualified business borrowers and that this refusal was retarding industrial recovery." Later that belief softened into the view that banks were not so much unwilling as <em>unable</em> on their own to supply businesses with the working capital they needed. According to <a href="https://library.cqpress.com/cqresearcher/document.php?id=cqresrre1939070100" rel="nofollow external noopener noreferrer" target="_blank">a 1939 <em>Editorial Research Report</em></a>,</p> <blockquote><p>Bank credit was often difficult to obtain in the early years of the depression not only because of the natural caution of lenders in hard times, but also because so many banks were suspended and the rest found it imperative to keep their assets in as liquid a condition as possible. In many smaller communities all of the banks failed and there were literally no local banking facilities whatever.</p> </blockquote> <p>In March 1934, <a href="https://www.minneapolisfed.org/article/2002/lender-of-more-than-last-resort" rel="nofollow external noopener noreferrer" target="_blank">David Fettig tells us</a>, FDR "wrote to the chairmen of the Banking and Currency committees of both houses of Congress: 'I have been deeply concerned with the situation in our small industries. In numberless cases their working capital has been lost or seriously depleted.'"</p> <p>The Federal Reserve Board concurred with FDR's assessment. In a letter Governor Eugene Black sent to the Senate Banking and Currency Committee, he referred (once again according to Fettig) to the "undoubted need" for credit beyond what commercial banks and the Federal Reserve as then equipped were able to provide. "In brief," he wrote, "the need is for loans to provide working capital for commerce and industry, and such loans necessarily must have a longer maturity than those rediscountable by Federal reserve banks." In May 1934, <a href="https://library.cqpress.com/cqresearcher/document.php?id=cqresrre1939070100" rel="nofollow external noopener noreferrer" target="_blank">Black followed up by testifying before the House Committee on Banking and Currency</a>, telling it that replies from a questionnaire the Board had sent to 4,958 banks and 1,066 chambers of commerce suggested that unless small businesses could somehow secure another six or seven million dollars' worth of loans, they'd go out of business, throwing another 350,000 employees out of work.</p> <p>On the whole, the lending the Fed was authorized to do by its 13(b) authority has much in common with the lending to be undertaken by the Fed's new Temporary Corporate and Small Business Liquidity Facility. Both arrangements allow the Fed to lend to smaller non-bank businesses. Both are aimed at funding businesses' short-term operating expenses, including their payroll, rent, and debt payments (their "working capital," in the language of the earlier program). Both allow for medium-term loans of up to five years in one case and four in the other. Both allow the Fed to make business loans through commercial banks (though Section 13(b) also allowed it to make such loans directly). Both supplement other government-financed emergency small-business lending programs. Finally, both involve Treasury backstops: $85 billion (or .24 percent of current GNP) for the TCSLF, versus $280 million (or .42 percent of 1934 GNP) for the Fed's 13(b) lending.</p> <p>Of course the programs also differ in important ways. One difference is that, while both the TCSLF and 13(b) allow small business support, the TCSLF is the first Fed arrangement intended solely for such businesses. Also, while all of the Fed's 13(3) lending must be confined to "unusual and exigent circumstances," only its direct (part a) 13(b) lending was limited to "exceptional circumstances" when businesses were "unable to obtain requisite financial assistance on a reasonable basis from the usual sources." Finally, the Fed's total outstanding 13(b) loans were never supposed to exceed the $280 million in Fed capital backing them. Besides that, the Fed's commercial lending partners also had to have skin in the game to the tune of 20 percent of and 13(b) lending they took part in. In contrast, the TCSLF can lend up to $1 trillion, or almost <em>1</em><em>2 times</em> its capital. That difference makes the new program both much larger in potential scale than its predecessor, and far more capable of exhausting the capital supporting it.</p> <h4>Risky Business</h4> <p>That the Fed's 13(b) lending was limited to the capital assigned to it reflected both the then-orthodox view that the Fed banks should never assume even the slightest risk of becoming insolvent and the highly risky nature of business lending, especially of medium-term (as opposed to short-term) lending, during a depression. (In fact by the end of the program's first 18 months 43 percent of the value of its outstanding advances took the form of loans for either four or five years.) Such lending could be expected, <a href="https://www.jstor.org/stable/1885023" rel="nofollow external noopener noreferrer" target="_blank">in James Dolley's words</a>, to "entail a substantial volume of loss charge-offs." And ordinary business-lending losses could well be compounded as a result of "political pressure imposed thru the Federal Reserve Board on the reserve banks to expedite loans and to extend as much credit as possible."</p> <p>Yet the Fed banks were determined, not only to stay solvent despite their 13(b) lending, but to avoid losing any money at all. To that end they insisted, first of all, that their 13(b) loans be collateralized. The protection this requirement offered was, however, far from complete. According to Dolley the Fed banks</p> <blockquote><p>found it impossible to establish and enforce standard requirements as to collateral margins. As a result, the actual value of the collateral pledged to secure advances has ranged from more than 100 per cent of the loan to a small percentage of the sum advanced. Almost every sort of collateral has been accepted as security for these industrial advances. Most frequently real estate and chattel mortgages have been used, but the reserve banks have accepted assignments of receivables, inventories, warehouse receipts, life insurance policies, and stocks and bonds of all types.</p> </blockquote> <p>To compensate for such iffy collateral, the Fed banks also subjected every applicant for a 13(b) loan to an exceptionally thorough credit investigation. For that purpose each equipped itself with a five-member Industrial Advisory Committee, the job of which was to review and appraise 13(b) loan applications from firms in its district, and to forward them to it together with the committee's recommendation. The Fed bank would then take the Advisory Committee's recommendation into account in considering the applications, though it was free to approve a loan that the committee recommended against, or reject one that the committee favored.</p> <p>And reject they did: as of October 23, 1935, the Reserve Banks had set aside three-quarters of the 7,140 applications their Advisory Committees forwarded to them, granting only $119 million of a total of over $280 million in requested advances. By May 31, 1940, that ratio had improved only slightly, with 2,900 of the 9,590 applications, or just 30 percent of them, approved.</p> <p>Yet many 13(b) loans still turned sour. Up to 1940, according to <a href="https://www.nber.org/chapters/c2571.pdf" rel="nofollow external noopener noreferrer" target="_blank">a 1958 NBER study</a> by Raymond J. Saulnier, Harold G. Halcrow, and Neil H. Jacoby, against $7,411,783 in 13(b) interest and fees, the Reserve Banks had to set off $6,883,098 in administrative and interest expenses (the latter owed to the Treasury for funds supplied by it), plus $480,293 for losses charged off, and another $2,447,459 for anticipated loan losses. The result—a net loss of $1,849,117—amounted to 3 percent of total advances, a level "greater than could be sustained by private agencies functioning under the requirement of earning a reasonable return on invested capital" (<a href="https://www.nber.org/chapters/c2572.pdf" rel="nofollow external noopener noreferrer" target="_blank">ibid., p. 89</a>).</p> <p>During the program's later years, its overall loss rate through declined to just .6 percent. That improvement was mainly due to the inflationary boom during and after War II. But it also reflected Reserve Banks' doubling-down on an already pronounced bias in favor of confining their 13(b) loans to larger businesses. Through 1950, according to Saulnier, Halcrow, and Jacoby, the average size of a Federal Reserve 13(b) loan was $175,000—many time larger than that of the average commercial bank business loan. As Dolley concludes that, during it's first year, the Fed's business lending program was "of but little assistance to the small industrial concerns for which it had been ostensibly created," we may safely conclude that this verdict holds for the program taken as a whole.</p> <h4>A Redheaded Stepchild</h4> <p>Despite their determination to avoid losses, the Federal Reserve banks "pushed the industrial advances program vigorously," publicizing it by means of "circular letters addressed to banks, radio talks, addresses before meetings of bankers and businessmen, and news releases" (Dolley). Thanks to these efforts, and to firms' desperate want of credit, the program started off with a bang. <a href="https://www.minneapolisfed.org/article/2008/the-history-of-a-powerful-paragraph" rel="nofollow external noopener noreferrer" target="_blank">According to David Fettig</a>, by the end of 1935, it had granted about $124.5 million to 1,993 businesses.</p> <p>But, as the following table, from the previously-cited <a href="https://library.cqpress.com/cqresearcher/document.php?id=cqresrre1939070100" rel="nofollow external noopener noreferrer" target="_blank"><em>Editorial Research Report</em></a>, shows, after that initial flurry of activity the program's scale declined rapidly, so that by 1939 it only approved 48 loans worth a total of just over $4 million.</p> <h4><strong>Federal Reserve Bank </strong><strong>13(b) Advances, </strong><strong>1934-May 1939</strong></h4> <table><thead><tr><td></td> <td><span><strong>Applications Number</strong></span></td> <td><span><strong>Received Amount</strong></span></td> <td><span><strong>Applications Number</strong></span></td> <td><span><strong>Approved Amount</strong></span></td> <td><span><strong>Advances and Commitments Outstanding At end of year</strong></span></td> </tr></thead><tbody><tr><td><span>1934</span></td> <td><span>5,108</span></td> <td><span>$190,798,000</span></td> <td><span>1,020</span></td> <td><span>$52,257,000</span></td> <td><span>$24,348,000</span></td> </tr><tr><td><span>1935</span></td> <td><span>2,507</span></td> <td><span>115,910,000</span></td> <td><span>973</span></td> <td><span>72,236,000</span></td> <td><span>60,142,000</span></td> </tr><tr><td><span>1936</span></td> <td><span>764</span></td> <td><span>35,991,000</span></td> <td><span>287</span></td> <td><span>15,336,000</span></td> <td><span>45,293,000</span></td> </tr><tr><td><span>1937</span></td> <td><span>298</span></td> <td><span>20,593,000</span></td> <td><span>126</span></td> <td><span>11,158,000</span></td> <td><span>30,977,000</span></td> </tr><tr><td><span>1938</span></td> <td><span>659</span></td> <td><span>35,606,000</span></td> <td><span>247</span></td> <td><span>24,024,000</span></td> <td><span>29,916,000</span></td> </tr><tr><td><span>1939 (to 5/17)</span></td> <td><span>88</span></td> <td><span>5,203,000</span></td> <td><span>48</span></td> <td><span>4,053,000</span></td> <td><span>27,040,000</span></td> </tr></tbody></table><p>Although 13(b) lending revived in 1942, when the Fed booked a record $128 million in loans, mostly to firms engaged in the war effort, and the Korean War kept the program active through the end of 1953, after that it tapered off rapidly, as can be seen in the next table, taken from <a href="https://fraser.stlouisfed.org/files/docs/publications/arfr/1950s/arfr_1955.pdf" rel="nofollow external noopener noreferrer" target="_blank">the Board of Governors 1955 Annual Report</a>. By the fall of 1955, the program had all but dwindled away.</p> <p><a href="https://www.alt-m.org/2020/03/30/when-the-fed-tried-to-save-main-street/loanamounts1955/" rel="attachment wp-att-219611 nofollow noopener noreferrer" target="_blank"><img alt="" height="589" src="https://cdn.alt-m.org/wp-content/uploads/2020/03/LoanAmounts1955.png" width="390" /></a></p> <p><a href="https://www.minneapolisfed.org/article/2008/the-history-of-a-powerful-paragraph" rel="nofollow external noopener noreferrer" target="_blank">According to Fettig</a>, the decline in 13(b) lending didn't happen because the Reserve banks resorted to even tougher lender standards. Instead, as the table's first column makes clear, it happened because fewer and fewer non-bank businesses applied to the Fed for loans. The slowness of the Fed's loan approval process, added to the low probability of approval, appears to have had much to do with this. Despite "the prodding of the Federal Reserve Board" and Fed banks' best efforts, <a href="https://www-jstor-org.proxy-remote.galib.uga.edu/stable/pdf/1885023.pdf" rel="nofollow external noopener noreferrer" target="_blank">Dolley says</a>,</p> <blockquote><p>the average period of time elapsing between the receipt of application and its final disposition was variously reported as from two to four weeks. After final approval of loan applications, further delays often occurred as a result of the borrower's failure to meet specified loan conditions.</p> </blockquote> <p>That the Fed's slow approval process and strict lending terms, rather than a general decline in small businesses' desire for credit, was responsible for the drop-off in 13(b) lending is suggested by the record of the RFC's alternative small business lending effort. By 1936, when it approved $32 million in loans, that program had already eclipsed its Fed counterpart. And thanks in part to a subsequent relaxation of its business lending rules, when the RFC ceased operations in 1953 it had lent businesses about $15 billion (<a href="https://www.nber.org/chapters/c2571.pdf" rel="nofollow external noopener noreferrer" target="_blank">Saulnier, Halcrow, and Jacoby, p. 71</a>), or many times what the Fed had.</p> <p>But the true insignificance of the Fed's 13(b) business lending only becomes evident when one realizes that while it went on <em>total </em>federal government debt to businesses never exceeded 5 percent of the amount business firms owed to private financial intermediaries (<a href="https://www.nber.org/chapters/c2570.pdf" rel="nofollow external noopener noreferrer" target="_blank">ibid., p. 48</a>).</p> <h4>Denouement</h4> <p>Although the Board of Governors tried, in 1938, to get the government to relax its 13(b) lending rules so it might reinvigorate that program, its appeal fell on deaf ears. And though the Board did at last succeed in securing a loosening of those rules in 1947, its enthusiasm for industrial lending gave way to disenchantment soon afterwards. Thus when a 1951 bill offered to relax the conditions for 13(b) lending still further, instead of supporting the measure the Board opposed it, saying that the relaxed rules might lead to inflation. By 1955, with only a few hundred industrial loans still on its books, the Fed was ready to quit the business altogether.</p> <p><a href="https://www.minneapolisfed.org/article/2002/lender-of-more-than-last-resort" rel="nofollow external noopener noreferrer" target="_blank">As David Fettig explains</a>, it was Fed Chairman William McChesney Martin himself who delivered the <em>coup de grâce</em> to the program when, in 1957, he revealed the Board's sentiments to a subcommittee of the Senate Banking and Currency Committee. "Basically," Martin said,</p> <blockquote><p><em>our concern stems from the belief that it is good government as well as good central banking for the Federal Reserve to devote itself primarily to objectives set for it by the Congress, namely, guiding monetary policy and credit policy so as to exert its influence toward maintaining the value of the dollar and fostering orderly economic growth.</em></p> </blockquote> <p>One year later, in August 1958, Section 13(b) was deleted from the Federal Reserve Act by Title VI of the <a href="https://www.govinfo.gov/content/pkg/STATUTE-72/pdf/STATUTE-72-Pg689.pdf#page=11" rel="nofollow external noopener noreferrer" target="_blank">Small Business Investment Act</a> (SBA). The same act transferred the Fed's remaining Section 13(b) capital to the Small Business Administration for it to use in funding various grants.</p> <p>In the meantime, the <a href="https://www-jstor-org.proxy-remote.galib.uga.edu/stable/pdf/2350836.pdf?refreqid=excelsior%3Aa45a697eb46bb3b9b9491660478c64bb" rel="nofollow external noopener noreferrer" target="_blank">Small Business Act</a>, passed two years earlier, had given the SBA permanent status, while increasing its lending capacity by more than 60 percent. The same measure raised the ceiling on individual SBA loans to a then-hefty $350,000, while reducing its maximum allowable lending rate to just 5.5 percent. The obvious intent of these steps was to allow the SBA to take exclusive responsibility for government-sponsored lending to small businesses, so that the Fed could instead give its full attention to "guiding monetary policy and credit policy."</p> <p>And so it did, until now.</p> <h4>History's Verdict</h4> <p>Posterity hasn't been kind to the Fed's original attempt to lend a hand to Main Street. Today it is all but forgotten; and it was little loved while it lasted. After a whirlwind romance, small businesses began to spurn its advances, eventually leaving it with few suitors; and even in its heyday it lent mainly to relatively large firms, rather than the smaller ones it had intended to woo.</p> <p>Expert opinion has been no kinder. According to James Dolley, the Fed's venture into business lending marked "a radical departure from the original theory of reserve bank lending," which called for it to lend to banks only, and to "avoid all semblance of direct competition with privately owned commercial banks." Saulnier, Halcrow, and Jacoby found that the Fed's 13(b) loans were but a drop in the bucket compared to lending done by commercial banks, and that they made up an less significant share of lending to small businesses. Even so, the Fed was lucky not to lose money on them. But the harshest verdict of all was delivered by <a href="https://www.alt-m.org/2015/11/11/happy-birthday-anna/" rel="nofollow noopener noreferrer" target="_blank">the late, lamented Anna Schwartz</a>, <a href="https://files.stlouisfed.org/files/htdocs/publications/review/92/09/Misuse_Sep_Oct1992.pdf" rel="nofollow external noopener noreferrer" target="_blank">who called</a> the Fed's industrial lending program "a sorry reflection on both Congress's and the Fed's understanding of the System's essential monetary control function."</p> <p>But what's done is done, and though history may rhyme, it needn't repeat itself. So here's to hoping that the Fed's 13(b) lending turns out to be, not a portent of things to come, but a prologue.</p> <p>[<a href="https://www.alt-m.org/2020/03/30/when-the-fed-tried-to-save-main-street/">Cross-posted from Alt-M.org</a>]</p> <p></p> Mon, 30 Mar 2020 13:07:18 -0400 George Selgin https://www.cato.org/blog/when-fed-tried-save-main-street Lawrence White discusses free banking in the age of crypto on the On The Brink with Castle Island podcast https://www.cato.org/multimedia/media-highlights-radio/lawrence-white-discusses-free-banking-age-crypto-brink-castle Mon, 30 Mar 2020 10:37:50 -0400 Lawrence H. White https://www.cato.org/multimedia/media-highlights-radio/lawrence-white-discusses-free-banking-age-crypto-brink-castle That Darn Coin https://www.cato.org/blog/darn-coin George Selgin <p>They say that a bad penny always turns up. But when it comes to crises these days, it seems that what keeps turning up is a bad idea—namely, the idea of having the U.S. Mint strike one or more trillion-dollar platinum coins.</p> <p>As I explained<span> </span><a href="https://www.alt-m.org/2019/03/20/mmts-big-coin-gambit/" rel="nofollow noopener noreferrer" target="_blank">last March</a>, the idea, which was first broached in 2009 and has since become very popular among Modern Monetary Theorists, gained prominence in January 2013, when<span> </span><a href="https://www.npr.org/sections/thetwo-way/2013/01/10/169020387/crazy-or-canny-talk-grows-about-1-trillion-platinum-coin" rel="nofollow external noopener noreferrer" target="_blank">they and several more orthodox economists latched onto it</a><span> </span>as a way around that month's<span> </span><a href="https://en.wikipedia.org/wiki/United_States_debt-ceiling_crisis_of_2013" rel="nofollow external noopener noreferrer" target="_blank">debt ceiling crisis</a>.</p> <p><a href="https://krugman.blogs.nytimes.com/2013/01/07/be-ready-to-mint-that-coin/" rel="nofollow external noopener noreferrer" target="_blank">Paul Krugman</a>, who was one of the idea's proponents, observed:</p> <blockquote><p>Should President Obama be willing to print a $1 trillion platinum coin if Republicans try to force America into default? Yes, absolutely. He will, after all, be faced with a choice between two alternatives: one that's silly but benign, the other that's equally silly but both vile and disastrous. The decision should be obvious. …[B]y minting a $1 trillion coin, then depositing it at the Fed, the Treasury could acquire enough cash to sidestep the debt ceiling—while doing<span> </span><a href="https://krugman.blogs.nytimes.com/2013/01/02/debt-in-a-time-of-zero/" rel="nofollow external noopener noreferrer" target="_blank">no economic harm at all</a>.</p> <p>So why not?</p> <p>It's easy to make sententious remarks to the effect that we shouldn't look for gimmicks, we should sit down like serious people and deal with our problems realistically. That may sound reasonable—if you've been living in a cave for the past four years. Given the realities of our political situation, and in particular the mixture of ruthlessness and craziness that now characterizes House Republicans, it's just ridiculous—far more ridiculous than the notion of the coin.</p> </blockquote> <p>In the event,<span> </span><a href="https://www.reuters.com/article/us-usa-debt-platinum/treasury-fed-kill-idea-of-1-trillion-platinum-coins-to-avert-debt-crisis-idUSBRE90B0HI20130112" rel="nofollow external noopener noreferrer" target="_blank">the Treasury put the kibosh to the big coin plan</a>, and Congress went on dickering about the Federal debt until October 17, 2013, when the crisis came to an end with the passing of the 2014<span> </span><a href="https://en.wikipedia.org/wiki/Continuing_Appropriations_Act,_2014" rel="nofollow external noopener noreferrer" target="_blank">Continuing Appropriations Act</a>.</p> <h4>The BOOST Act</h4> <p>Now the idea has come back again, this time as part of<span> </span><a href="https://tlaib.house.gov/sites/tlaib.house.gov/files/Automatic%20Boost%20to%20Communities%20Act%20.pdf" rel="nofollow external noopener noreferrer" target="_blank">the "Automatic BOOST to Communities Act,"</a><span> </span>sponsored by Congresswoman Rashida Tlaib (D-MI). The BOOST Act's goal is to "provide a U.S. Debit Card pre-loaded with $2000 to every person in America," where the cards could be "recharged with $1,000 monthly until one year after the end of the Coronavirus crisis." Instead of having the Treasury finance the plan by selling securities, the bill calls for it to use "its legal authority to create money via coin seigniorage, which is a statutory delegation of Congress's constitutional power of the purse."</p> <p>Because of the sum involved, the plan would have the U.S. Mint strike not one but<span> </span><em>two</em><span> </span>platinum coins, each containing one ounce of platinum but having a face value of $1 trillion. It would also compel the Fed to purchase the coins for their face value, by crediting the Treasury General Account by that amount.</p> <p>Finally, the bill says that the plan it proposes "would preserve the historical separation between fiscal and monetary policy and avoid financial entanglement between the Treasury and the Federal Reserve which would eventually undermine the independence of the Fed." We shall see about that.</p> <h4>Why Not Borrow?</h4> <p>When the platinum coin idea was being pitched back in 2013, it was, as I've noted, as a way to get around the debt ceiling, which many viewed as a serious impediment to needed fiscal stimulus. Allowing that the stimulus was indeed desirable, the idea had the merit of solving a real problem, even if it did so in a somewhat devious way, and one that risked establishing a precedent that could lend itself to future abuse.</p> <p>Today, in contrast, there's no debt-ceiling impediment to aggressive fiscal action: as part of last year's budget deal, the debt ceiling was suspended until July 2021. That leaves Congress and the Treasury free to spend as much as they want, without having to compel the Fed to pay $2 trillion for a couple platinum coins that, so far as it's concerned, wouldn't be worth as many plugged nickels.</p> <p>If platinum coins aren't needed to replenish the Treasury's coffers, why should Congress bother with them? It's a good question, and especially so considering that rates on many Treasury securities are now<span> </span><a href="https://markets.businessinsider.com/news/stocks/us-treasury-yield-curve-below-1-percent-red-flag-investors-2020-3-1028975968" rel="nofollow external noopener noreferrer" target="_blank">at record low levels</a>. What's more, rates on some shorter-term Treasury bills are actually below the meager 10 basis points the Fed now pays on bank reserves.</p> <p>Taken together with the fact that we're entering what's likely to be a deep recession with no immediate risk of<span> </span><a href="https://en.wikipedia.org/wiki/Crowding_out_(economics)" rel="nofollow external noopener noreferrer" target="_blank">"crowding out,"</a><span> </span>what all this means is that the Treasury might actually<span> </span><em>save<span> </span></em>money by selling T-bills instead of making the Fed buy platinum coins from it. That's partly because it costs money to make the coins, including about $1250 bucks worth of platinum. But that's the least of it. The real difference is that, once the funds created get disbursed by the Treasury, and thence spent by their recipients, the coin strategy will ultimately increase<span> </span><em>bank reserves</em><span> </span>by about $2 trillion. The Fed will then have to pay interest on those reserves at the IOER rate, and so will have to deduct that amount from its Treasury remittances. If instead the spending program were bond financed, bank reserves would stay unchanged.</p> <p>In short, under the current, "floor" system of monetary control, coin financing is equivalent to having the Treasury borrow the face value of the coins from the nation's banks, while paying them interest at the IOER rate, and wasting perfectly good platinum to boot.</p> <h4>Coins and Copters</h4> <p>As<span> </span><a href="https://www.economist.com/free-exchange/2013/01/09/platinomics" rel="nofollow external noopener noreferrer" target="_blank">Greg Ip has observed</a>, the platinum coin plan resembles a Treasury-initiated version of "helicopter money":</p> <blockquote><p>Banks won't want a $1 trillion platinum coin, so the Fed will only buy the coin if Treasury forces it to. The Treasury, in "depositing" its coin at the Fed, is in reality ordering the Fed to print money. And if Treasury doesn't take the coin back, the money stays printed.</p> </blockquote> <p>The helicopter money nature of coin-financed spending might make it appear capable of achieving a greater stimulus effect than ordinary debt-financed spending. But here again, the fact that bank reserves bear interest throws a wrench into the works, as<span> </span><a href="https://www.bloomberg.com/opinion/articles/2016-03-24/-helicopter-money-won-t-provide-much-extra-lift" rel="nofollow external noopener noreferrer" target="_blank">Narayana Kocherlakota observed several years ago</a>. It means that coin financed spending confronts taxpayers with the same interest burden they would bear if the Treasury financed its expenditures by selling consols with coupons pegged to the floating IOER rate. <span> </span><a href="https://voxeu.org/article/true-costs-helicopter-money" rel="nofollow external noopener noreferrer" target="_blank">Biaggo Bossone</a><span> </span>makes the point especially succinctly, and in a way fans of Modern Monetary Theory should find especially persuasive. "A positive remuneration on excess reserves," he says, "transforms them into fiscal liabilities (analogous to debt financing) in the consolidated public sector balance sheet."</p> <h4>Exposing a Charade?</h4> <p>If the coin gambit may not allow the Treasury to borrow for less, and isn't likely to accomplish anything that plain-old deficit spending can't, what use is it?</p> <p>I posed this question on Twitter to Clint Ballinger and Nathan Tankus, two very smart Modern Monetary Theorists. And both said, in essence, that the plan's real purpose is educational. According to Ballinger, it would shine a light on the sheer silliness of the Treasury's<span> </span><a href="https://twitter.com/clintballinger/status/1241866910012076032?s=20" rel="nofollow external noopener noreferrer" target="_blank">"self-imposed rule"</a><span> </span>against simply creating and spending its own<span> </span><a href="https://twitter.com/clintballinger/status/1241866910012076032?s=20" rel="nofollow external noopener noreferrer" target="_blank">"tax-credit token[s]."</a><span> </span>Tankus likewise sees the plan as a way of<span> </span><a href="https://twitter.com/NathanTankus/status/1241815371637837824?s=20" rel="nofollow external noopener noreferrer" target="_blank">"contesting the idea that the Treasury is not a monetary institution."</a><span> </span>The coin gambit is not, in other words, a way of<span> </span><em>allowing</em><span> </span>the Treasury to create money. The Treasury<span> </span><em>already</em><span> </span>creates money. It just does it in a "Rube Goldberg" fashion (Ballinger) rather than openly. While Fed officials may consider monetary policy their responsibility, the Treasury really calls the shots.</p> <p>But does it? That would be so were the "self imposed rules" that Modern Monetary Theorists dislike merely so much window dressing.<span> </span><a href="https://www.alt-m.org/2019/03/05/on-empty-purses-and-mmt-rhetoric/" rel="nofollow noopener noreferrer" target="_blank">But they aren't.</a><span> </span>That the Treasury has thus far not considered the striking of trillion-dollar coins a legitimate exercise of its authority, that it supplies other coins only to meet the Fed's requests for them, and that it is not allowed to overdraw its TGA account, all have real implications. They mean that the Treasury is incapable on its own of expanding the Fed's balance sheet. That doesn't mean that it can't alter the quantity of bank reserves: it can and does alter that quantity when it allows its TGA balance to change. But once it exhausts that balance, its power to add to bank reserves comes to an end.</p> <p>Present procedures also assign to the FOMC the exclusive authority to set the Fed's interest rate targets, while granting to the Fed Board authority to set the Fed's interest rate on excess reserves. Finally—and most importantly—Congress has delegated to the Fed responsibility for achieving "the goals of maximum employment, stable prices, and moderate long-term interest rates."</p> <p>Together these things mean that, while the Treasury is indeed a monetary institution, as is most obvious from its role in minting coins and printing Federal Reserve notes, it is far from having as much influence on monetary policy as it might have under different circumstances, including one in which it considered it appropriate to strike and compel the Fed to purchase trillion-dollar platinum coins. The MMT coin gambit is, for this reason, not just about "contesting an idea." It is about changing the delegation of the government's "power to coin money and regulate the value thereof."</p> <p>In particular,<a href="https://twitter.com/NathanTankus/status/1241821996821942272?s=20" rel="nofollow external noopener noreferrer" target="_blank"><span> </span>as Tankus observes</a>, the platinum coin plan would be more in keeping with "the original spirit of the mint" which, when it was established in 1791, was this nation's principal monetary authority. However, in those days the dollar was a commodity money unit, based on either gold or silver. Consequently, the scarcity of those metals alone sufficed to place meaningful limits on the U.S. Mint's, and hence the Treasury's, monetary powers. There was no need for any further measures to guard against the<span> </span><a href="https://simplicable.com/new/fiscal-dominance" rel="nofollow external noopener noreferrer" target="_blank">"fiscal dominance"</a><span> </span>of monetary policy. With today's fiat money regime, that's no longer the case. Instead, some public authority has been both responsible for and capable of regulating the value of money. So far at least, the Fed alone bears the responsibility. It therefore needs the capability.</p> <h4>A Bankrupt Fed?</h4> <p>But today there is such a need. That is,<span> </span><em>someone<span> </span></em>in government has to be responsible for seeing to it that the power to create fiat money isn't abused. And whoever bears that responsibility must also enjoy such powers of monetary control as are required to do so.</p> <p>Would relaxing the Treasury's "self imposed" rule against minting trillion-dollar coins leave us as safe, or safer, from abuse of the money power than we are now? To answer that question, one has to consider possible future consequences of the change. That means asking what might happen if the Treasury could mint not just one or two trillion-dollar coins, but as many such coins as it liked, and not just to combat a severe recession, but for any reason. Once the government disburses the funds so raised, the Fed ends up with $1 trillion of liabilities on which it owes interest for each coin it has to accept, but without any additional interest-earning assets. Should the government's spending boost demand and prices, as it's likely to do, the Fed will have to raise its IOER rate, driving a still larger wedge between its interest earnings and its interest expense.</p> <p>Nathan Tankus suggests that the Fed could prevent the Treasury from adding to its interest-earning liabilities by selling securities, that is, by "sterilizing" the Treasury's platinum coin deposits. But that would leave it with an even lower ratio of interest-earning assets to interest-earning liabilities. Allowing the Fed to sell its own securities—another Tankus proposal—would have the same result.</p> <p>How many platinum coins would it take to raise the Fed's expenses above its interest earnings? Actually, a couple coins might suffice, for then the Fed's non-interest earning assets would exceed its non-interest earning liabilities, consisting of $1.8 trillion or so in circulating Federal Reserve notes, by about $200 billion. Assuming that the Fed's security holdings yield more than its IOER rate, it might still cover its expenses. But it would be a close-run affair. A third coin would almost certainly put it in the black. Probably a quarter-trillion coin would suffice.</p> <p>To make the point more concretely, let's think back to 2019 for a moment. President Trump is convinced that more QE will make the economy<span> </span><a href="https://www.cnbc.com/2019/04/30/trump-calls-on-fed-to-cut-rates-by-1percent-and-urges-more-quantitative-easing.html" rel="nofollow external noopener noreferrer" target="_blank">"go up like a rocket,"</a><span> </span>but the Fed won't go along. A Treasury staffer recalls the platinum coin loophole, and after some logrolling Congress comes up with an omnibus bill authorizing $2 trillion in spending on border walls, infrastructure repair, zero-emission energy projects, and a job-guarantee program, to be paid for by having the Treasury jam a couple platinum discs down the Federal Reserve System's throat.</p> <p>Looking at<span> </span><a href="https://www.federalreserve.gov/aboutthefed/files/combinedfinstmt2019.pdf" rel="nofollow external noopener noreferrer" target="_blank">the Fed's income and expense statement for that year</a>, without being saddled with the coins, the Fed earned about $100 billion in interest on about $4 trillion in securities, while paying about $40 billion in interest on $1.5 trillion in reserves. That left it with $60 billion to remit to the Treasury. (I set aside the Fed's non-interest income and operating expenses, as these are relatively minor items.) By resorting to the coins, the Treasury would have saddled the Fed with another $53 billion in interest expense, leaving it with a surplus to remit to the Treasury of a scant $7 billion! Like I said, that would be cutting things awfully close.</p> <p>The problem isn't simply that the Fed's earnings might temporarily fall short of its expenses. The Fed's accounting practices allow it to handle temporary losses. As<span> </span><a href="https://www.federalreserve.gov/pubs/feds/2013/201301/revision/201301pap.pdf" rel="nofollow external noopener noreferrer" target="_blank">Seth Carpenter and several coauthors explain</a>, when that happens, the Fed creates a "deferred asset" recording the loss. It then stops remitting funds to the Treasury until its earnings become positive again, allowing it to make up for its deficits.</p> <p>But platinum coin financing doesn't just risk exposing the Fed to temporary losses: it could risk having it operate in the red for so long that its deferred asset ends up being worth more than the present value of its anticipated future earnings. As Carpenter et al. note,</p> <blockquote><p>Because there has never been a deferred asset of any meaningful size, there is little guidance as to the whether or not there is a limit to the potential size of the asset. It may be plausible to assume that it would not be allowed to exceed the value of all future earnings, possibly in present discounted terms, given the fact that it is paid down through future earnings.</p> </blockquote> <p>In other words, the Fed might end up losing the budgetary autonomy that's intended to bolster its independence, by allowing it to avoid periodic bargaining with the government. Alternatively, in order to avoid such bargaining, it might be tempted to limit its interest expenses by failing to raise its IOER rate enough to keep inflation on target. Responsible monetary control could suffer either way.</p> <p>How likely is such an outcome? I don't know. I only know that it would be very unwise for Congress to cast-aside current limits on the Treasury's money-creating powers until a serious discussion has taken place concerning that step's possible consequences.</p> <h4>The Direct Draw Alternative</h4> <p>None of what I've said should be taken to suggest that there are no constraints on the Treasury that couldn't safely be relaxed at once. The rules preventing the Fed from purchasing securities directly from the Treasury, or from otherwise lending directly to it, come to mind. The ban on direct Fed purchases of Treasurys is of purely cosmetic significance. Despite appearances it doesn't stop the Fed from doing anything it can't do by purchasing securities on the secondary market.<span> </span><a href="https://www.alt-m.org/2019/11/14/stop-the-presses-or-how-the-fed-can-avoid-reserve-shortages-without-bulking-up-part-2/" rel="nofollow noopener noreferrer" target="_blank">Restoring the Treasury's "Direct Draw Authority,"</a><span> </span>which until 1981 allowed it to repo securities with the Fed to meet its short-term cash needs, also wouldn't do any harm, particularly if the authority were limited to emergencies. Before we spring for platinum, let's try these less gaudy options. After all, it's the thought that counts.</p> <p>[<a href="https://www.alt-m.org/2020/03/24/that-darn-coin-again/">Cross-posted from Alt-M.org</a>]</p> <p></p> Tue, 24 Mar 2020 09:04:58 -0400 George Selgin https://www.cato.org/blog/darn-coin The Treasury’s Helicopter Cop‐​Out https://www.cato.org/blog/treasurys-helicopter-cop-out George Selgin <p>Predictably, the depths of the present economic crisis, including the remarkable flattening of interest rates since it began, have led to several calls by economists, including<span> </span><a href="https://voxeu.org/article/helicopter-money-time-now" rel="nofollow external noopener noreferrer" target="_blank">Jordi Gali</a><span> </span>and the Mercatus Institute's<span> </span><a href="https://www.mercatus.org/publications/monetary-policy/covid-19-pandemic-direct-cash-transfers-and-federal-reserve" rel="nofollow external noopener noreferrer" target="_blank">David Beckworth</a>, for the Fed and other central banks to ready their money choppers for a major money-financed spending-spree.</p> <h4>Helicopter Money vs. Deficit Monetization</h4> <p>"Helicopter money" in its strictest sense is money simply given to people by a central bank. This needn't be done using actual helicopters, of course; and in practice, proposals for it have central banks handing out free money, not directly to the public, but to their sponsoring governments, for use in financing some spending or transfer program.</p> <p>Either way—and this point is crucial—helicopter money is distinct from deficit monetization in its usually-understood sense. As<span> </span><a href="https://www.cato.org/cato-journal/winter-2018/against-helicopter-money#ch08_ref7" rel="nofollow external noopener noreferrer" target="_blank">Kevin Dowd explains</a>, "debt monetization involves an explicit increase in the federal government's indebtedness, whereas under helicopter money that same increased indebtedness is written off by the Fed" or whichever central bank undertakes it. It has the central bank increasing its liabilities without acquiring any offsetting, valuable asset.</p> <p>Alternatively,<span> </span><a href="https://www.brookings.edu/blog/ben-bernanke/2016/04/11/what-tools-does-the-fed-have-left-part-3-helicopter-money/" rel="nofollow external noopener noreferrer" target="_blank">as "Helicopter Ben" explains</a>, helicopter money can be likened to an extreme version of deficit monetization in which the Treasury gets money from the Fed in exchange for a security that bears no interest and that the Fed agrees to hold on to<span> </span><em>forever.</em><span> </span>The Fed, in other words, has to commit itself to permanently increase its balance sheet by the amount of its security "purchase."</p> <h4>Dubious Advantages</h4> <p>The benefits of helicopter money, Bernanke explains, consist of</p> <p>(1) the direct effects of the public works spending on GDP, jobs, and income;</p> <p>(2) the increase in household income from the rebate, which should induce greater consumer spending;</p> <p>(3) a temporary increase in expected inflation, the result of the increase in the money supply. Assuming that nominal interest rates are pinned near zero, higher expected inflation implies lower real interest rates, which in turn should incentivize capital investments and other spending; and</p> <p>(4) the fact that, unlike debt-financed fiscal programs, a money-financed program does not increase future tax burdens.</p> <p>Significantly, as Bernanke also notes, advantages (1) and (2) would also be achieved by a debt-financed government spending program. Benefit (3) can, in turn, be achieved through other sorts of unconventional monetary policy, including either ordinary or expanded-asset quantitative easing (QE), aided perhaps by a Fed commitment to temporarily raise its inflation target, or<span> </span><a href="https://www.themoneyillusion.com/time-to-end-the-growth-rate-targeting-experiment/" rel="nofollow external noopener noreferrer" target="_blank">by its agreeing to switch to NGDP level targeting</a>.</p> <p>This leaves only advantage (4). But this "advantage" is no real advantage at all. It assumes, first of all, that<span> </span><a href="https://en.wikipedia.org/wiki/Ricardian_equivalence" rel="nofollow external noopener noreferrer" target="_blank">Ricardian Equivalence</a><span> </span>holds, or at least that the public takes considerable account of future tax increases in adjusting their current spending, but that they do not take future inflation into account in doing so.* But that's not all: under the present abundant reserves or "floor" system, even helicopter money generates a future tax burden, because it generates fresh reserves on which the Fed must pay interest at a variable rate; and the Fed may have to increase this rate to keep inflation under control.</p> <p>It follows that, as the IOER rate approaches the government's non-helicopter financing rate, the reduction in the government's future tax burden approaches zero. Should the IOER rate<span> </span><em>exceed</em><span> </span>the alternative financing rate, helicopter money, instead of having a fiscal advantage, actually results in a greater fiscal burden.</p> <p>Yet it's precisely in the sorts of extreme crises in which helicopter money is most likely to be proposed that this last possibility is most likely to come into play. As I write, for example, the Fed has also lowered its IOER rate to a measly 10 basis points. Yet one-month and three-month T-bill rates<span> </span><a href="https://finance.yahoo.com/news/dash-cash-pushes-treasury-bill-210027769.html" rel="nofollow external noopener noreferrer" target="_blank">have fallen lower still</a>! Though rates on longer-maturity Treasurys are above IOER, still those fixed rates seem like a safer long-run bet than the floating IOER alternative.</p> <h4>And Real Disadvantages</h4> <p>If the advantages of helicopter money are doubtful, its potential costs are hard to dispute. Here again, Bernanke is a good guide. He observes, among other things, that "helicopter money" might prove incompatible with the Fed's use of an interest-rate operating target and that it could threaten the Fed's political independence, particularly by serving "as a 'slippery slope' for legislators, who might be tempted to use it to facilitate spending or tax cuts when such actions no longer make macroeconomic sense"—that is, as a slippery-slope leading toward<span> </span><a href="https://www.amazon.com/Menace-Fiscal-QE-George-Selgin/dp/1948647931" rel="nofollow external noopener noreferrer" target="_blank">"fiscal QE."</a></p> <p>Perhaps the biggest drawback of helicopter money has to do with the way in which<span> </span><a href="https://www.alt-m.org/2020/03/18/holding-the-line-maintaining-fiscal-and-monetary-policy-boundaries-in-the-midst-of-a-crisis/" rel="nofollow noopener noreferrer" target="_self">it smudges the boundary line separating fiscal from monetary policy</a>, and the division of powers that boundary line is supposed to protect. This problem becomes most evident in pondering the question, "whose responsibility is helicopter money?" while supposing that Treasury-central bank cooperation can't be counted on. If the government is to take the initiative, then the central bank must be made subservient to it, risking the undermining of its monetary control while opening the floodgates to fiscal QE. If, on the other hand, the central bank is to take charge, the government must arrange its spending plans in accordance with the central bank's wishes. Neither prospect seems appealing. Call it the "helicopter money dilemma."</p> <h4>Passing the Fiscal Policy Buck</h4> <p>But a helicopter money dilemma exists only assuming that helicopter money can achieve something that can't be achieved through a combination of ordinary bond-financed deficit spending and responsible monetary policy. For reasons I've explained, I don't believe this to be so. On the contrary: just now it makes more fiscal sense for the Treasury to flood the market with T-bills, while the Fed sticks to achieving its monetary policy targets, whether by means of non-helicopter QE or otherwise. As Bernanke observes, several conditions must hold for helicopter money to be necessary, among which is the "unwillingness of the legislature to use debt-financed fiscal policies." Why insist that the Fed take on duties that properly belong to Congress, when we can just as well insist that Congress do its job?</p> <hr /> <p>*In a footnote Bernanke observes that "It's true that higher inflation acts as a de facto tax on money holdings, but that tax becomes relevant only if actual inflation rises, which would be a sign that the program is achieving its goal of stimulating spending." This is correct. But rather than evading the issue it only suggests that, to the extent that forward-looking taxpayers expect helicopter money to spur spending, it won't!</p> <p>[<a href="https://www.alt-m.org/2020/03/20/the-treasurys-helicopter-cop-out/">Cross-posted from Alt-M.org</a>]</p> <p></p> Fri, 20 Mar 2020 16:52:16 -0400 George Selgin https://www.cato.org/blog/treasurys-helicopter-cop-out Painful Choices Will Have to Be Made the Longer This Goes On https://www.cato.org/publications/commentary/painful-choices-will-have-be-made-longer-goes Ryan Bourne <div class="lead text-default"> <p>“Whatever it takes.” Just in case&nbsp;you didn’t hear the intended government message of reassurance to businesses, Chancellor Rishi Sunak repeated the&nbsp;mantra five times through Tuesday’s speech and in answering subsequent questions.</p> </div> , <div class="text-default"> <p>As the coronavirus ravages demand across the food, <a href="https://www.telegraph.co.uk/business/2020/03/17/governmenthas-effectivelyshut-hospitalitysector-says-trade-body/" target="_blank">&nbsp;transport and hospitality sectors</a>, and subdues demand in other industries, the Chancellor offered up to £330bn in zero‐​interest loans to businesses, business rates relief and cash grants to retail, hospitality and leisure companies, and £10,000 grants to small firms. Further subsidies for employment are reportedly to be announced.</p> <p>The Chancellor’s rationale for such action is more clear‐​headed than the US response, with president Trump promising cheques to every American.&nbsp;Rather than targeting consumption, Sunak wants instead to ease cashflow problems and curb layoffs from companies labouring under a&nbsp;necessary partial shutdown of&nbsp;the economy. His desire is to preserve capacity.</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>We can support business if disruption is short, but after several months it becomes actively wasteful.</p> </div> </div> </aside> , <div class="text-default"> <p>A collapse in spending arising from “social distancing” and government‐​imposed containment measures risks killing many firms by holding back revenues, while costs such as rent, debt payments and payrolls persist.</p> <p>Sunak’s goal here isn’t to “stimulate the economy”, as such. He doesn’t want to risk speeding up the virus’s transmission. No, the aim, at least, is for taxpayer support to help companies to bridge the time until the virus passes.</p> <p>Taxpayers, so the thinking goes, are paying out or supporting activity in lieu of a&nbsp;missing insurance market. Households and businesses couldn’t feasibly have foreseen a&nbsp;global pandemic and if the state didn’t step in, thousands of normally viable businesses could be wiped out, so creating a&nbsp;deep recession and financial&nbsp;crisis.</p> <p>Now, we can all debate whether the&nbsp;measures will prevent that outcome. A&nbsp;lot of self‐​employed and gig economy workers seem precarious.&nbsp;<a href="https://www.telegraph.co.uk/business/2020/03/18/markets-live-coronavirus-latest-news-pound-euro-ftse-100/" target="_blank">Markets seem sceptical about the effectiveness of the business measures</a>. Aside from the scale, one reason might be that this strategy requires the effective economic shutdown to be brief. Policymakers ideally want it to become like an extended Christmas week or “bad season”, from which rapid bounce‐​back occurs, even if some economic activity disappears forever.</p> <p>But the truth is we simply don’t know the duration of this crisis yet. Epidemic modelling from Imperial College has suggested that we might need suppression policies for 55pc to 96pc of time over the next 18 months. Even when government controls are relaxed, workers and customers might still be reluctant to return to activities or establishments where fear of catching or spreading the virus is greatest. Until widespread testing and/​or a&nbsp;vaccine are available, this is the huge uncertainty.</p> <p>Reassuring businesses then, in principle, doesn’t require just committing to do “whatever it takes” but to do it for “however long it takes”. Yet such a&nbsp;promise would neither be believable, nor desirable. If we are really talking about 12 to 18 months of disruption, trying to hibernate much of the economy of February 2020 to “reawaken” it in mid‐​2021 becomes no strategy at all.</p> <p>Such an approach would require a&nbsp;gargantuan commitment from taxpayers. Zero‐​interest loans from government won’t help many firms with this duration of mothballing. As the Office for Budget Responsibility’s Sir Charles Bean explained on Tuesday, the longer this crisis rolls on, the more loans have to become cash grants, lest firms loaded with debts become insolvent. Many will be reluctant to take on loans anyway without certainty about the duration of disruption. So direct taxpayer support will ratchet.</p> <p>If longer than a&nbsp;year, up to a&nbsp;fifth of the economy being replaced by government transfers for no activity starts becoming actively wasteful. As the economy adjusts to its new reality, novel forms of business, new attitudes to teleworking, altered tastes, and alternative supply chains, will develop, making it less and less desirable or feasible to try to return to the economy of yesterday.</p> <p>And we see seeds of economic adjustment already. Supply chains for supermarkets are running on overtime. Amazon is hiring and raising wages. Demands have understandably shifted to certain coronavirus‐​related products and, before long, certain workers, who really need the income, will divert into delivery, supermarkets, and care work.</p> <p>Many families might re‐​examine too their preferences about having two income earners as childcare becomes scarcer. Paying firms to maintain the same workforces&nbsp;as today, in light of all this, becomes destructive.</p> <p>Cost‐​benefit analyses are always uncomfortable to think about during the heat of a&nbsp;crisis. But there must logically come a&nbsp;point when the rise in cost and the falling benefits of “bridging to recovery” makes a&nbsp;change of approach optimal.</p> <p>We are certainly not there yet and, given the flashing warning signs of an imminent output recession, the Government’s framework of thinking is sensible enough, for now. This genuine public health crisis must mean we all temporarily rethink the role of government.</p> <p>Highly targeted provisions of income support for households and businesses deeply affected by the downturn have a&nbsp;much clearer justification than expensive universal schemes such as a&nbsp;temporary “basic income”, although deciding on deserving targets is always fraught with difficulty.</p> <p>The key point is that the Government should avoid making promises it can’t keep. Bills currently in the US Congress for business support are good until June. By that time, the trajectory of the virus’s transmission should be much clearer. Programmes can always be renewed, if necessary. But promising “whatever it takes, for however long it takes” would be foolhardy.</p> <p>In what’s left of the market economy during this time, change occurs quickly. Governments could relax certain regulations, particularly the licensing of occupations and business “types”, to make transition easier still. What we cannot do is try to freeze the economy for years.</p> <p>Let us hope that the end of this current crunch then comes sooner rather than later. Otherwise we are looking at huge destruction, be it to livelihoods or our health.</p> </div> Thu, 19 Mar 2020 08:47:42 -0400 Ryan Bourne https://www.cato.org/publications/commentary/painful-choices-will-have-be-made-longer-goes Holding the Line: Maintaining Fiscal and Monetary Policy Boundaries in the Midst of a Crisis https://www.cato.org/blog/holding-line-maintaining-fiscal-monetary-policy-boundaries-midst-crisis George Selgin <p>Not long ago, the CMFA staff and I were preparing to officially launch<span> </span><a href="https://www.amazon.com/Menace-Fiscal-QE-George-Selgin-ebook/dp/B084GZ1RFQ" rel="noopener noreferrer" target="_blank"><em>The Menace of Fiscal QE</em></a>, my book aimed at countering efforts to have the Fed undertake or otherwise fund off-budget government spending programs.</p> <p>Then came the crisis. Of course our plans were dashed. But so, I feared, were my hopes of having people take the message of<span> </span><em>Menace</em><span> </span>seriously. "Who now," I wondered, "wants to hear about the need to respect policy boundaries? More likely the hue-and-cry will be, 'Let's pull all the stops: boundaries be damned!'"</p> <p>And so it has come to pass, in some quarters at least. Thus Congresswoman Maxine Waters, Chair of the House Committee on Financial Services (D-CA),<span> </span><a href="https://financialservices.house.gov/news/documentsingle.aspx?DocumentID=406435" rel="noopener noreferrer" target="_blank">declared on March 16th</a>:</p> <blockquote><p>This is in many ways an unprecedented crisis which calls for extraordinary federal response. Unfortunately, the Fed appears to be using its old playbook in trying to calm funding markets by flooding them with liquidity. During this time of economic turbulence, it is critical that the Fed go beyond these steps and provide much-needed support to those who are on the front lines of this pandemic. …While Congress works on a bold, fiscal stimulus package to help these individuals, I call on the Fed to reevaluate its response and work creatively to address the needs of everyday Americans.</p> </blockquote> <p>Some experts, in the meantime, are recommending that the Fed resort to "helicopter money."<span> </span><a href="https://voxeu.org/article/helicopter-money-time-now" rel="noopener noreferrer" target="_blank">Jordi Gali, for example</a>, suggests that it and other central banks finance emergency spending programs by simply crediting their governments' accounts:</p> <blockquote><p>That credit would not be repayable, i.e. it would amount to a transfer from the central bank to the government. …[S]uch a transfer from the central bank to the government would be equivalent to a commensurate purchase of government debt by the central bank, followed by its immediate writing-off, thus no longer having an impact on the government's effective debt liabilities.</p> </blockquote> <p>Gali recognizes that his plan subordinates monetary policy to "the requirements of the fiscal authority" and that it could therefore be considered "an outright violation of the principle of central bank independence." "But," he says,</p> <blockquote><p>we have seen many occasions in which rules that were considered sacred have been relaxed in the face of extraordinary circumstances. …Furthermore, the central bank could agree to participate voluntarily in such a scheme, thus preserving its formal independence.</p> </blockquote> <p>Perhaps I am reading this wrongly, but Gali seems to be saying that central banks need never worry about losing their independence so long as they do whatever the government asks them to do.</p> <p>Notwithstanding such appeals, and the urgency of the crisis, I believe that it's as important as ever for the Fed and Congress to stick to their respective fiscal and monetary turfs, and that if there's any reason why they can't do so, while taking all necessary steps to address the crisis, it's that Congress refuses to take responsibility for any potentially risky operations it would rather have the Fed undertake.</p> <h4>The Power of the Purse</h4> <p>The case for insisting on a strict division of fiscal and monetary responsibilities rests on the principle, enshrined in the U.S. Constitution, that Congress alone should determine how public funds, including funds secured by borrowing against future tax revenues, should be spent. Because losses stemming from any risky government program are also ultimately borne by taxpayers, such losses should also be treated as "potential" government expenditures which Congress alone should be allowed to authorize, and for which it should bear full responsibility.</p> <p>These stipulations, far from being arbitrary, derive from the U.S. Constitution's Appropriations Clause (Article I, section 9, clause 7):</p> <blockquote><p>"No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time."</p> </blockquote> <p>Nor should the rationale for this clause be difficult to fathom. It is simply the spending counterpart of the idea that there should be no taxation without representation, itself enshrined in another part (section 7, clause 1) of the Constitution's first article:</p> <blockquote><p><em>All Bills for raising Revenue shall originate in the House of Representatives; but the Senate may propose or concur with amendments as on other Bills</em></p> </blockquote> <p>Together these clauses are intended to award Congress exclusive control of the<span> </span><a href="https://history.house.gov/institution/origins-development/power-of-the-purse/" rel="noopener noreferrer" target="_blank">"power of the [national] purse."</a></p> <p>Because it may result in losses that must come out of that purse, risky lending is properly regarded as something Congress alone can authorize, and for which it must be prepared to pay.</p> <h4>The Fed's Independence</h4> <p>The Constitution also awards Congress "the power to coin money [and] regulate the value thereof." Congress in turn has chosen—though<span> </span><a href="https://www.amazon.com/Constitutional-Money-Supreme-Monetary-Decisions/dp/1107032547" rel="noopener noreferrer" target="_blank">hardly without controversy!</a>—to exercise those powers by establishing the Fed and granting it some degree of independence from political, including Congressional, interference.</p> <p>That<span> </span><a href="https://www.amazon.com/Myth-Independence-Congress-Governs-Federal/dp/0691163197" rel="noopener noreferrer" target="_blank">the Fed is hardly as independent as it claims to be</a><span> </span>no one should gainsay. Still it possesses a modicum of independence, if no more than that, and that independence, such as it is, makes it somewhat easier for it to stick to its mandate, or at least to resist pressure to bend to Congress's will,<span> </span><a href="https://www.politico.com/news/2019/10/07/jerome-powell-fed-freedom-037731" rel="noopener noreferrer" target="_blank">or to that of the Executive</a>.</p> <p>The Fed's (limited) independence itself rests mainly on two provisions of the Federal Reserve Act. One of these grants members of its Board of Governors nonrenewable 14-year terms, except the Chair, who serves a renewable four-year term. It also prevents elected officials from serving on the Board. The other allows the Fed to operate without a budget from Congress, by covering its expenses using interest income from its security holdings and fees it charges for its services.</p> <p>Any Congressional interference with the above-mentioned provisions necessarily chips away, however slightly, at the Fed's already tenuous independence. This goes for any action by Congress that might expose the Fed to losses. As<span> </span><a href="https://www.researchgate.net/publication/241403791_Central_Bank_Finances_and_Independence_-_How_Much_Capital_Should_a_CB_Have" rel="noopener noreferrer" target="_blank">Alex Cukierman explains,</a><span> </span>although central banks differ from ordinary banks in being able to operate with negative net worth, so that they are in that sense able to bear losses, those losses, should they become large enough, may force them to "depend on infusions of funds from the Treasury," thereby raising the possibility that the Treasury will "explicitly or implicitly, condition the recapitalization… on certain policy actions."</p> <h4>Fiscal Backup</h4> <p>Cukierman's observations lead him to recommend that central banks not be asked to take on substantial risk unless the "political authorities" agree to cover any losses they may incur:</p> <blockquote><p>If, due to a financial crisis or other reasons, government decides to rescue financial institutions the implementation of such operations should not affect the net capital position of the CB [central bank]. This implies that such operations should appear as explicit items on the government's budget. Such an arrangement is desirable not only because it protects the instrument independence of the bank, but also because of transparency and accountability considerations of politicians to the public that elected them. … More generally, the CB net worth [had] better be shielded from the impact of decisions that are made by other authorities.</p> </blockquote> <p>During the last crisis, the British government followed this advice, at least to some extent, by offering to indemnify the Bank of England for any losses it incurred by acquiring risky assets. However, as<span> </span><a href="https://voxeu.org/article/how-much-fiscal-backing-do-key-central-banks-have" rel="noopener noreferrer" target="_blank">Willem Buiter reported then</a>, even it failed to assume responsibility for the credit risk the Bank took on in offering "repos and other forms of collateralized lending to banks where the collateral offered consists of private securities." The ECB, in contrast, received no protection at all. Instead,<span> </span><a href="https://voxeu.org/article/european-fiscal-vacuum-makes-ecb-timid-quantitative-and-credit-easing" rel="noopener noreferrer" target="_blank">Buiter says</a>, it was "hobbled severely by the non-existence of a fiscal Europe, and specifically by the absence of a fiscal authority, fiscal facility, or fiscal arrangement that can recapitalize it should it suffer losses due to credit risk assumed as part of its monetary, liquidity, or credit-enhancing policies."</p> <p>As for the Fed, although it was not "hobbled" as the ECB had been, it, too, took on risk without the benefit of anything beyond a meager fiscal guarantee or "backup":</p> <blockquote><p>For the Fed's potential $1 trillion exposure to private credit risk through the Term Asset-Backed Securities Loan Facility, for instance, the Treasury only guarantees $100 billion. They call it 10 times leverage. I call it the Fed being potentially in the hole for $900 billion. Similar credit risk exposures have been assumed by the Fed in the commercial paper market, in its purchases of Fannie and Freddie mortgages, in the rescue of AIG, and in a host of other quasi-fiscal rescue operations mounted by the Fed and by the Fed, the Federal Deposit Insurance Corporation, and the US Treasury jointly.</p> </blockquote> <p>Buiter considered "this use of the Federal Reserve as an active (quasi-) fiscal player… extremely dangerous and highly undesirable from the point of view of the health of the democratic system of government in the US." Besides compromising the Fed's independence, he said, it "undermines Congressional and wider public accountability for this vast commitment of public resources." The Fed, he said, "should insist on a full Treasury indemnity for any private sector credit risk it assumes."</p> <h4>No Time Like Now</h4> <p>Though it may be tempting, in the midst of the current crisis, to set Buiter's advice aside as an encumbering nicety, that temptation needs to be vigorously resisted. What, after all, is the point of having a Constitution that assigns to Congress alone the power of the purse, and a Federal Reserve Act designed to keep the Fed from becoming subservient to Congress, if these safeguards are to be swept aside, or simply ignored, on the very occasions when they're most likely to serve a purpose?</p> <p>Nor is it so difficult for Congress to obey the law, by taking responsibility for risky lending or asset-purchase programs that call for the Fed's involvement.<span> </span><a href="https://www.wsj.com/articles/let-the-fed-administer-an-antiviral-shot-11584314083" rel="noopener noreferrer" target="_blank">Kevin Warsh's recent proposal</a><span> </span>for Fed-assisted lending to non-bank businesses and households calls for it to do just that. "The Fed possesses powerful untapped authority," Warsh writes; "and<span> </span><em>with the help of Congress and the administration</em><span> </span>there is much it can do to improve economic prospects":</p> <blockquote><p>In consultation with the Treasury secretary and congressional leaders, the Fed should immediately invoke its emergency powers under Section 13(3) of the Federal Reserve Act and establish a new credit facility to ensure that sound businesses and households have ready access to cash to get through the crisis. …</p> <p>The Fed board of Governors would authorize the program and ensure its accord with Walter Bagehot's dictum: lend freely to solvent firms and individuals on good collateral at interest rates higher than are customary. …Borrowers would need to demonstrate that they are unable to obtain credit elsewhere but are solvent, consistent with the requirements of the Federal Reserve Act.</p> </blockquote> <p>But Warsh's proposal would not expose the Fed itself to any risk:</p> <blockquote><p>Crucially, Congress would also authorize a fiscal backstop to offset any loan losses incurred by the Fed or the banks themselves. These actions would maintain an appropriate line between monetary and fiscal policy.</p> </blockquote> <p>Whether or not the sort of lending Warsh proposes is essential for dealing with the present crisis, Warsh is certainly right to insist that ultimate responsibility for it, and especially for the risks it entails, be taken not by the Fed, but by Congress. It only remains for members of Congress themselves to acknowledge this responsibility, and act accordingly, instead of passing the buck.</p> <p>President Trump can help. If he needs an example to follow, let him consider what FDR told then New York Fed Governor George Harrison following the passage of the 1933 Emergency Banking Act:</p> <blockquote><p>It is inevitable that some losses may be made by the Federal Reserve banks in loans to their member banks. The country appreciates, however, that the 12 regional Federal Reserve Banks are operating entirely under Federal Law and the recent Emergency Bank Act greatly enlarges their powers to adapt their facilities to a national emergency. Therefore, there is definitely an obligation on the federal government to reimburse the 12 regional Federal Reserve Banks for losses which they may make on loans made under these emergency powers. I do not hesitate to assure you that I shall ask the Congress to indemnify any of the 12 Federal Reserve banks for such losses.</p> </blockquote> <p>President Trump can and should do FDR one better by getting Congress on board before he puts the Fed on the hook.</p> <p>[<a href="https://www.alt-m.org/2020/03/18/holding-the-line-maintaining-fiscal-and-monetary-policy-boundaries-in-the-midst-of-a-crisis/">Cross-posted from Alt-M.org</a>]</p> <p></p> Wed, 18 Mar 2020 14:29:53 -0400 George Selgin https://www.cato.org/blog/holding-line-maintaining-fiscal-monetary-policy-boundaries-midst-crisis Robert Murphy on Market Monetarism https://www.cato.org/blog/robert-murphy-market-monetarism George Selgin <p>In <a href="https://mises.org/wire/%E2%80%9Cmarket-monetarists%E2%80%9D-and-ngdp-targeting" rel="noopener noreferrer" target="_blank">the latest installment in his series, "Understanding Money Mechanics,"</a> Bob Murphy takes on Market Monetarism, and <a href="https://www.mercatus.org/system/files/Sumner-NGDP-Targeting-sum-v1.pdf" rel="noopener noreferrer" target="_blank">Scott Sumner's case for having central banks practice NGDP level targeting</a> in particular. A commentator there writes, "I hope George S. pipes up to defend MM! Seeing the other side can helps [sic] me to understand the theory better."</p> <p>Far be it from me to refuse such a request!</p> <p>Murphy devotes much of his post to distinguishing Market Monetarism from both old-time Monetarism and Austrian monetary economics. Much of what I have to say also concerns those distinctions. I hope to persuade readers that Market Monetarism is more consistent with both old-fashioned Monetarism and Austrian economics than Murphy allows, and that, to the extent that it differs from versions of either, it does so in ways that improve upon them.</p> <h4>Velocity: The Elephant in the Room</h4> <p>Murphy's essay begins with a generally accurate summary of the many points of resemblance between Sumner's Market Monetarism and Monetarism of the old-fashioned Milton Friedman sort, from which Sumner draws much of his inspiration. Among other things Murphy notes, correctly, that both Sumner and Friedman reject the naive view that the level of nominal interest rates is a reliable indicator of the stance of monetary policy, with low rates serving as evidence that money is "easy," and high ones suggesting that it's "tight."</p> <p>Murphy's summary falls short, however, when it comes to explaining the difference between Sumner's framework and Friedman's. He recognizes that Sumner's "proposal to use a futures market in NGDP contracts to effectively automate Fed policy" supplies the "Market" aspect of Market Monetarism. And he of course understands that Sumner differs from Friedman in regarding the value of nominal GDP as a better indicator of the stance of monetary policy, and hence as a more fitting object of the Fed's stabilization efforts, than any money-stock measure. But he never considers the <em>rationale</em> for this second, more crucial difference, and his failure to do this vitiates a substantial part of his critique.</p> <p>That rationale couldn't be simpler. It's that <a href="https://en.wikipedia.org/wiki/Velocity_of_money" rel="noopener noreferrer" target="_blank">the <em>velocity</em> of money</a>—the ratio of nominal GDP to the money stock, which is an inverse measure of the intensity of people's desire for "real" (that is, purchasing-power-adjusted) money balances—<a href="https://marketmonetarist.com/2012/03/18/how-unstable-is-velocity/" rel="noopener noreferrer" target="_blank">is unstable</a>. There are times when people want to stock up on real balances, just as there are times when, for reasons good or bad, they want to stock up on toilet paper. And there are others when they'd rather not hold onto money at all, as happens when hyperinflation burns a hole in their pockets.</p> <p>Friedman and other old-fashioned Monetarists long took the predictability of the velocity of money for granted, treating it as a stable function of a relatively small set of variables. But the merit of that procedure <a href="https://www.jstor.org/stable/2724409?seq=1" rel="noopener noreferrer" target="_blank">fell into doubt during the 1970s</a>, and since then velocity has become notoriously unstable. Consider, for example, how the behavior of the M2 velocity has changed since 1960:</p> <p><a href="https://www.alt-m.org/2020/03/16/robert-murphy-on-market-monetarism/velocity/" rel="attachment wp-att-217942"><img alt="" height="246" src="https://cdn.alt-m.org/wp-content/uploads/2020/03/Velocity.png" width="611" /></a></p> <p>The story for M1 velocity is similar: although it was never constant, until the early 80s it seemed to grow at a modest, steady rate. But since then, its movements resemble those of a roller coaster:</p> <p><a href="https://www.alt-m.org/2020/03/16/robert-murphy-on-market-monetarism/velocitym1/" rel="attachment wp-att-217944"><img alt="" height="244" src="https://cdn.alt-m.org/wp-content/uploads/2020/03/VelocityM1.png" width="606" /></a></p> <p>So long as the velocity of money was itself stable, it made sense to suppose that some correspondingly stable money stock growth pattern would prevent monetary policy from becoming either too easy or too tight, and to regard any substantial deviation from the same pattern as evidence of over-tightening or its opposite. But when, by the 1980s, velocity had ceased to be stable, this was no longer so. From then on, whether changes in the level or growth rate of some money measure signified over- or under-tightening depended on whether they compensated for an opposite velocity change. In terms of the famous equation of exchange, MV = Py, what mattered wasn't whether M grew at a modest and steady rate, but whether MV or, equivalently, Py, did so. Nominal GDP is, of course, a popular measure of Py. <em>Nominal GDP targeting can thus be understood as nothing more than a velocity-compensated version of Friedman's famous money growth rate rule.</em></p> <h4>Money Growth Measures Mislead</h4> <p>That the velocity of money ceased being stable has for some decades now been recognized by most self-described Monetarists, who stopped recommending constant money growth rate rules for that reason. Prominent early examples included <a href="https://www.jstor.org/stable/1816390?seq=1" rel="noopener noreferrer" target="_blank">Ben McCallum</a> and John Taylor. So it's only natural that Sumner and other "Market Monetarists" today would no longer treat the behavior of any money-stock measure as a guide to the stance of monetary policy. Nor of course would most non-Monetarists wish to treat it so.</p> <p>Still, there are exceptions; and Murphy is one of them.<a href="#_ftn1" name="_ftnref1" rel="noopener noreferrer" target="_blank" id="_ftnref1">[1]</a> He writes as if it were still 1960, and as if the pace of money growth alone could be treated, as old-fashioned Monetarists once treated it, as a sufficient indicator of the tightness or looseness of monetary policy. Remarkably, the word "velocity" never even comes up in his essay.</p> <p>Thus, of four "problems" Murphy has with Market Monetarism, the first consists of its alleged failure to recognize that "Monetary Growth Accelerated after the 2008 Crisis." According to Murphy, that growth proves that Sumner and other Market Monetarists are wrong to think that money was tight during the recession and subsequent, slow recovery.</p> <p>But as we've seen, Murphy's claim makes sense only assuming that the velocity of money hasn't decelerated enough to offset, or more than offset, the more rapid money growth he documents. And that assumption is clearly wrong, for otherwise the level and growth rate of nominal GDP themselves would not have declined! In short, Murphy faults Market Monetarists for failing to treat a stable money growth rate as the key to sound monetary policy, when the whole point of Market Monetarism is to improve upon that long outmoded perspective!</p> <p>It gets worse. For Murphy also treats the rapid post-October 2008 growth of the monetary base as <em>ipso</em> <em>facto</em> evidence of easy monetary policy. That he does so makes one wonder, not only whether he appreciates the need to account for velocity changes, but whether he's aware of the important changes to the Fed's operating procedures that anticipated its resort to quantitative easing. In particular, he seems to overlook how, in October 2008, the Fed began paying interest on bank reserves with the deliberate aim of encouraging banks to hoard newly-created reserves that came their way, thereby severing the traditional link between base money growth and growth in broader money measures. Just how well this strategy worked isn't evident from Murphy's charts. I trust this one will make it so:</p> <p><a href="https://www.alt-m.org/2020/03/16/robert-murphy-on-market-monetarism/bsaeandm2/" rel="attachment wp-att-217947"><img alt="" height="248" src="https://cdn.alt-m.org/wp-content/uploads/2020/03/BsaeandM2.png" width="616" /></a></p> <p>Despite the change just described, both the M2 and the M1 money stock did grow somewhat more rapidly after 2008 than they had beforehand. But owing to a concurrent decline in velocity, the increase fell short of what was needed to avoid lackluster growth of total spending on final goods, let alone make up for an initial, absolute spending drop. Here's the relevant chart from M1. (The one for M2 tells the same story.)</p> <p><a href="https://www.alt-m.org/2020/03/16/robert-murphy-on-market-monetarism/m1andvelocity/" rel="attachment wp-att-217949"><img alt="" height="236" src="https://cdn.alt-m.org/wp-content/uploads/2020/03/M1andVelocity.png" width="586" /></a></p> <h4>Monetary Quackery</h4> <p>Murphy's second complaint about Market Monetarism is that its NGDP criterion for judging the stance of monetary policy is "vacuous and (almost) non-falsifiable." "Sumner argues that <em>by definition</em>," he says, the 2008-9 decline in NGDP represented "a 'tight' central bank policy." "The fundamental problem with this definition," he adds, "is that it assumes Sumner's conclusion."</p> <p>I confess that I can't make much sense out of Murphy's complaint. Yes, Sumner and other Market Monetarists regard the behavior of NGDP as a reliable indicator of the stance of monetary policy. Accordingly, when that value falls significantly below trend, they conclude that monetary policy is too tight; and when it rises above the same trend, they consider it too easy. It's also true that, were there nothing more to Market Monetarism, it would indeed be "vacuous." But that's hardly the case: Market Monetarists' treatment of NGDP as a reliable indicator of the stance of monetary policy isn't a mere article of faith, as Murphy suggests. It's a position they've arrived at on the basis of a substantial body of theory and evidence.</p> <p>Much of that theory and evidence can be found in works by Market Monetarists themselves, including several by Sumner and <a href="https://www.mercatus.org/system/files/beckworth-ngdp-targeting-mercatus-special-study-v1.pdf" rel="noopener noreferrer" target="_blank">David Beckworth</a> that Murphy himself refers to. More can be found in various other works, <a href="https://www.alt-m.org/2018/06/19/some-serious-theoretical-writings-that-favor-ngdp-targeting/" rel="noopener noreferrer" target="_blank">including several I surveyed here not long ago</a>. Being myself a Market Monetarist fellow traveler, and even a pioneer of sorts, I've contributed to its foundations myself, especially in my book <a href="https://www.amazon.com/Less-Than-Zero-Falling-Growing/dp/1948647109" rel="noopener noreferrer" target="_blank"><em>Less than Zero</em></a>, which argues for a particular stable-NGDP norm that would typically allow for modest, secular deflation.</p> <p>In light of all these writings, it's absurd for Murphy to portray Sumner's case for treating NGDP as an indicator of the stance of monetary policy as a mere case of circular reasoning. Still, he tries, not by seriously considering the arguments and evidence to be found in the aforementioned writings, but by means of the following "medical analogy":</p> <blockquote><p>Suppose a patient is suffering from fever, running a temperature of 103 degrees. One group of doctors recommends injecting the patient with substance M, in order to cure the fever. Yet another group of doctors argues that <em>past </em>injections of substance M are what made the patient sick in the first place.</p> <p>Now, if they are to have any hope of resolving this dispute, how should the doctors <em>measure </em>the amount of substance M being injected into the patient? Most people would argue that the doctors should look at absolute physical measurements, involving the volume and/or rate of injection. And so, for example, if they injected the patient with more M than had ever been administered to any patient in the history of that hospital, it would be odd if the patient's chart read, "Received a very restrictive treatment of M."</p> <p>Indeed, imagine if the doctors who think that substance M is a helpful medicine wanted to <em>define </em>the M treatment in terms of the fever. That is, if after they had injected the patient with unprecedented amounts of M, whether the fever stayed the same or went up, the doctors were to declare, "We just made the patient sicker with our shift to restrict the M treatment." This would be Orwellian and obviously would make it virtually impossible to figure out whether more or less M was what the patient needed.</p> </blockquote> <p>Analogies are necessarily imperfect. But some are worse than that; and this one is just plain foolish, for all sorts of reasons.</p> <p>The issue, first of all, is not how to define "M." Market Monetarists define it the same way, or ways, as other economists do. They deny, however, that a fixed M regimen is always the right treatment for every possible condition. Some conditions call for more M, while others call for less.</p> <p>To understand the Modern Monetarist perspective, consider a slightly different—but I dare say less labored—version of Murphy's analogy. A doctor specializing in diabetes treats every patient who comes to his clinic with a fever to the same regimen of 100 units of insulin per day, without considering other symptoms or test results. Such a doctor would surely count as a quack, for not every patient with a fever (which can be a symptom of either hyper- or hypoglycemia, or of any number of other things) requires such a treatment: on the contrary, a hypoglycemic might well die from it. A responsible doctor, in contrast, would first determine a patient's blood sugar level, and would only then decide how much insulin to give him, assuming he needs any. In this analogy, insulin is like money, a 100-unit regimen is like Friedman's naive k-percent money growth rule, and a patient's blood sugar level is like an economy's NGDP level: it depends both on preexisting insulin input and the patient's particular insulin needs.</p> <p>We thus return yet again to the subject of velocity. Like a naive Monetarist, our quack assumes that it's constant. And Murphy sides unabashedly with the quack.</p> <h4>Austrian and Monetarist Busts</h4> <p>If the assumption that an economy always requires the same dose of monetary medicine is dangerously naive, the view that <em>any </em>dose of monetary medicine is harmful is downright puerile.</p> <p>Yet that view is implicit in Murphy's final criticism of Sumner, which is that his recommended solution to a collapse of NGDP, namely, a Fed-engineered boost to money growth, would "simply perpetuate the boom-bust cycle."</p> <p>Although I stopped calling myself an Austrian economist long ago, I'm pretty familiar with the Austrian business cycle theory to which Murphy's complaint alludes. What's more, I agree that it can help explain the boom-bust cycle of the last half of the 2000s. Still, I reject Murphy's suggestion that a central bank following Sumner's advice would be bound to trigger an Austrian-type cycle.</p> <p>Why wouldn't it? According to the Austrian theory, excessive money growth distorts relative prices, in part by leading to artificially low-interest rates, and this gives rise to booms. But the theory also holds that relative prices, and the rate of interest in particular, are bound to eventually return to their undistorted or "natural" levels, and that as they do, booms give way to busts. In other words, once the bust begins, the economy starts with a clean slate, so far as the efficient working of its price system is concerned: there's absolutely no need for any contraction of either the money stock or total spending (money times velocity), or for deflation, to restore relative prices to their proper levels. The opposite view—that a bout of deflation somehow helps the economy to rid itself of prior malinvestment—was quite properly scorned by von Mises as akin to the view that one might make up for running over a neighbor's cat by backing over it as well.</p> <p>So what money growth rate—what dose of "money medicine"—does the economy require going forward? I agree with Murphy that the last thing the economy needs is another boom-generating dose. But monetary expansion is warranted so long as it only serves to maintain a stable and modest level of spending. Because it's common for money's velocity to decline, even drastically, during busts, that needed dose might be substantial.</p> <h4>Avoiding a Depression Double-Whammy</h4> <p>Monetarists, "Market" ones included, tend to downplay the importance of Austrian-style boom-bust cycles, while some Austrians dismiss the Monetarist theory that busts are caused by money shortages. This is a shame, because it often takes both theories, and then some, to explain any actual cycle. I'm pretty sure that's so for both the 1927-33 and the 2005-10 cycles. In each of these episodes, a period of overly-loose money was followed by one in which money was too tight, adding the insult of deflation to the injury of malinvestment.</p> <p>When I used to teach undergraduates about the Great Depression, I made this point using yet another (semi) medical analogy, after having first covered both the Austrian and the Monetarist explanations.</p> <blockquote><p>Suppose that a man has the bad habit of coming home very late, and badly hungover, every Friday night. His wife has had to put up with this for years. One Friday, he stumbles through their apartment door, and immediately starts to throw up. His wife has had enough: she wallops him with a frying pan. A neighbor, hearing the ruckus, runs in from across the hall, to find the man lying unconscious, in a pool of his own vomit. "What happened!?," she asks.</p> </blockquote> <p>Must the answer be either "he's hungover" or "he's been hit by a frying pan"? Can't it be both?</p> <p>Yes, it can. And the correct answer to the question, "What caused the Great Depression?," I said to my students, is "both monetary excess in the late 20s, and a severe monetary shortage in the early 30s.</p> <p>The correct answer to the question, what was ailing the economy in late 2008 and 2009, is likewise that it was suffering from both the after-effects of easy monetary policy between 2004 and 2007 and a money shortage afterward.</p> <h4>Hair of the Dog?</h4> <p>Murphy, however, argues that even monetary expansion aimed at preventing a collapse in NGDP is harmful, because it distorts relative prices, inviting another boom-bust cycle:</p> <blockquote><p>if the Austrians are correct, then if the Fed reacts to a downturn (which normally would go hand-in-hand with a fall in NGDP growth) with monetary expansion, then, besides the impact on aggregate nominal variables, this action will also distort <em>relative </em>prices. In particular, short-term interest rates will typically be pushed below their "natural" levels, giving the wrong signal to entrepreneurs and setting in motion another unsustainable boom.</p> </blockquote> <p>This claim has now become commonplace among certain Austrians. Yet far from being sound, it shows a very poor understanding of basic monetary theory.</p> <p>Suppose, for example, that I want to increase my money holdings. To do so, I just have to spend less on goods and on non-money assets. Then, provided the monetary system is working properly, my nominal money holdings can accumulate.</p> <p>The rub is that, for any <em>given</em> stock of money, I can only increase my money holdings if others reduce theirs by the same amount. It follows that, if the overall demand for money goes up, <em>either </em>prices have to fall to make every unit of money worth more, so that we all can once again rest content with what we've got, <em>or </em>the total stock of money must increase. In the second case, the Fed generally has to help, either by supplying more currency and bank reserves, or by otherwise lowering interest rates to encourage more commercial bank lending and borrowing. Of course, the new money thus created doesn't itself go to those who wish to increase their money holdings. But it doesn't have to: the mere fact that it is created at all allows those persons to collectively gather to themselves the extra money they want, as they wouldn't be able to do otherwise. Nor is there anything perverse about this. On the contrary: it's just what one would wish to see in any system in which money consists of claims on financial intermediaries. Those who accumulate such claims—like me if I let my bank deposit grow—supply that many more savings to the banks that issue them; and in an ideal system those banks will in turn generate more claims. The Fed's job is to see to it that this ideal is achieved, at least approximately.</p> <p>It follows that some monetary expansion and the lowering of interest rates that may accompany it needn't imply any "artificial" lowering of rates. Instead, it can reflect a genuine increase in savings. This doesn't mean that interest rates always need to decline when the demand for money goes up, for people might choose to hold more money, not as an alternative to spending it on final goods and services, but as an alternative to other sorts of saving. Either way, monetary expansion isn't like a "hair of the dog" remedy for a hangover. It's more like making sure that the hangover isn't compounded by dehydration. Money may resemble alcohol in being able to spur reckless behavior that eventually results in a painful reckoning, but it also resembles water in being absolutely essential to an economy's health.</p> <p>There is, by the way, nothing particularly un-Austrian about the arguments I've just made. Similar ones can be found in Hayek's writings of the mid-1930s, and especially in his 1933 essay on "Saving," reprinted as <a href="https://mises-media.s3.amazonaws.com/Profits%2C%20Interest%2C%20and%20Investment_5.pdf" rel="noopener noreferrer" target="_blank">chapter five of <em>Profits, Interest and Investment</em></a>. They occur as well in <a href="https://cdn.mises.org/Stock%20Market,%20Credit,%20and%20Capital%20Formation_4.pdf" rel="noopener noreferrer" target="_blank">chapter twelve of Fritz Machlup's 1940 work, <em>The Stock Market, Credit, and Capital Formation</em></a>. The same ideas take up a large chunk of <a href="https://oll.libertyfund.org/titles/selgin-the-theory-of-free-banking-money-supply-under-competitive-note-issue" rel="noopener noreferrer" target="_blank">chapter four of <em>The Theory of Free Banking</em></a>, which I wrote while I was still a very Austrian grad student, and a similarly large chunk of <a href="https://www.amazon.com/Microfoundations-Macroeconomics-Perspective-Routledge-Foundations-ebook/dp/B000FBFIGK" rel="noopener noreferrer" target="_blank">Steve Horwitz's <em>Microfoundations of Macroeconomics</em></a>.</p> <p>The case of von Mises is more complicated. While certain passages of his appear to treat any growth in the quantity of "fiduciary" money as harmful, others suggest on the contrary that such growth can help to keep relative prices where they belong. Thus he observes, in <em>The Theory of Money and Credit</em>, that insofar as banks "increase and decrease their circulation <em>pari passu</em> with the variations in the demand for money… they make an essential contribution to stabilizing the inner objective exchange value of money." <a href="https://mises.org/library/value-money-0" rel="noopener noreferrer" target="_blank">As Jörg Guido Hülsmann explains</a>, Mises regards "a stable inner objective exchange value of money" as a monetary policy ideal, albeit one that's unobtainable in practice.</p> <h4>1920 and 2020</h4> <p>In fact, Murray Rothbard and those who cleave to his teachings, including Murphy, are the only Austrians—if not the only economists of <em>any</em> school—who deny that monetary expansion can be beneficial even when it matches corresponding growth in the demand for real money balances. Their dissidence has several roots, one of which is their belief that, instead of being rigid or "sticky," prices are perfectly capable of quickly adjusting downward in response to such shortages. If prices respond quickly enough, people can always have all the real money balances they want, without delay, even if the money stock never grows.</p> <p>Bob Murphy is nothing if not forthright when it comes to pleading this Rothbardian case, as he does in his essay's closing paragraph. "The entire 'sticky prices' boogeyman," he says,</p> <blockquote><p>is a red herring. During the 1920–21 depression, consumer prices collapsed more rapidly than in any twelve-month stretch during the Great Depression. <a class="see-footnote" id="footnoteref12_s2wuugd"></a>Yet the 1920s were not a decade of economic stagnation. Blaming the worst economic crises in US history on "deflation" and "sticky prices" doesn't fit the facts.</p> </blockquote> <p>Let's set aside the burning question of whether a herring of any color can qualify as a boogeyman. Instead, let's just ask whether the 1920-21 episode really shows what Murphy thinks it shows, namely, that prices aren't really sticky, so that there's never anything to be gained from an expanding money stock.</p> <p>The answer is that it shows no such thing. First of all, although prices fell relatively quickly during the 1920-21 recession, it was a recession nonetheless, and a serious one. It lasted a year and a half, which was longer than most post-WWI recessions, and it involved a substantial decline (6.9 percent) in output—the largest between the Panic of 1873 and the Great Depression. Unemployment rose sharply, to somewhere between 8.7 and 11.7 percent, depending on which statistics one consults, to roughly twice its level for the remainder of the decade. Although it's true that the relatively rapid decline in prices prevented a still longer recession, it's also obvious that they weren't flexible enough to prevent a serious, albeit temporary, shortage of money with its inevitable counterpart: a glut of goods and labor.</p> <p>Although the U.S. was on a gold standard when it entered the World War, a gold export embargo soon put that standard in abeyance, allowing both the U.S. money stock and U.S. prices to rise substantially. After the war, as the U.S. and other belligerent nations resumed gold payments, it was understood that prices would have to come down again. This supplies another reason for doubting the general relevance of the 1920-21 episode, for actual prices are more likely to keep up with their equilibrium counterparts, when equilibrium price changes, instead of coming as a surprise, are expected. The rapid downward adjustment of prices in 1920-21 was in this respect at least atypical, for in other episodes, including both the Great Depression and the slump that began in 2007, no one had been anticipating a major decline in prices or the rate of inflation.</p> <p>Finally, although it should go without saying, things have changed since 1921, including the extent of price and wage stickiness. Indeed, they'd already changed substantially by the end of the 1930s—an era that witnessed numerous initiatives aimed at discouraging or prohibiting downward changes to prices and wage rates. These initiatives began with Hoover's "high wages" campaign, by which he sought to convince businessmen to stick to paying high wage rates <a href="https://link.springer.com/article/10.1007/s12122-999-0014-1" rel="noopener noreferrer" target="_blank">on the dubious grounds that doing so would allow workers to spend more</a>. They continued with the various price- and wage-control programs of FDR's first New Deal, and also with the 1935 Wagner Act. Finally, they culminated, in 1938, in the nation's first minimum wage law.<a href="#_ftn2" name="_ftnref2" rel="noopener noreferrer" target="_blank" id="_ftnref2">[2]</a></p> <p>As those last two measures mentioned illustrate, some of those depression-era measures remain in place to this day; and as <a href="https://pdfs.semanticscholar.org/50fb/79207493a90f034363cb8ff9d2fa63a5bd3f.pdf" rel="noopener noreferrer" target="_blank">a vast empirical literature suggests</a>, they together with a host of other factors—whether legislative, contractual, or psychological—continue to limit the extent of downward nominal price and (especially) wage adjustment that occur in response to spending downturns in modern economies.</p> <p>Murphy has himself written eloquently of <a href="https://www.econlib.org/library/Columns/y2015/Murphydisemployment.html" rel="noopener noreferrer" target="_blank">the destructive effects of minimum wage <em>increases</em></a>; and he presumably understands that the same lawmakers responsible for such increases have never so much as considered reducing the minimum wage in response to an economic downturn. In light of this, and of the aforementioned empirical evidence, can he really be capable of such a stroke of cognitive dissonance as would allow him seriously to maintain that wage rates and prices are perfectly flexible?</p> <p>Alas, I suspect he can. But that's no reason why anyone else should.</p> <p>_________________</p> <p><a href="#_ftnref1" name="_ftn1" id="_ftn1">[1]</a> So, back in 2008, were <a href="https://www.cato.org/publications/briefing-paper/greenspans-monetary-policy-retrospect" rel="noopener noreferrer" target="_blank">David Henderson and Jeff Hummel</a>, whose outdated Monetarist metrics <a href="https://mises.org/library/guilty-charged" rel="noopener noreferrer" target="_blank">I criticized</a> at the time. Using it they concluded that Greenspan's Fed contributed little if anything to that era's housing boom. I can't help wondering now what Bob Murphy thinks of this old exchange!</p> <p><a href="#_ftnref2" name="_ftn2" id="_ftn2">[2]</a> These depression-era impediments to downward price and wage adjustments are nowhere better described than in the historical chapters of Rothbard's <a href="https://cdn.mises.org/Americas%20Great%20Depression_3.pdf" rel="noopener noreferrer" target="_blank"><em>America's Great Depression</em></a>. That makes it particularly perplexing that, in its opening chapters, the same work treats concerns about downward wage rigidity as a question-begging obsession of "Keynesian" economics, dismissing them—and arguments for preserving a stable level of overall spending on final goods—accordingly. "The Keynesian linkage of total employment with total monetary demand for products," Rothbard writes, "implicitly assumes rigid wage rates downward; it therefore cannot be used to criticize the policy of freely-falling wage rates." "Policy"? The question isn't whether it would be best if wages fell as needed. It's whether they can fall that far in fact. Generally speaking, they can't.</p> <p>[<a href="https://www.alt-m.org/2020/03/16/robert-murphy-on-market-monetarism/">Cross-posted from Alt-M.org</a>]</p> <p></p> Mon, 16 Mar 2020 13:04:30 -0400 George Selgin https://www.cato.org/blog/robert-murphy-market-monetarism Lawrence H. White discusses whether the US needs a national digital currency on the Monero Talk podcast https://www.cato.org/multimedia/media-highlights-tv/lawrence-h-white-discusses-whether-us-needs-national-digital Sat, 14 Mar 2020 15:09:25 -0400 Lawrence H. White https://www.cato.org/multimedia/media-highlights-tv/lawrence-h-white-discusses-whether-us-needs-national-digital Solvency, Liquidity, and Help for the Cash‐​Strapped During Pandemic https://www.cato.org/multimedia/cato-daily-podcast/solvency-liquidity-help-cash-strapped-during-pandemic Diego Zuluaga, Caleb O. Brown <p>Banks will no longer face certain regulatory scrutiny for helping cash‐​strapped people during this pandemic. Diego Zuluaga comments.</p> Sat, 14 Mar 2020 09:08:58 -0400 Diego Zuluaga, Caleb O. Brown https://www.cato.org/multimedia/cato-daily-podcast/solvency-liquidity-help-cash-strapped-during-pandemic Steve H. Hanke discusses his WSJ article, “How the Federal Reserve Can Ease the Coronavirus Panic,” on CNBC’s Squawk on the Street https://www.cato.org/multimedia/media-highlights-tv/steve-h-hanke-discusses-wsj-article-how-federal-reserve-can-ease Thu, 12 Mar 2020 14:58:24 -0400 Steve H. Hanke https://www.cato.org/multimedia/media-highlights-tv/steve-h-hanke-discusses-wsj-article-how-federal-reserve-can-ease Government Control of Fannie and Freddie in Historical Perspective https://www.cato.org/regulation/spring-2020/government-control-fannie-freddie-historical-perspective Wed, 11 Mar 2020 03:00:00 -0400 Vern McKinley https://www.cato.org/regulation/spring-2020/government-control-fannie-freddie-historical-perspective George Selgin discusses the stock market under the Trump administration on CBS WUSA 9 News at 11 PM https://www.cato.org/multimedia/media-highlights-tv/george-selgin-discusses-stock-market-under-trump-administration-cbs Tue, 10 Mar 2020 11:18:09 -0400 George Selgin https://www.cato.org/multimedia/media-highlights-tv/george-selgin-discusses-stock-market-under-trump-administration-cbs The Classical Gold Standard Can Inform Monetary Policy https://www.cato.org/blog/classical-gold-standard-can-inform-monetary-policy James A. Dorn <p>Watching the frenzy surrounding Judy Shelton's<span> </span><a href="https://www.banking.senate.gov/hearings/02/03/2020/nomination-hearing" rel="noopener noreferrer" target="_blank">confirmation hearing</a><span> </span>before the Senate Banking Committee on February 13, one is led to believe that the gold standard is a "nutty" idea, for which no serious economist or monetary policymaker could possibly have a kind word. This post critiques that wholesale refutation of the gold standard. In recent years (as well as in the past), both serious economists and reputable monetary policymakers have recognized the benefits of a gold standard in reducing regime uncertainty and promoting monetary and social order. Whatever one may think of President Trump's recent Fed picks, the gold standard itself deserves more respect than it's been getting.</p> <h4><strong>Misguided Criticisms</strong></h4> <p>All serious persons agree that stable money of some sort is crucially important to social order. But journalists and others commenting on Judy Shelton's views took for granted that a gold standard could not be consistent with such stability.<span> </span><a href="https://www.washingtonpost.com/opinions/yes-trumps-latest-fed-pick-is-that-bad-heres-why/2020/02/10/a13fa1ec-4c44-11ea-9b5c-eac5b16dafaa_story.html" rel="noopener noreferrer" target="_blank">Catherine Rampell</a>, a respected journalist with<span> </span><em>The Washington Post</em>, wrote that "pegging the dollar to gold could restrict liquidity just when the economy needs it most, as happened during the Great Depression," while<span> </span><a href="https://prospect.org/blogs/tap/trumps-latest-crackpot-judy-shelton-federal-reserve/" rel="noopener noreferrer" target="_blank">Robert Kuttner</a>, another widely read journalist, opined:</p> <blockquote><p>As we painfully learned from economic history, a gold standard is profoundly deflationary, because it prevents necessary expansion of the money supply in line with economic growth. No serious person advocates it. …[I]f you want lower interest rates, the last thing you want is a gold standard.</p> </blockquote> <p>In considering these claims, one must first of all distinguish between the "classical" gold standard, which functioned from the 1870s until World War I, and the interwar "gold exchange standard." While some highly respected authorities have good things to say about the classical gold standard, the interwar gold exchange standard has been universally condemned. And it was the breakdown of that interwar standard, which depended much more heavily on cooperation among various central banks than its pre-1914 counterpart, that contributed to the Great Depression.<a href="#_ftn1" name="_ftnref1" rel="noopener noreferrer" target="_blank" id="_ftnref1">[1]</a><span> </span>George<span> </span><a href="https://www.cato.org/sites/cato.org/files/pubs/pdf/pa729_web.pdf" rel="noopener noreferrer" target="_blank">Selgin</a>, Doug<span> </span><a href="https://www.nber.org/papers/w16350.pdf" rel="noopener noreferrer" target="_blank">Irwin</a>, Barry<span> </span><a href="https://www.nber.org/papers/w2198.pdf" rel="noopener noreferrer" target="_blank">Eichengreen</a>, Michael<span> </span><a href="https://files.stlouisfed.org/files/htdocs/publications/review/81/05/Classical_May1981.pdf" rel="noopener noreferrer" target="_blank">Bordo</a> , and Milton<span> </span><a href="https://www.journals.uchicago.edu/doi/abs/10.1086/466571?journalCode=jle" rel="noopener noreferrer" target="_blank">Friedman</a> elaborate on this argument.</p> <p>Furthermore, not even the generally defective gold exchange standard can be blamed for having restricted liquidity in the United States' case. So far as the U.S. was concerned, as Friedman states,</p> <blockquote><p>It was certainly not adherence to any kind of gold standard that caused the [Great Depression]. If anything, it was the lack of adherence that did. Had either we or France adhered to the gold standard, the money supply in the United States, France, and other countries on the gold standard would have increased substantially.</p> </blockquote> <p>Even a constitutional political economist like James<span> </span><a href="https://www.aier.org/research/prospects-for-a-monetary-constitution/" rel="noopener noreferrer" target="_blank">Buchanan</a> can point to the gold standard and see both its benefits and flaws. He writes: "I am not necessarily anti-gold standard. I think gold would be far better than what we have. But I think there might be better regimes."</p> <p>The gold standard is not a panacea. It is only one of many monetary arrangements that might succeed in checking arbitrary government. There are others. And all of them are imperfect. Because no arrangement is ideal, we must choose among realizable, imperfect alternatives—there are always tradeoffs. But it is also important to take a principled approach to thinking about monetary reform and not to simply accept the status quo.</p> <p>That the "gold standard"—or, more accurately, the interwar "gold exchange standard"—contributed to the Great Depression, understood as a<span> </span><em>worldwide</em><span> </span>depression, is something most economic historians accept. Yet the belief that the<span> </span><em>pre-1914 gold</em><span> </span><em>standard</em><span> </span>was responsible for the U.S. economic collapse of the early 1930s is a myth. It was the Federal Reserve's policy mistakes, rather than its commitment to the gold standard, that was the major cause of the Great Depression. That, at least, is what Milton Friedman and Anna J. Schwartz claim in their landmark book,<span> </span><a href="https://www.amazon.com/Monetary-History-United-States-1867-1960/dp/0691003548" rel="noopener noreferrer" target="_blank"><em>A Monetary History of the United States</em>.</a></p> <p>The United States entered the 1930s with massive excess gold reserves. The Fed was not constrained in using those reserves to expand base money, and thus the broader money supply. As Richard<span> </span><a href="https://www.cato.org/sites/cato.org/files/serials/files/cato-journal/2008/5/cj28n2-13.pdf" rel="noopener noreferrer" target="_blank">Timberlake</a><span> </span>wrote in 2008:</p> <blockquote><p>By August 1931, Fed gold had reached $3.5 billion (from $3.1 billion in 1929), an amount that was 81 percent of outstanding Fed monetary obligations and more than double the reserves required by the Federal Reserve Act. Even in March 1933 at the nadir of the monetary contraction, Federal Reserve Banks had more than $1 billion of excess gold reserves. …Whether Fed Banks had excess gold reserves or not, all of the Fed Banks' gold holdings were expendable in a crisis. The Federal Reserve Board had statutory authority to suspend all gold reserve requirements for Fed Banks for an indefinite period.</p> </blockquote> <p>More recently, both<span> </span><a href="https://www.amazon.com/Gold-Real-Bills-Doctrine-Fed/dp/1948647559" rel="noopener noreferrer" target="_blank">Timberlake and Thomas Humphrey</a>, in their path-breaking book—<em>Gold, The Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922–1938</em>—identified the real culprit responsible for the Fed's misconduct. Instead of adhering to the rules of the gold standard, Fed officials managed the Fed's policies according to a fallacious theory known as the "Real Bills Doctrine." That doctrine holds that the money supply can be regulated by making only short-term loans based on the output of goods and services. The problem is that adhering to that doctrine would link the nominal value of the money stock to the nominal expected value of real bills, and there would be no anchor for the price level. Lloyd Mints had it right when he argued: "whereas convertibility into a given physical amount of specie [gold or silver]… will limit the quantity of notes… the basing of notes on a given money's worth of any form of wealth… presents the possibility of unlimited expansion of loans."</p> <p>Setting up straw men, misreading economic history, and using ad hominem arguments are no way to conduct a hearing or improve monetary policy. Richard<span> </span><a href="https://www.independent.org/pdf/tir/tir_11_03_01_timberlake.pdf" rel="noopener noreferrer" target="_blank">Timberlake</a><span> </span>is correct in noting that unless policymakers understand the real causes of the Great Depression—namely, the failure of Fed policy to maintain a steady path for nominal GDP and the failure of the Real Bills Doctrine to guide monetary policy in an era that did not have a real gold standard—then they "are forever in danger of repeating past mistakes or inventing new ones."</p> <p>It is true that, during the classical gold standard, mild deflation did occur, but it was generated by robust economic growth and was beneficial, in contrast to the severe deflation that occurred during the Great Depression due to Fed mismanagement of the money supply.</p> <p>In their meticulous study of the link between deflation and depression for 17 countries over more than a century,<span> </span><a href="https://pubs.aeaweb.org/doi/pdfplus/10.1257/0002828041301588" rel="noopener noreferrer" target="_blank">Andrew Atkenson and Patrick J. Kehoe</a><span> </span>find:</p> <blockquote><p>The only episode in which there is evidence of a link between deflation and depression is the Great Depression (1929–1934). We find virtually no evidence of such a link in any other period. …[M]ost of the episodes in the data set that have deflation and no depression occurred under a gold standard.</p> </blockquote> <p>Moreover, under a commodity standard, long-run price stability allowed the British government to issue bonds without a maturity date, called<span> </span><a href="https://en.wikipedia.org/wiki/Consol_(bond)" rel="noopener noreferrer" target="_blank">"consols."</a><span> </span>Interest rates on those securities were relatively low and actually fell, going from 3 percent in 1757 to 2.75 percent in 1888, and 2.5 percent in 1903. The United States issued consols during the classical gold standard, in the 1870s.</p> <h4><strong>The Importance of Thinking about Monetary Alternatives</strong></h4> <p>There are many alternative monetary regimes, ranging from a pure commodity standard to a pure fiat money system. Serious debate over those alternatives is a worthwhile project, which Cato has been involved with for decades (e.g., see<span> </span><a href="https://www.amazon.com/Search-Stable-Money-Essays-Monetary/dp/0226158292" rel="noopener noreferrer" target="_blank"><em>The Search for Stable Money</em></a><span> </span>and<span> </span><a href="https://www.amazon.com/Monetary-Alternatives-Rethinking-Government-Money/dp/194442444X" rel="noopener noreferrer" target="_blank"><em>Monetary Alternatives: Rethinking Government Fiat Money</em></a>).</p> <p>The importance of studying the properties of alternative monetary regimes and their consequences for safeguarding an essential property right—namely, the promise of a monetary unit that maintains a stable purchasing power in both the short- and long-run—cannot be understated. Indeed, we should not forget that Article 1, Section 8, of the U.S. Constitution grants Congress "the power …to coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures." That power was given to Congress, not to inflate the money supply, but to safeguard its value under a rule of law. Consequently, sympathy for gold can begin with a strict reading of that constitutional clause, the language of which clearly presupposes a commodity (gold or silver) standard. As<span> </span><a href="https://www.cato.org/sites/cato.org/files/serials/files/cato-journal/2014/9/cj34n3-10.pdf" rel="noopener noreferrer" target="_blank">Milton Friedman</a><span> </span>himself told members of Congress, "As I read the original Constitution, it intended to limit Congress to a commodity standard."</p> <p>The "chief architect" of the Constitution, James Madison, was clear that his preference was for a commodity standard, not for a fiat money standard:</p> <blockquote><p>The only adequate guarantee for the uniform and stable value of a paper currency is its convertibility into specie—the least fluctuating and the only universal currency. I am sensible that a value equal to that of specie may be given to paper or any other medium, by making a limited amount necessary for necessary purposes; but what is to ensure the inflexible adherence of the Legislative Ensurers to their own principles and purposes?</p> </blockquote> <p>Maybe such a concern is quaint, but it's hardly nutty. In fact, it's backed by a considerable base of knowledge on the history of money and monetary arrangements. (<a href="https://www.cato.org/sites/cato.org/files/pubs/pdf/bp100.pdf" rel="noopener noreferrer" target="_blank">Lawrence H. White</a><span> </span>provides an admirable bibliography.)</p> <p><a href="https://www.sciencedirect.com/science/article/abs/pii/S0014498385710194" rel="noopener noreferrer" target="_blank">Michael Bordo and Finn Kydland</a><span> </span>highlight the gold standard's ability to solve the time-inconsistency problem: "When an emergency occurred, the abandonment of the [gold] standard would be viewed by all to be a temporary event since, from their [the public's] experience, only gold or gold-backed claims truly served as money."</p> <p><a href="https://www.minneapolisfed.org/research/qr/qr2222.pdf" rel="noopener noreferrer" target="_blank">Arthur J. Rolnick and Warren E. Weber</a>, in their classic study "Money, Inflation, and Output under Fiat and Commodity Standards," find that, "under fiat standards, rates of money growth, inflation, and output growth are all higher than they are under commodity standards." And Nobel Laureate economist James<span> </span><a href="https://www.aier.org/research/prospects-for-a-monetary-constitution/" rel="noopener noreferrer" target="_blank">Buchanan</a>, who favored a rules-based approach to monetary policy, argues:</p> <blockquote><p>The dollar has absolutely no basis in any commodity base, no convertibility. What we have now is a monetary authority [the Fed] that essentially has a monopoly on the issue of fiat money, with no guidelines that amount to anything; an authority that never would have been legislatively approved, that never would have been constitutionally approved, on any kind of rational calculus.</p> </blockquote> <p>The constitutional political economist is interested in thinking about how to shape institutions to limit the power of government and allow free individuals to go about their own affairs. The pre-1914 gold standard provided "rules of the game," in which human creativity flourished—and people could count not only on long-run price stability, but also on stable exchange rates. Finally, most authorities agree that the period from 1880 to 1914, when the classical gold standard prevailed, was one of innovation, wealth creation, free trade, and sound money. Joseph Schumpeter emphasized:</p> <blockquote><p>An "automatic" gold currency is part and parcel of a laissez-faire and free trade economy. It links every nation's money rates and price levels with the money-rates and price levels of all the other nations that are "on gold." It is extremely sensitive to government expenditure and even to attitudes or policies that do not involve expenditure directly, for example, to foreign policy, to certain policies of taxation, and, in general, to precisely all those policies that violate the principles of [classical] liberalism. …It is both the badge and the guarantee of bourgeois freedom—of freedom not simply of the bourgeois<span> </span><em>interest</em>, but of freedom in the bourgeois<span> </span><em>sense</em>. From this standpoint a man may quite rationally fight for it.</p> </blockquote> <p>Even<span> </span><a href="https://www.econlib.org/library/YPDBooks/Keynes/kynsCP.html?chapter_num=3#book-reader">John Maynard Keynes</a><span> </span>recognized the great benefits stemming from the pre-1914 gold standard:</p> <blockquote><p>What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort, yet were, to all appearances, reasonably contented with this lot. But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages.</p> </blockquote> <p>It is a legitimate and important role of scholars to think about monetary alternatives—even when they may not appear politically feasible. This is one reason the Cato Institute established a<span> </span><a href="https://www.cato.org/centers/center-monetary-financial-alternatives" rel="noopener noreferrer" target="_blank">Center for Monetary and Financial Alternatives</a>. It's also why each year, our<span> </span><a href="https://www.cato.org/multimedia/media-highlights-radio/james-dorn-discusses-history-monetary-policy-washington-dc-its" rel="noopener noreferrer" target="_blank">Annual Monetary Conference</a><span> </span>brings together the best minds to discuss, in a civil manner, how to improve current policies in order to increase trust in the future value of money and promote financial stability. From constitutional political economists to central bankers, we welcome contributions from across the spectrum in what we consider a crucial ongoing conversation.</p> <h4><strong>What Would Gold Principles Bring to the Fed? </strong></h4> <p>If one is unfit to serve on the Federal Reserve Board because he or she sees the beauty of the classical gold standard, then Alan<span> </span><a href="https://www.constitution.org/mon/greenspan_gold.htm" rel="noopener noreferrer" target="_blank">Greenspan</a><span> </span>also should never have been allowed to serve on the Board. He too was a strong defender of the classical gold standard. In 1966, he wrote:</p> <blockquote><p>An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense—perhaps more clearly and subtly than many consistent defenders of laissez-faire—that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.</p> </blockquote> <p>The operation of the classical gold standard offered many lessons, including the importance of enforceable private contracts under a just rule of law, to how the existing system might be improved. This does not mean we should necessarily return to such a standard. It simply means that we shouldn't dismiss that system as a "nutty idea."<span> </span><a href="https://fraser.stlouisfed.org/files/docs/publications/somc/1987_03_09.pdf" rel="noopener noreferrer" target="_blank">Karl Brunner</a>, the cofounder of the Shadow Open Market Committee, for example, once called for an international "club of financial stability" in which member states would agree to bind themselves to a monetary rule and thereby help reduce the uncertainty inherent in a discretionary government fiat money regime. To return to rules-based monetary policy would, itself, be to honor lessons learned during the era of the gold standard.</p> <p>Although Greenspan lauded the classical gold standard, he realized that, once appointed, he would have to work within the existing legal framework—not advocate a return to the pre-1914 gold standard. Yet, his knowledge of how that system worked to maintain the value of money—and to allow interest rates, not central bankers, to allocate scarce capital—helped inform his approach to monetary policy at the Fed. Even many years after he began his long tenure as Fed chairman,<span> </span><a href="http://www.usagold.com/gildedopinion/greenspangold.html" rel="noopener noreferrer" target="_blank">Greenspan</a><span> </span>stated, at a 2001 congressional hearing: "Mr. Chairman, so long as you have fiat currency, which is a statutory issue, a central bank properly functioning will endeavor to, in many cases, replicate what a gold standard would itself generate."</p> <p>________________________</p> <p><a href="#_ftnref1" name="_ftn1" id="_ftn1">[1]</a><span> </span>The gold exchange standard operated from 1925 to 1931. Under that system, central banks could sterilize gold flows to insulate their domestic money supplies. Moreover, countries (other than the United States and United Kingdom) were allowed to hold their reserves in the form of dollars or pounds, in addition to gold. This system collapsed in 1931, after the UK ended convertibility to stem large outflows of gold and capital (see <a href="https://files.stlouisfed.org/files/htdocs/publications/review/81/05/Classical_May1981.pdf" rel="noopener noreferrer" target="_blank">Bordo</a>).</p> <p>[<a href="https://www.alt-m.org/2020/03/04/the-classical-gold-standard-can-inform-monetary-policy/">Cross-posted from Alt-M.org</a>]</p> <p></p> Wed, 04 Mar 2020 08:38:34 -0500 James A. Dorn https://www.cato.org/blog/classical-gold-standard-can-inform-monetary-policy Why the Fed Shouldn’t (and Can’t) “Do Nothing” https://www.cato.org/blog/why-fed-shouldnt-cant-do-nothing George Selgin <p>One of the challenging parts of my job here at Cato is that it calls for me, not only to make the case for monetary alternatives, but to comment on current Fed policies. Why is that such a challenge? Because so far as many of my fellow free-market fans are concerned, saying that the Fed should do X rather than Y amounts to endorsing monetary central planning—a major free-market no-no. Their own preferred policy recommendation is simple: "End the Fed."</p> <p>Well, I'm not against ending the Fed, provided it can be done without raising havoc, and particularly without harming innocent people, including the many holders of U.S. dollar-denominated assets. My own ideal resembles Milton Friedman's plan for replacing the FOMC with a computer, the difference being that my computer would automatically provide, not for stable growth of some monetary aggregate, but for a stable level of nominal spending. Whether such a reform would amount to "ending" the Fed is a question of semantics. Anyway, it would be good enough for me, if we ever managed to get there. But in the meantime, I don't favor a "do nothing" Fed. Moreover, I deny there's any such thing.</p> <p>As I write this, for example, the Fed has just announced an immediate, emergency 50 bps rate cut in response to the coronavirus panic. I don't know if that response is ideal; but despite what many of my libertarian friends think, I'm certain it's better than no Fed response at all. Nor do I believe that a prudent libertarian case can be made for claiming we'd be better off had the Fed stood pat—let alone vanished in a puff of smoke!</p> <h4>Supply and Demand</h4> <p>Saying that it's appropriate for the Fed to respond to coronavirus outbreak isn't the same as saying that it can prevent the outbreak from doing some serious damage to the world economy. Fed actions won't cure the disease, keep it from spreading, undo government lock-downs, or prevent disease-related factory closings from disrupting supply chains and production elsewhere. But Fed officials know this, as do most economists who have called for a fed response. Their claim isn't that the Fed either can or should try to make-up for the disease's adverse supply-side consequences. It's that it can and should take steps to keep the financial-market repercussions of these supply-side developments, which have included a sharp worldwide increase in the demand for dollar-denominated assets, from leading to<span> </span><a href="https://www.mercatus.org/bridge/podcasts/03032020/scott-sumner-how-central-banks-should-respond-coronavirus-threat">a collapse in spending</a>.</p> <p>The idea, in short, is to spare the U.S. and world economy from the double-wammy of a combination adverse supply AND adverse demand (spending) shock. To do that the Fed can't just stand pat; and telling it to do so is offering advice which, were it taken seriously, would not harm the Fed so much as it would harm many innocent people.</p> <h4>A Fire-Fighting Analogy</h4> <p>Let's set monetary policy aside for the moment and consider a different case: fire-fighting policy. And let's assume, for the sake of argument, that fire-fighting is a government monopoly and that private fire-fighting companies would, if allowed to, handle it better than the government does. That of course would justify one in arguing for fire-service privatization.</p> <p>But now suppose that, that argument having fallen on deaf ears, dry weather, high temperatures, and high winds cause brush fires to break out everywhere, with some threatening major population centers. Would it be prudent for those who favor fire-service privatization to recommend that the government fire-fighting crews stay put? Would it help gain support for the case for privatization? Or would it merely make proponents of that idea appear irresponsible, if not callous?</p> <p>I think the question answers itself. At least, I hope it does! While we may not like the government-run fire department, so long as it's all we have, we should insist, not that it "do nothing," but that it try to replicate the preferred private-market outcome as well as it can.</p> <h4>With Fiat Money, "Doing Nothing" is Meaningless</h4> <p>The fire-fighting analogy only goes so far, in part because in it the meaning of "doing nothing" is straightforward. When it comes to managing fiat money, that idea has no equally clear counterpart. Even when the Fed (<a href="https://marketmonetarist.com/2011/10/25/central-banks-cannot-%e2%80%9ddo-nothing%e2%80%9d/">or any other central bank</a>) appears to "do nothing," it's still engaged in monetary central planning. In particular, it's still influencing short-term interest rates. It's therefore also meaningless for libertarians to say that the Fed should "let markets" set those rates. Whether we like it or not, and no matter what specific actions the Fed takes, it is "the" big player in the credit market, and in the short-term credit market especially, and it couldn't avoid influencing short-term rates if it tried.</p> <p>That the Fed can't help influencing short-term interest rates should be especially obvious in the case of its present, abundant-reserve or "floor" operating framework. Here, the Fed's policy stance is fundamentally a matter of the values it assigns to two rates it sets directly: the rate of interest it pays on banks' excess reserves (the IOER rate) and the lower rate it pays other counterparties in its overnight reverse-repurchase operations (the ON-RRP rate). When, for example, the Fed lowered its rate target settings just now, it also lowered each of these administered rates by 50 basis points. When the Fed adjusts its own rates, market rates tend to follow, as a simple matter of interest-rate arbitrage.</p> <p>Given this description of how the Fed operates, what would it mean for the Fed to have "done nothing" today? Suppose it had left rates alone. Would that have been "doing nothing"? Hardly: it would have meant pursuing an alternative Fed plan ("central plan" if you prefer), calling for a continuation of the plan the Fed happened to implement some days ago. Nor could one say that<span> </span><em>any<span> </span></em>Fed rate settings would have been equivalent to its "not" engaging in monetary central planning. Finally, because "natural" or "neutral" interest rates (rates consistent with minimal Fed disruption of market-clearing price signals) can themselves change frequently, there's no reason to suppose that an unchanging Fed stance is generally better than a changing one.</p> <h4>No Different Before 2008</h4> <p>I've said that the meaninglessness of a "do nothing" Fed policy is especially obvious nowadays. But it was also meaningless before 2008, when the Fed influenced market interest rates, not by adjusting its own, administered interest rates, but by adjusting the size of its balance sheet.</p> <p>If the point seems any less obvious here, it's because of the temptation to equate an unchanging Fed balance sheet—more particularly, its refraining altogether from either buying or selling assets in the open market—with "doing nothing." But the temptation should be resisted. A constant Fed balance sheet under the pre-2008 regime was no less a monetary central plan then than a constant Fed interest-rate setting is today.</p> <p>What's more, it could be a particularly foolish monetary central plan. It would have been a lousy alternative to the classical gold standard, which itself allowed for steady growth in the monetary base, and thereby kept deflation within tolerable limits. Nor would it have been a wise plan in 1930-33 (cf. Milton Friedman and Anna Schwartz), or on 9/11, or in 2008. And, if we still relied on that old framework today, it would be a particularly foolish plan now.</p> <h4>Not Chutzpah</h4> <p>In observing that some monetary central plans are worse than others, I don't mean to gloss over the difficulties of monetary central planning. Much less do I intend to suggest that I myself know the "right" plan, either now or at any time. I don't know whether the Fed's decision today was the best one it could have made or not. I only know that when it comes to Fed policy there's nothing especially "free market" about sheer inertia. Allowing that the Fed's central planning was lousy yesterday, why should its plan for yesterday be a good plan for today?</p> <p>By all means, let's keep making the case for limiting the Fed's powers, and putting it on automatic pilot, while encouraging the development of private monetary alternatives. But let's not suppose that we forward the case for such alternatives, or reduce the Fed's powers and privileges, by having it do less than it might to contain a crisis. The Fed's serious policy blunders have seldom led to any reduction in its powers in the past. On the contrary: as I pointed out some years back,<span> </span><a href="https://www.cato.org/publications/commentary/fed-nothing-succeeds-failure" rel="noopener noreferrer" target="_blank">at the Fed, nothing succeeds like failure</a>.</p> <p>[<a href="https://www.alt-m.org/2020/03/03/why-the-fed-shouldnt-and-cant-do-nothing/">Cross-posted from Alt-M.org</a>]</p> <p></p> Wed, 04 Mar 2020 08:35:00 -0500 George Selgin https://www.cato.org/blog/why-fed-shouldnt-cant-do-nothing We Shouldn’t Have to Wait for FedNow to Have Faster Payments https://www.cato.org/publications/commentary/we-shouldnt-have-wait-fednow-have-faster-payments George Selgin, Aaron Klein <div class="lead text-default"> <p>America’s payment system seems more like it belongs to a&nbsp;developing nation than to one of the wealthiest countries on the planet.</p> </div> , <div class="text-default"> <p>U.S. banks can still&nbsp;<a href="https://www.americanbanker.com/podcast/is-the-u-s-payment-system-fair" target="_blank">take three days or longer</a>&nbsp;to grant customers access to their own deposits. That delay costs real money to many of this country’s poorest citizens, causing them to resort to high‐​interest payday and car title loans, or to endure costly bank overdraft fees.</p> <p>Payment delays are a&nbsp;<a href="https://www.brookings.edu/research/the-fastest-way-to-address-income-inequality-implement-a-real-time-payment-system/" target="_blank">hidden driver of income inequality</a>&nbsp;in America. Those who always have at least a&nbsp;couple thousand dollars in their bank accounts seldom have to worry about when payments get settled. But for the nearly half of Americans who live with little to no money in their bank account, the ramifications of waiting a&nbsp;few days for funds can be dire.</p> <p>Poorer Americans have already&nbsp;<a href="https://www.federalreserve.gov/SECRS/2018/December/20181221/OP-1625/OP-1625_121418_133277_428769914666_1.pdf" target="_blank">lost more than $100 billion</a>&nbsp;to payday lenders, check cashers,&nbsp;<a href="https://www.newyorker.com/business/currency/the-high-cost-for-the-poor-of-using-a-bank" target="_blank">and bank overdraft fees</a>&nbsp;during the 2010’s as a&nbsp;result of slow payments — something many&nbsp;<a href="https://www.nytimes.com/2019/08/05/business/economy/fed-real-time-payments.html" target="_blank">Federal Reserve officials bemoan</a>.</p> <p>Yet the Fed itself deserves much of the blame for the slow pace of clearing U.S. payments. While other nations were modernizing their payment systems, the U.S. fell further and further behind.</p> <p>For instance, the U.K. switched to instant&nbsp;<a href="https://en.wikipedia.org/wiki/Faster_Payments_Service" target="_blank">or “real‐​time” payments</a>&nbsp;beginning in 2007. Instead of moving quickly as the U.K. did, the Fed spent a&nbsp;full decade deciding how to proceed.</p> <p>On the plus side, Fed officials finally made up their minds in August,&nbsp;<a href="https://www.govinfo.gov/content/pkg/FR-2019-08-09/pdf/2019-17027.pdf" target="_blank">announcing FedNow</a>, the central bank’s own retail real‐​time payments service. Unfortunately, FedNow won’t be up and running for several years. And thus far, the Fed hasn’t announced making significant steps that could speed many payments up a&nbsp;lot sooner.</p> <p>Those steps include improvements to the Fedwire and the National Settlement Service,&nbsp;<a href="https://www.newyorkfed.org/aboutthefed/fedpoint/fed43.html" target="_blank">two “wholesale” payment services&nbsp;</a>the Fed uses to move funds between different banks. Unlike FedNow, which will eventually operate every day around the clock, Fedwire and the NSS keep limited weekday hours, and don’t open on weekends and holidays.</p> <p>A recent change&nbsp;<a href="https://fedpaymentsimprovement.org/news/blog/federal-reserve-to-support-same-day-ach-with-extended-operating-hours/" target="_blank">by the Fed to extend services</a>&nbsp;for an extra 30 to 60&nbsp;minutes is a&nbsp;step in the right direction, but it is&nbsp;<a href="https://www.pymnts.com/news/regulation/2019/nacha-same-day-ach-fed-board/" target="_blank">both long overdue</a>&nbsp;and far less than what is needed.</p> <p>Most payments today, including direct deposits and bill payments made on the automated clearing house network, rely on either Fedwire or the NSS for completion. According to Nacha, which manages the ACH network, that&nbsp;<a href="https://www.nacha.org/news/ach-network-moves-23-billion-payments-and-51-trillion-2018" target="_blank">network processed 23 billion payments</a>&nbsp;worth $51 trillion, 178 million of which were completed within a&nbsp;single day in 2018. And ACH payments are expected to grow by&nbsp;<a href="https://www.pymnts.com/news/faster-payments/2019/rtp-gig-economy-ach-flexwage-wagestream/" target="_blank">more than 30%</a>&nbsp;by 2025.</p> <p>But limited Fedwire and NSS hours currently allow for only two ACH “payment windows” on weekdays (the extended hours will allow for a&nbsp;third). This means that payments not ordered early enough can’t be settled until the following weekday. This is a&nbsp;problem for West Coast residents especially.</p> <p>And because Fedwire and the NSS aren’t open on weekends and holidays, many ACH payments can take several days to complete. The small scale changes announced by the Fed do not fix this problem.</p> <p>Nor will FedNow quickly render ACH payments redundant when it finally goes live in by 2024. Banks will still have to hook up to the new network. And even if many quickly do so, there’s no telling just how rapidly and to what extent ACH payments will give way to FedNow payments.</p> <p>Much the same&nbsp;<a href="https://medium.com/wharton-fintech/why-checks-still-exist-and-the-state-of-b2b-payments-b41f3cddea9c" target="_blank">applies to check payments</a>. Although checks have gone entirely out of fashion in some countries — and their use here has fallen off considerably since the 1990s — checks remain popular, especially among the less computer‐​savvy, and in business‐​to‐​business payments. As recently as 2015, American’s wrote 18 billion checks.</p> <p>Yet the last major improvement to U.S. check payments came in 2003, when Congress passed&nbsp;<a href="https://en.wikipedia.org/wiki/Check_21_Act" target="_blank">the Check 21 Act</a>, allowing images of checks to be transmitted in place of paper checks. Thanks to that change, in which the Fed played the lead part, people can deposit checks with a&nbsp;smartphone.</p> <p>But while Check 21 sped up check processing, many check payments are still ultimately settled using Fedwire and the NSS, so that check recipients can still wait days for their money.</p> <p>Though it could make a&nbsp;huge difference, keeping Fedwire and NSS open longer is relatively easy. It’s also one of the few payment‐​system reforms that nearly all payments‐​industry stakeholders support.</p> <p>For that reason, it was also&nbsp;<a href="https://fasterpaymentstaskforce.org/meet-the-task-force/" target="_blank">one of the main recommendations</a>&nbsp;of the 332‐​member Faster Payments Task Force the Fed established in 2015. Yet in deciding to launch FedNow — a&nbsp;far more ambitious and controversial project — Fed officials set aside the simpler reform, saying they&nbsp;<a href="https://www.federalreserve.gov/newsevents/pressreleases/other20190805a.htm" target="_blank">needed more time to “explore”</a>&nbsp;it.</p> <p>The Fed’s decision to postpone one of the few implementable policy recommendations of its own task force is at best perplexing. At worst, it raises the concern that the Fed may simply not want to improve the speed and efficiency of retail payment networks that it eventually plans to compete against.</p> <p>What tenants would applaud a&nbsp;landlord who proposed to add a&nbsp;spectacular penthouse to their rickety old building? Let’s not applaud the Fed’s fast payment plan until it puts its existing house in order.</p> </div> Fri, 28 Feb 2020 13:24:22 -0500 George Selgin, Aaron Klein https://www.cato.org/publications/commentary/we-shouldnt-have-wait-fednow-have-faster-payments Handouts, Helicopters, Hong Kong Dollars, and Hogwash https://www.cato.org/blog/handouts-helicopters-hong-kong-dollars-hogwash George Selgin <p>This morning, upon logging in to my Twitter account, I found it brimming with reports that the Hong Kong government was about to embark upon an unprecedented experiment with helicopter money. "Helicopter Money is Here," blurts<span> </span><a href="https://ftalphaville.ft.com/2020/02/26/1582705518000/Helicopter-money-is-here/" rel="noopener noreferrer" target="_blank">an<span> </span><em>FT Alphaville<span> </span></em>headline</a>. "Hong Kong Embraces Helicopter Money,"<span> </span><a href="https://www.zerohedge.com/economics/hong-kong-embraces-helicopter-money-govt-gives-every-adult-citizen-hk10000" rel="noopener noreferrer" target="_blank">says<span> </span><em>Zero Hedge</em></a>. The foreign press has also chimed in: "Helicopter Money Comincia a Hong Kong," writes<span> </span><a href="https://www.maurizioblondet.it/helicopter-money-comincia-a-hong-kong/" rel="noopener noreferrer" target="_blank">Italian financial journalist Maurizio Blondet</a>.</p> <p>In typically understated fashion,<span> </span><em>Zero Hedge</em>'s report concludes thus:</p> <blockquote><p><strong>So Hong Kong is about to unleash the mother of all stagflations on its people</strong>—who were already on the brink of massive social unrest before the virus forced lockdowns. Supply chains have collapsed, therefore there is no supply of goods or services, but demand is about to soar (thanks to free money drops from the government)…<em><strong>What happens to prices we wonder?</strong></em></p> </blockquote> <p>To which the correct answer is, not much—or nothing, at any rate, that can be blamed on exceptional additions to Hong Kong's money stock. Why not? Because Hong Kong's plan doesn't actually involve any extraordinary growth in the supply of Hong Kong dollars. That is, Hong Kong isn't planning to resort to helicopter money at all. Nor does its plan even come close.</p> <h4>Been There, Done That</h4> <p>This isn't to say that the Hong Kong government isn't planning to give away money. According to the more sober<span> </span><em>FT</em><span> </span>piece, under the proposed plan</p> <blockquote><p>Hong Kong permanent residents aged 18 and above will each receive a cash handout of HK$10,000 (US$1,200) in a HK$120 billion (US$15 billion) relief deal rolled out by the government to ease the burden on individuals and companies, while saving jobs.</p> </blockquote> <p>So far so good. But what the<span> </span><em>FT</em><span> </span>fails to note is, first, that such handouts are nothing new, and, second and more importantly, that fiscal handouts aren't the same thing as helicopter money.</p> <p>Concerning the first point, far from being unprecedented, the current Hong Kong plan will be the fourth such handout there. The first was 2011's <span> </span><a href="https://en.wikipedia.org/wiki/Scheme_$6,000" rel="noopener noreferrer" target="_blank">"Scheme $6,000,"</a><span> </span>by which the Hong Kong government gave every permanent Hong Kong resident over 18 years of age that many Hong Kong dollars. The second took place in 2018, and involved<span> </span><a href="https://www.scmp.com/news/hong-kong/politics/article/2138617/28-million-hongkongers-get-cash-handout-hk4000-each-targeted" rel="noopener noreferrer" target="_blank">handouts of up to HK$4000</a>, while the third, with handouts twice as big as those of the 2018 amount, was announced last summer. So the only unprecedented thing about the current plan is its scale, and even that change is far from sensational.</p> <h4>Grounded</h4> <p>But the second point is more important. "Helicopter money" isn't just another name for government handouts, whether they're distributed by whirlybirds or not. It refers to handouts<span> </span><em>financed by new money creation</em><span> </span>rather than by either taxes or bond-financed deficits.<span> </span><a href="https://www.brookings.edu/blog/ben-bernanke/2016/04/11/what-tools-does-the-fed-have-left-part-3-helicopter-money/" rel="noopener noreferrer" target="_blank">As "Helicopter Ben" himself puts it</a>, " a “'helicopter drop' of money is an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock."</p> <p>So, is Hong Kong planning to finance its latest handouts by printing money? No. Nor is it planning to finance them by borrowing more. Instead, it's financing them the same way it financed those earlier handouts: with tax revenues. Specifically, it plans to finance them by drawing upon its substantial "fiscal reserve" of HK$1.1 trillion.</p> <p>Hong Kong's government is lucky enough, you see, to routinely take in tax revenues exceeding its expenditures. The difference—its annual fiscal surplus—funds its "fiscal reserve," which is, in essence, funds it sets aside for a rainy day. That reserve of set-aside tax revenues allows the Hong Kong government to run an occasional deficit without having to either borrow more or print money. With the handout its planning for this year,<span> </span><a href="https://www.scmp.com/news/hong-kong/politics/article/3052405/hong-kong-budget-hk120-billion-relief-package-includes">it expects to run a deficit of $139 billion</a>, or less than 13 percent of its reserves. That is, it might give away almost ten times as much and still avoid having to either borrow or print money.</p> <h4>A Currency-Board Twist</h4> <p>Some Twitter commentators wondered whether Hong Kong's unusual currency system would itself prevent it from resorting to any genuine helicopter money plan. They wonder because the Hong Kong Monetary Authority (HKMA for short), instead of being a central bank, is a<span> </span><a href="https://en.wikipedia.org/wiki/Currency_board" rel="noopener noreferrer" target="_blank">currency-board</a><span> </span>of sorts.</p> <p>In an orthodox currency board, domestic currency is linked to some foreign "host" currency by a fixed exchange rate, and backed 100 percent by host-currency assets. Growth in the money stock is in turn geared to the domestic economy's net receipts of host currency, and hence to its balance of trade surplus with the host country. In short, there's no such thing as discretionary monetary policy, let alone a radical monetary policy experiment like helicopter money. The Hong Kong dollar is fixed to the U.S. dollar at a rate of about $7.8 to $US1. And like any currency board the HKMA is not allowed to issue Hong Kong dollar notes that are not fully backed by equivalent U.S. dollar assets. So it might appear that Hong Kong couldn't resort to helicopter money even if it wanted to.</p> <p>Only the appearance is deceiving: for the workings I just described are those of an<span> </span><em>orthodox<span> </span></em>currency board; and Hong Kong's "currency board of sorts" is far from orthodox. That's mainly because, instead of holding U.S. dollar assets just equal to an equivalent value in outstanding HKD banknotes, the Hong Kong Monetary Authority's "Exchange Fund," which manages its currency issues and manages its asset portfolio, has for some time now held U.S. dollar reserves far in excess of the value of Hong Kong's currency stock. At latest count, they amounted to<span> </span><a href="https://www.hkma.gov.hk/eng/news-and-media/press-releases/2019/11/20191107-4/" rel="noopener noreferrer" target="_blank">US$440.6 billion dollars, or about<span> </span><em>seven times</em><span> </span>the value of outstanding HKD banknotes</a>! It follows that, if the government let it, the HKMA could easily finance this year's planned handout by just creating a like value of banknotes (or, more accurately, "certificates of indebtedness" that the HKMA awards to Hong Kong's currency-issuing banks in order to allow them to issue notes) without violating the 100 percent reserve requirement. Instead, the HKMA will probably end up selling some of its U.S. dollar assets to acquire notes with which to cash-out part of the government's account balance with it.</p> <p>***</p> <p>To conclude: Far from being created "out of thin air," to be given away, Hong Kong's planned cash handouts have already been paid for, in full, by its taxpayers—and with plenty to spare. The handouts are nothing more than a government income-redistribution scheme, with no monetary policy implications whatsoever. Those looking for a test of the theory of helicopter money, or for an outbreak of Hong Kong hyperinflation, will have to wait longer for it. With a little luck, they'll wait forever.</p> <p>[<a href="https://www.alt-m.org/2020/02/26/handouts-helicopters-hong-kong-dollars-and-hogwash/">Cross-posted from Alt-M.org</a>]</p> <p></p> Wed, 26 Feb 2020 13:38:31 -0500 George Selgin https://www.cato.org/blog/handouts-helicopters-hong-kong-dollars-hogwash George A. Selgin discusses what the Fed’s response to the Coronavirus might be on Hearst TV https://www.cato.org/multimedia/media-highlights-tv/george-selgin-discusses-what-feds-response-coronavirus-might-be Mon, 24 Feb 2020 10:45:34 -0500 George Selgin https://www.cato.org/multimedia/media-highlights-tv/george-selgin-discusses-what-feds-response-coronavirus-might-be Does the U.S. Need a National Digital Currency? No: It Would Be Costly and Inefficient https://www.cato.org/publications/commentary/does-us-need-national-digital-currency-no-it-would-be-costly-inefficient Lawrence H. White <div class="lead text-default"> <p>The U.S. government already issues paper currency, so having it issue a&nbsp;modern digital currency might seem like a&nbsp;no‐​brainer. But a&nbsp;closer look suggests it won’t be a “win” for the public.</p> </div> , <div class="text-default"> <p>What most proponents of central bank digital currency envision isn’t a&nbsp;<em>currency</em> that would circulate peer‐​to‐​peer as dollar bills or bitcoins do without the banking system’s knowledge. Rather, most favor a&nbsp;model in which the Fed would provide households and nonbank businesses with transaction accounts on its own books, giving government the ability to track all payments and eliminating the anonymity provided by physical cash today.</p> <p>Advocates say a&nbsp;national digital currency would make retail payments almost instantaneous, costless and secure, and safeguard the Fed’s ability to conduct monetary policy. These claims are dubious, and there are easier ways to speed up payments in the U.S. The Fed could facilitate faster check settlement by expanding the operating hours of the <a href="https://www.cato.org/publications/testimony/facilitating-faster-payments-us?mod=article_inline" target="_blank">settlement services it provides</a> to commercial banks, a&nbsp;move favored by the National Automated Clearing House Association.</p> <p>A central bank retail‐​account system cannot be costless if it hopes to provide the level of customer service that consumers expect. The Fed deals only with commercial banks, the U.S. Treasury and other central banks, and knows only how to process payments at the wholesale level. To match the level of service provided by commercial banks today, the Fed would need to invest in branch offices, ATMs, websites and phone apps, and hire tellers and service representatives to process account applications, answer customer questions and more.</p> <p>Given the government’s poor record on efficiency, the likely outcome would be a&nbsp;system that falls short on customer service or loses money at taxpayers’ expense—or both.</p> <p>Consumers also want a&nbsp;payment system that continually improves through innovation. Entrepreneurs have launched successful digital payment platforms like <a href="https://quotes.wsj.com/PYPL">PayPal</a> and Venmo in the U.S., Alipay and WeChat Pay in China, Paytm in India and M‑Pesa in Kenya. Private initiatives have introduced bitcoin and other cryptocurrencies. Central‐​bank bureaucracies? Not so much. The central bank of Ecuador launched a&nbsp;retail‐​account system in 2015, but the project failed to attract users due to poor design, poor marketing and lack of public trust in the system. It was terminated after three years.</p> <p>Those who say the U.S. government needs to act to ensure the dollar doesn’t lose its dominance to another nation’s digital currency or a&nbsp;private cryptocurrency have it backward. The best way to improve the speed and convenience of dollar payments is through entrepreneurial competition, not the heavy hand of government. The dollar will reign so long as the Fed keeps the dollar inflation rate low.</p> <p>Some economists are pushing a&nbsp;Fed retail‐​account system as a&nbsp;way to abolish most or all paper currency with less public inconvenience and complaint. Once that happens and the public can no longer cash out, the Fed will be free to impose negative nominal interest rates on all dollar‐​holders. This will improve monetary policy, they say. Some improvement.</p> <p>A Fed retail‐​account system also raises serious concerns about privacy because the government would be able to track where every dollar goes. Unlike private firms that encrypt customer data, the Fed as an arm of the federal government can’t be expected to protect users from surveillance. Other federal agencies—such as the Internal Revenue Service, Drug Enforcement Administration, Bureau of Alcohol, Tobacco, Firearms and Explosives, and Immigration and Customs Enforcement—would likely meet less resistance when they pressure the Fed the way they pressure commercial banks to share account information.</p> <p>Finally, moving retail accounts to the Fed would diminish funds in commercial banks, shrinking the volume of growth‐​enhancing small‐​business loans they make. In principle, that could be avoided if the Fed agreed to auction all of its retail funds back to banks with no strings attached. But given recent history, the Fed can’t be expected to maintain a&nbsp;fair neutrality in credit allocation.</p> </div> Sun, 23 Feb 2020 15:50:07 -0500 Lawrence H. White https://www.cato.org/publications/commentary/does-us-need-national-digital-currency-no-it-would-be-costly-inefficient No Place Like Home? Don’t Tell That to Fed Board Nominees https://www.cato.org/publications/commentary/no-place-home-dont-tell-fed-board-nominees George Selgin <div class="lead text-default"> <p>When the Trump administration officially announced its&nbsp;<a href="https://www.latimes.com/business/story/2020-02-13/trump-fed-shelton-senate" target="_blank">most recent nominees</a>&nbsp;to fill vacancies on the Federal Reserve Board, they were listed as “Judy Shelton, of Virginia,” and “Christopher Waller, of Missouri.” But when the nominations were forwarded to the Senate a&nbsp;dozen days later, they were listed as “Judy Shelton, of California,” and “Christopher Waller, of Minnesota.” What gives?</p> </div> , <div class="text-default"> <p>It’s a&nbsp;shady tactic commonly practiced as part of the Fed’s nominating and confirmation process. It involves skirting a&nbsp;once rigorously enforced Federal Reserve requirement about geographical diversity on the Fed Board of Governors. Now that requirement has become something of a&nbsp;sham — and mainly comes into play in the service of partisan politics.</p> <p>The requirement is a&nbsp;little‐​known&nbsp;<a href="https://books.google.com/books?id=ml5FAQAAMAAJ&amp;pg=PA3&amp;lpg=PA3&amp;dq=%22not+more+than+one%22+%22shall+be+selected+from+any+one+Federal+Reserve+District%22&amp;source=bl&amp;ots=c-Kyxv1RfO&amp;sig=ACfU3U3plaFHMBBZzu3lQ6V1cJGJvj5q_g&amp;hl=en&amp;sa=X&amp;ved=2ahUKEwj27dSAl-PnAhUEj54KHWe4Dj4Q6AEwDHoECAkQAQ#v=onepage&amp;q=%22not%20more%20than%20one%22%20%22shall%20be%20selected%20from%20any%20one%20Federal%20Reserve%20District%22&amp;f=false" target="_blank">clause in the Federal Reserve Act</a>&nbsp;saying&nbsp;that&nbsp;“not more than one” Fed governor “shall be selected from any one Federal Reserve district.” Lael Brainard and Michelle Bowman already represent Fed districts that include all of Virginia and Missouri. So neither a “Judy Shelton, of Virginia,” nor a “Christopher Waller, of Missouri” would qualify to join the board.</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>Is the Trump administration flouting yet another law? Yes. And no</p> </div> </div> </aside> , <div class="text-default"> <p>However, the board’s California (San Francisco Fed) and Minnesota (Minneapolis Fed) slots are empty. Hence — presto! — the candidates suddenly hail from new home states.</p> <p>Is the Trump administration flouting yet another law? Yes. And no.</p> <p>First of all, the new designations aren’t altogether bogus. Besides having a&nbsp;residence in California, Shelton was born there; and being born somewhere has long counted, in Fed board appointments, as being “from” that place.</p> <p>Waller’s link to Minnesota is considerably weaker: He earned his undergraduate degree from the state’s Bemidji State University. In 2016, economist Peter Diamond’s similarly tenuous ties to Illinois — he lectured there on occasion — gave Republicans an excuse for refusing to confirm his appointment to represent the Chicago Fed district.</p> <p>But Diamond’s case was a&nbsp;noteworthy exception. For more than two decades, the rule has essentially been … no rule at all. Ten board members, including two Fed chairs and a&nbsp;vice chair, have been appointed without even the pretense of meeting the Federal Reserve Act’s geographic diversity requirement, while several others have had only slim ties to the districts they were appointed to represent.</p> <p>One recent case is Randy Quarles, the Fed’s vice chair for supervision. He was born in San Francisco and lived in Utah (which is also in the San Francisco Fed district), but when President Trump nominated him in 2017, he became “Randy Quarles, of Colorado,” where he lived as a&nbsp;boy and often spent his Christmas holidays. The designation avoided a&nbsp;clash with Janet Yellen, the Fed’s chair at the time, who already represented the San Francisco district.</p> <p>Vice Chair Richard Clarida’s case is even more recent, and more unusual. When nominated, Clarida, who represents the Boston Federal Reserve district, was designated “of Connecticut,” where he lived. But Clarida resided in in Fairfield County, which happens to belong to the New York Fed district — and was already represented. So far as the record reveals, no senator bothered to ask Clarida which part of Connecticut he was “of.”</p> <p>When the geographic diversity requirement has served any purpose lately, it’s been as a&nbsp;blunt weapon of partisan politics, to be hurled at otherwise well‐​qualified Fed nominees when nothing else avails. And, apparently, it’s only useful when the party that controls the Senate doesn’t also control the White House.</p> <p>The situation presents Congress with a&nbsp;clear choice: Either scrap the Fed’s moribund geographic diversity requirement, or enforce it. Congress could pursue diversity by simply amending the law to specify that nominees must truly be “of” the places they list as their residences on tax returns for the year immediately preceding their nominations.</p> <p>In pondering that possibility, Congress should recall the diversity requirement’s original purpose: keeping the Fed from becoming a&nbsp;plaything of East Coast bankers. Between 1914 and 1996, only 30% of Fed board members were born on the East Coast. But since 1996, thanks to the requirement’s slack enforcement, that figure has risen to 80%, according to an article in the Yale Law &amp;&nbsp;Policy Review&nbsp;<a href="https://www.alt-m.org/2020/02/04/a-fed-geography-lesson/" target="_blank">and analysis by the Cato Institute</a>.</p> <p>In an age that prizes diversity and fears Wall Street’s influence, the Fed’s geographically skewed governance makes for bad optics, if not for faulty Fed governance. So rather than scrap the requirement, Congress would be wise to give it some real teeth.</p> </div> Sun, 23 Feb 2020 09:34:48 -0500 George Selgin https://www.cato.org/publications/commentary/no-place-home-dont-tell-fed-board-nominees Vice Chair Quarles’ Stigma Problem https://www.cato.org/blog/vice-chair-quarles-stigma-problem George Selgin <p>Speaking to NYU’s “Money Marketeers” last week, Randy Quarles, the Fed’s Vice Chair for Supervision, shared his views on Fed policy, and particularly on steps he thinks the Fed should take to reduce the size of its balance sheet.</p> <p>Perhaps better than anyone else at the Fed, Mr. Quarles understands the role that liquidity requirements play in propping‐​up banks’ demand for excess reserves, and how those requirements foiled the Fed’s attempt to get the quantity of such reserves substantially below its crisis‐​era peak.</p> <p>Rather than accept that defeat, Mr. Quarles wants the Fed to try again, after first doing something to reduce banks’ demand for reserves. Reducing the Fed’s balance sheet, he says, is worth the effort because it will ultimately make its policies more credible:</p> <blockquote><p>Although I fully support the FOMC’s current plan to purchase Treasury bills and increase the size of the balance sheet in the very short term, over the longer‐​term, I believe that the viability of balance sheet policies is enhanced if we can show that we can meaningfully shrink the size of the balance sheet relative to gross domestic product following a recession‐​induced balance sheet expansion. In effect, I believe that balance sheet policies are more credible if we can show that there is not a persistent ratcheting‐​up effect in the size of the Fed’s asset holdings.</p> </blockquote> <h4>Abundant, but Finite, Reserves</h4> <p>The danger to which Mr. Quarles refers, if only vaguely, is one that BPI’s Bill Nelson has repeatedly emphasized, namely, that unless something is done to reduce banks’ appetite for excess reserves, they might gobble‐​up as many reserves as the Fed tosses their way, and still end up crying for more. “Such a dynamic,” <a href="https://www.brookings.edu/wp-content/uploads/2019/11/Nelson-remarks.pdf" rel="noopener noreferrer" target="_blank">Bill told a packed house at Brookings last December</a>, “led the Norges Bank (the central bank of Norway) in 2010 to switch from a system with abundant reserves to a system with more scarce reserves.” As Norges Bank officials explained at the time,</p> <blockquote><p>When Norges Bank keeps reserves relatively high for a period, it appears that banks gradually adjust to this level…With ever increasing reserves in the banking system, there is a risk that Norges Bank assumes functions that should be left to the market. It is not Norges Bank’s role to provide funding for banks…If a bank has a deficit of reserves towards the end of the day, banks must be able to deal with this by trading in the interbank market.</p> </blockquote> <p>Where Mr. Quarles differs from his Norges Bank counterparts is in holding that the Fed can shrink its balance sheet without abandoning its abundant reserves (or “floor”) operating framework. For him, as for most Fed officials, the Fed’s announcement early last year that it planned to stick to a floor system might as well have been chiseled on a stone tablet. “As the FOMC announced in January of 2019,” Quarles says, “the Committee intends to implement monetary policy in an ample‐​reserves regime.” In light of events since last January, this digging‐​in of official heels seems imprudent, to say the least. Yet it’s an all too common Fed practice, to which Fed officials are all the more inclined to resort when they have good reason to doubt the merits of some past decision.</p> <p>Though Mr. Quarles rules out any alternatives to a floor system, he at least wants a floor system that keeps banks from becoming excess reserve junkies. In explaining how to limit banks’ appetite for excess reserves, he harkens back to <a href="https://www.hoover.org/sites/default/files/research/docs/cochranepalermotaylor_currencies_ch7.pdf" rel="noopener noreferrer" target="_blank">something he said at a Hoover Institution conference back in May 2018</a>. Asked by the very same Bill Nelson quoted earlier whether “despite how the LCR [Basel’s Liquidity Coverage Ratio requirement] is written, banks are told that they have to meet a material part of their high‐​quality liquid assets requirements with reserves,” Mr. Quarles answered that “I do know that that message has been communicated at least in some supervisory circumstances in the past. I would say that that’s in the process of being rethought.”</p> <p>Evidently, despite <a href="https://www.alt-m.org/2019/10/03/reflections-on-the-repo-market-imbroglio/" rel="noopener noreferrer" target="_blank">last year’s repo‐​market turmoil</a>, the Fed’s rethink has still not gone far. Hence Mr. Quarles’ New York remarks urging it forward.</p> <blockquote><p>I think it is worth considering whether financial system efficiency may be improved if reserves and Treasury securities’ liquidity characteristics were regarded as more similar than they are today—that is to say, that reserves and Treasury securities were more easily substitutable in the context of liquidity buffers. … I want to explore options that would maintain at least the level of resilience today while also facilitating the use of HQLA beyond reserves to meet the immediate liquidity needs projected in banks’ stress scenarios.</p> </blockquote> <h4>Assume a Can‐​Opener Reliable Lender of Last Resort</h4> <p>The option Mr. Quarles prefers is that of having banks and their supervisors “assume” that the Fed stands ready to “provide liquidity to bridge the monetization characteristics of HQLA [High Quality Liquid Asset] securities versus reserves”:</p> <blockquote><p>If firms could assume that this traditional form of liquidity provision from the Fed was available in their stress‐​planning scenarios, the liquidity characteristics of Treasury securities could be the same as reserves, and both assets would be available to meet same‐​day needs.</p> </blockquote> <p>Which brings us to the main shortcoming of Mr. Quarles’ remarks. For he proposes no actual changes to the Fed’s long‐​standing last‐​resort lending arrangements. Instead, he appears to consider those arrangements, and the Fed’s discount window in particular, adequate. The problem, he suggests, isn’t institutional: it’s psychological. The change that’s needed is a change in the <em>beliefs</em> of Fed supervisors and the bankers they supervise. Instead of treating Treasurys as less‐​than‐​perfect substitutes for reserves, they should assume henceforth that they can and will “rely on the Fed’s discount window” to make those assets practically identical whenever markets become stressed.</p> <p>But this solution begs the question: assuming that bankers and their regulators can be coaxed into taking such a leap of faith, would their doing so be <em>prudent</em>? If experience counts for anything, the answer to that question is a resounding “no.”</p> <h4>The Stigma Problem</h4> <p>The rub is the notorious “stigma problem”—bankers’ reluctance to take advantage of the Fed’s discount window loans for fear that doing so will cause people to suspect that they’re in hot water. Though the problem has been around much longer, it became notorious during the last financial crisis. During that crisis, Ben Bernanke explains <a href="https://www.amazon.com/Courage-Act-Memoir-Crisis-Aftermath/dp/0393353990" rel="noopener noreferrer" target="_blank">in his memoir</a>, “banks were reluctant to rely on discount window credit to address their funding needs” because they worried that the word would get out, and that that would “lead market participants to infer weakness.” If that happened a bank’s normal funding sources could dry. Worse than that, it could suffer a run.</p> <p>Proving that the stigma problem is real can be difficult, for there are all sorts of reasons why a bank might resist borrowing from the Fed. But in December 2007 the Fed set up an emergency facility—the Term Auction Facility—specifically designed to be a stigma‐​free alternative to the discount window. So, it’s possible to gauge the severity of the discount window stigma by comparing its popularity with that of the newer facility, and especially by noting the extent to which banks turned to the TAF even when that meant paying more interest than the Fed’s discount windows would have charged.</p> <p>Several years ago, <a href="https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr483.pdf" rel="noopener noreferrer" target="_blank">Olivier Armentier and his coauthors</a> did just that. And they found that the stigma problem was indeed severe. First of all (as the figure below, reproduced from <a href="https://www.frbatlanta.org/cenfis/publications/notesfromthevault/1606.aspx" rel="noopener noreferrer" target="_blank">an article by Atlanta Fed economist Larry Wall</a>, clearly shows), while the TAF became an instant hit, banks remained reluctant to borrow from the discount window throughout the crisis. Just as importantly, “more than half of the TAF participants submitted bids above the DW [discount window] rate.”</p> <p><a href="https://www.alt-m.org/2020/02/13/vice-chair-quarles-stigma-probleme-feds-balance-sheet/taf/" rel="attachment wp-att-215857"><img alt="" height="360" src="https://cdn.alt-m.org/wp-content/uploads/2020/02/TAF.gif" width="395" /></a></p> <p>On the basis of these findings, Armentier and his coauthors conclude that</p> <blockquote><p>Although the DW may still have a role to play as an emergency lending facility when a bank cannot find financing in the market for occasional and idiosyncratic reasons, one may question the ability of the DW as a channel to supply liquidity to a broad set of banks after a systemic funding shock.</p> </blockquote> <p>Nor is there any reason to suppose that the stigma problem has gone away since the last crisis. On the contrary: thanks to a provision in the 2010 Dodd‐​Frank Act compelling the Fed to publish bank‐​specific data on its discount‐​window operations after a two‐​year lag, it seems to have gotten worse. Discount window borrowings have been considerably lower during the last decade than they were in the years leading to the financial crisis (see <a href="https://www.google.com/url?sa=t&amp;rct=j&amp;q=&amp;esrc=s&amp;source=web&amp;cd=11&amp;ved=2ahUKEwifj-TllMrnAhUpknIEHQtOBNcQFjAKegQIBBAB&amp;url=https%3A%2F%2Fwww.richmondfed.org%2F-%2Fmedia%2Frichmondfedorg%2Fpublications%2Fresearch%2Fworking_papers%2F2018%2Fpdf%2Fwp18-08.pdf&amp;usg=AOvVaw13PuRJkbDtGTYmSuD6wHGI" rel="noopener noreferrer" target="_blank">here</a>), with <a href="https://www.wsj.com/articles/how-the-discount-window-became-a-pain-in-the-repo-market-11574337601" rel="noopener noreferrer" target="_blank">recent figures the lowest on record</a>. Most significantly of all, as <a href="https://www.wsj.com/articles/how-the-discount-window-became-a-pain-in-the-repo-market-11574337601" rel="noopener noreferrer" target="_blank">David Benoit reported last November in the <em>W</em><em>all Street Journal</em></a>, discount window borrowings didn’t increase much when repo rates spiked last September. Yet that spike was an example of just “the kind of stress the discount window is designed to ease.”</p> <p>Mr. Quarles instead thinks the stigma problem exaggerated. “While there has long been discussion about how the discount window is ‘broken’ because of stigma about using it,” he says,</p> <blockquote><p>we know it is still an important part of firms’ contingency planning and preparations. Banks currently pledge over $1.6 trillion in collateral to the discount window, which means that banks have gone to the trouble of working with their local Reserve Bank to make sure they have access to the window, if needed, and they have set aside a portion of their balance sheets as collateral to do so.</p> </blockquote> <p>This is far from compelling. Experience shows rather that, while many (though hardly all) banks pledge collateral with their reserve banks, they may do so only in case they must borrow from the discount window for those “occasional and idiosyncratic reasons” to which Armentier et al. refer. They may have no intention of using the discount window otherwise. Since roughly half of the collateral banks pledge for primary credit borrowings consists of low opportunity cost commercial and consumer loans, such discount‐​window insurance comes cheap.</p> <h4>A Stigma‐​Free Alternative</h4> <p>If the discount window’s stigma problem can’t simply be waved aside, the Fed needs to take seriously Armentier et al.‘s conclusion that it</p> <blockquote><p>complement the DW by designing new “stigma proof” facilities specifically aimed at supplying liquidity to the entire banking sector. This is precisely what the Fed did when it created the TAF. Similarly, the BoE recently adopted a twofold approach: a DW for meeting idiosyncratic liquidity shocks, and a contingency liquidity facility activated in response to exceptional market‐​wide stress.</p> </blockquote> <p>While it’s tempting to suppose that a revived TAF might solve the problem, things aren’t so simple. Instead of standing ready to lend to any bank at any time, the TAF supplied funds only during auctions held once every two weeks. It also took three days to actually credit the funds to winning banks’ accounts. For these reasons alone, it might not be of any use to a bank facing a genuine stress scenario. The TAFs auction‐​determined rates based on fixed credit allotments would also render it useless as a means for policing the upper limit of the Fed’s overnight target range.</p> <p>What the Fed could really use is a full (that is, unlimited) allotment, fixed rate standing facility that’s also stigma‐​free, for unless it’s so banks might still be willing to borrow on the private market for more than the Fed’s upper rate limit, thereby causing the Fed to miss its target, much as it did last September.</p> <p>Is it possible to design such a facility? In a note written several years ago, <a href="https://www.frbatlanta.org/cenfis/publications/notesfromthevault/1606.aspx" rel="noopener noreferrer" target="_blank">the Atlanta Fed’s Larry Wall</a> expressed his doubts.</p> <blockquote><p>The original TAF was not designed to set an upper bound on overnight rates. If the Fed wanted to establish a new TAF that would be effective for monetary control, several changes would have to be made in the new facility. First, the new TAF would need to provide funds at a fixed rate if it were to set an effective upper bound on short‐​term rates. Additionally, the new TAF would have to provide for full allotment, that is, every bank would have to get the full amount of its request—otherwise, it would need to buy funds at the elevated market rate. Finally, if the new TAF were going to set a limit on overnight rates, it would need to be available every day and would have to settle the same day as the auction. In other words, the new TAF would have to operate just like primary credit if it is to set an effective ceiling on short‐​term rates. But if a new TAF were set up with the same terms as primary credit, it would seem to be just as vulnerable to stigma as primary credit.</p> </blockquote> <h4>The SRF Alternative</h4> <p>If Wall’s “new TAF” won’t answer, could <a href="https://www.alt-m.org/2019/05/02/the-feds-new-repo-plan/" rel="noopener noreferrer" target="_blank">the Standing Repo Facility (SRF) proposed by Jane Ihrig and David Andolfatto</a>, which resembles that idea in many respects, do so? Ihrig and Andolfatto believe it could. In particular, <a href="https://www.stlouisfed.org/on-the-economy/2019/march/why-fed-create-standing-repo-facility" rel="noopener noreferrer" target="_blank">they say</a> it “would not suffer from stigma problems that make the discount window an ineffective tool in these circumstances.”</p> <p>Why not? Although the proposed SRF wouldn’t possess the same stigma‐​reducing features as the TAF, it has other features that might serve just as well. For starters, instead of lending at a “penalty” rate, the SRF would supply funds at a rate only slightly above the Fed’s target‐​range upper limit. Discount window loans, in contrast, are made at rates substantially above that limit—at present the surcharges are 50bps and 100 bps for primary and secondary credit, respectively. The lack of a penalty rate would prevent anyone from inferring that firms taking advantage of the SRF are doing so because they’re desperate. <a href="https://www.federalreserve.gov/econres/notes/feds-notes/stigma-and-the-discount-window-20171219.htm" rel="noopener noreferrer" target="_blank">The SRF would, in other words, avoid the “adverse selection” problem</a> that gives people a reason to doubt the soundness of any firm that borrows at above‐​market rates. The SRF’s modest rate premium would also make it more tempting for banks to plan on using it in drafting their living wills.</p> <p>But there’s perhaps a more important reason why the SRF would not stigmatize banks that take advantage of it. Because it exists in part to enforce the Fed’s rate target upper limit, while charging a rate slightly above that limit, it would become active only at times when reserve‐​market stress causes private‐​market overnight rates to reach the Fed’s target upper limit: at other times banks needing cash in a hurry, including large banks that have filed resolution plans, would be better‐​off swapping Treasurys for cash in the private repo market. But once private market rates do reach the SRF rate, <em>any </em>bank might find it economical to borrow from the SRF. The presence of a substantial number of borrowers, borrowing at rates that actually carry no real penalty at all, would further help to avoid a stigma problem, if not to eliminate it altogether.</p> <p>Nor are these the only reasons why an SRF might be stigma‐​free. <a href="https://bpi.com/design-challenges-for-a-standing-repo-facility/" rel="noopener noreferrer" target="_blank">According to Bill Nelson</a> (him again!), the fact that the SRF would probably accept only Treasurys and other first‐​tier HQLA’s as collateral would also help to render it stigma‐​free, since any “bank that has Treasury securities available to secure a loan from the Fed is unlikely to be a bank experiencing liquidity pressures.” Also, although SRF “transactions would be subject to the same two‐​year disclosure requirement as discount window loans,” they “would be provided under Section 14 of the Federal Reserve Act, which authorizes monetary policy operations, rather than section 10B, which authorizes discount window advances” and to that extent would resemble the temporary repo operations the Fed once routinely engaged in with primary dealers, which bore no stigma on account of them. (Nor, one can now add, do any of the banks that have participated in the Fed’s recent, ad‐​hoc repo operations appear to have feared being stigmatized by doing so.)</p> <h4>If It Ain’t Broken…</h4> <p>Why doesn’t Mr. Quarles consider the SRF alternative? Actually, he does: instead of having banks rely on the discount window, he says,</p> <blockquote><p>Another approach could be to set up a new program or facility: For example, there has been much discussion among market participants, as well as policymakers, about the potential benefits of setting up a standing repurchase agreement, or repo, facility for banks and how such a facility could improve the substitutability of reserves and Treasury securities for these firms.</p> </blockquote> <p>However, Quarles adds that “While this option is still of interest, there may be benefits to working first with the tools we already have at our immediate disposal.”</p> <p>Considering all the new tools the Fed has toyed with since the onset of the last crisis, one might find Mr. Quarles’ stance refreshing. I fear, however, that he has chosen the wrong occasion on which to put a kind word in for old‐​fashioned <a href="https://en.wikipedia.org/wiki/Bureaucratic_inertia" rel="noopener noreferrer" target="_blank">bureaucratic inertia</a>. For in this case any potential gains from sticking to the Fed’s old toolkit are far outweighed by the potential costs of having to rely upon a tool which, if it isn’t quite “broken,” is too close to it for comfort.</p> <p>[<a href="https://www.alt-m.org/2020/02/13/vice-chair-quarles-stigma-probleme-feds-balance-sheet/">Cross‐​posted from Alt‑M.org</a>]</p> Thu, 13 Feb 2020 14:11:10 -0500 George Selgin https://www.cato.org/blog/vice-chair-quarles-stigma-problem Resurrecting the Fountainhead of Removal Doctrine https://www.cato.org/publications/commentary/resurrecting-fountainhead-removal-doctrine Ilya Shapiro, Trevor Burrus <div class="text-default"> <p>The Consumer Financial Protection Bureau has been controversial since its creation. First proposed by then‐​Harvard Law professor Elizabeth Warren, the CFPB administers 19 federal consumer‐​protection statutes and is overseen by a&nbsp;single director nominated by the president and confirmed by the Senate. That director serves a&nbsp;five‐​year term, removable only for “inefficiency, neglect of duty, or malfeasance in office.”</p> </div> , <div class="text-default"> <p>Even in a&nbsp;town where so much power is wielded, it isn’t going too far to say that the CFPB director is one of the most powerful and unaccountable people in Washington. The agency isn’t even beholden to the normal appropriations process because its funding comes from the Federal Reserve. The director simply requests an amount “reasonably necessary to carry out” the agency’s duties, and the Fed provides it (so long as it doesn’t go above a&nbsp;set percentage of the Fed’s operating expenses).</p> <p>A dedicated CFPB director could rework a&nbsp;large part of America’s financial system and there’s almost nothing any elected official could do about it. A&nbsp;dedicated president could promise his constituents that he would fix certain broken aspects of consumer lending, but he would be nearly powerless against the awesome and unaccountable power of the CFPB director.</p> <p>There’s something wrong with that. Although independent agencies may sometimes be good for governance, they fit uneasily into our constitutional structure. Seila Law is a&nbsp;California‐​based law firm that assists clients with consumer debt. When the CFPB opened an investigation into whether the firm violated consumer‐​finance law, it probably didn’t expect to end up at the Supreme Court litigating the constitutionality of its own structure. Or maybe it did, because the structure of the CFPB has hung like a&nbsp;sword of Damocles over the agency since its creation.</p> <p>This is a&nbsp;good time to have this fight. Independent agencies have been criticized for decades, and the judicial decisions that authorized them have long been questioned. This fourth branch of government skirts the usual system of checks and balances by exercising powers reserved for each of the three branches, frequently without any oversight or control by anyone, let alone the branch to which the power was originally entrusted. Yet the Constitution says, “The executive Power shall be vested in a&nbsp;President.” A&nbsp;fair reading of those words would look to the meaning of “executive power” and to anyone wielding that power. Those officials should be, at minimum, accountable to the president.</p> <p><a href="https://casetext.com/case/humphreys-executor-v-us"><em>Humphrey’s Executor v. United States</em></a> (1935) is the foundational case upon which independent agencies were created. The Supreme Court looked to the meaning of “executive power” and ruled that limits on the president’s removal powers were constitutional with respect to the recently created Federal Trade Commission. The court described the FTC’s statutory duties as “neither political nor executive, but predominantly quasi‐​judicial and quasi‐​legislative,” emphasizing the “non‐​partisan” and “expert” aspects of the commission. When conducting investigations and reporting its findings to Congress, the FTC “acts as a&nbsp;legislative agency.” When acting “as a&nbsp;master in chancery under rules prescribed by the court, it acts as an agency of the judiciary.” The court viewed FTC commissioners as “occup[ying] no place in the executive department” and “exercis[ing] no part of the executive power vested by the Constitution in the President.” Any exercise of “executive function,” which the court described as distinguishable from “executive power in the constitutional sense,” is in the service “of its quasi‐​legislative or quasi‐​judicial powers, or as an agency of the legislative or judicial branches of government.”</p> <p>While the court concluded that the FTC is quasi‐​legislative, quasi‐​judicial, and nonexecutive, the core of <em>Humphrey’s Executor</em> is a&nbsp;respect for the separation of powers. If an agency is “wholly disconnected from the executive department,” then it follows that the president would not have the inherent, unlimitable authority to control it. Congress may restrict the president’s removal power to protect the nonexecutive agency from the executive branch’s control. Think, for an obvious example, of a&nbsp;congressional committee. The president has no inherent authority to appoint or remove members of such a&nbsp;committee because it exercises legislative authority. The president could only feasibly gain such authority if Congress gave it to him (and then there would be a&nbsp;significant nondelegation problem).</p> <p>In the decades after <em>Humphrey’s Executor</em>, the court continued to examine whether independent agencies wield “executive power.” In <a href="https://casetext.com/case/wiener-v-united-states-2"><em>Wiener v. United States</em></a> (1958), the court looked to the “intrinsic judicial character” of the War Claims Commission in ruling that the president could not remove members of the commission at will. In <a href="https://casetext.com/case/morrison-v-olson"><em>Morrison v. Olson</em></a> (1988), however, the court changed course, upholding limits on a&nbsp;president’s ability to remove an independent counsel after considering whether “the removal restrictions are of such a&nbsp;nature that they impede the President’s ability to perform his constitutional duty.”</p> <p>It is an odd decision. Because the independent counsel was essentially a&nbsp;prosecutor, and prosecution is traditionally a&nbsp;core executive function, the court was obliged to move away from distinctions between the “executive power” and “quasi‐​legislative” and “quasi‐​judicial” powers in order to uphold the restrictions on presidential removal. Instead, it turned to the much vaguer question of whether it is “essential to the President’s proper execution of his Article II powers that these agencies be headed up by individuals who were removable at will.”</p> <p>Seven justices (with Anthony Kennedy recused and Justice Antonin Scalia vigorously dissenting), none of whom had ever been president or a&nbsp;governor, opined on what was “essential to the President’s proper execution of his Article II powers.” But there had earlier been a&nbsp;justice who had been president—and who wrote eloquently and knowingly about the nature of effective executive power. Chief Justice William Howard Taft, in <a href="https://casetext.com/case/myers-v-united-states-25"><em>Myers v. United States</em></a> (1926), wrote that “when the grant of the executive power is enforced by the express mandate to take care that the laws be faithfully executed, it emphasizes the necessity for including within the executive power as conferred the exclusive power of removal.”</p> <p>Taft’s lengthy opinion in <em>Myers </em>concluded that constitutional structure and separation of powers principles made the president’s removal power regarding officers exercising executive power “illimitable.” “From [the] division” of powers into three branches, Taft wrote, “the reasonable construction of the Constitution must be that the branches should be kept separate in all cases in which they were not expressly blended, and the Constitution should be expounded to blend them no more than it affirmatively requires.” Taft understood that when an agency exercises executive power, such as by filing suit to enforce a&nbsp;federal consumer‐​protection law, the officers of that agency are exercising the power vested by the Constitution in the president alone. For that exercise of the president’s power to be constitutionally valid, the president must retain ultimate control over its use.</p> <p>If the CEO of a&nbsp;company were limited in her ability to remove a&nbsp;lesser officer, that would severely curtail her prerogative as executive. Similarly, the president’s ability to remove agency heads at will means that he can remove them if he disapproves of their use of the executive power—leaving ultimate responsibility for the exercise of executive power with the president. The public can in turn hold the president accountable for his decision to remove, or not remove, an agency head. If the president is limited in his ability to remove an agency head, then the executive power exists at least partially outside his control. Instead, it rests with the agencies and their chief officers—bureaucrats, unaccountable to the people. Such a&nbsp;system has no place in our constitutional structure, which rigidly defines where each power of government is vested.</p> <p>Yet only a&nbsp;decade after <em>Myers</em> was decided, <em>Humphrey’s Executor</em>, in the words of Scalia’s dissent in <em>Morrison</em>, “gutt[ed], in six quick pages devoid of textual or historical precedent for the novel principle it set forth, [<em>Myers’</em>s] carefully researched and reasoned 70‐​page opinion.” While on the U.S. Court of Appeals for the District of Columbia Circuit, then‐​Judge Brett Kavanaugh described in his concurrence in <a href="https://casetext.com/case/in-re-aiken-county"><em>In re Aiken County</em></a> (2011) how <em>Humphrey’s Executor</em> has led to a&nbsp;situation in which the president “lacks day‐​to‐​day control over large swaths of regulatory policy and enforcement in the Executive Branch” due to independent agencies with “huge policymaking and enforcement authority” that can “greatly affect the lives and liberties of the American people.”</p> <p>The test should be whether an officer exercises executive power. Because the executive power is vested by the Constitution exclusively in the president, any officer who exercises that power is removable by the president at his discretion. In <em>Seila Law</em>, this is not a&nbsp;close call: The CFPB director obviously exercises executive power. This case, which presents such a&nbsp;clear violation of the separation of powers, will allow the Supreme Court to set down a&nbsp;ground rule that will guide the lower courts in how to expound on the doctrine within the proper constitutional framework.</p> <p>As Scalia noted in <em>Morrison</em>—one of those solo dissents that has come to be viewed as the true reading of the law all along—determining which kind of governmental power an officer exercises is not always easy, and there will always be close cases. Dealing with those close cases of quasi‐​powers under a&nbsp;clear and definitive test is, however, preferable to the status quo, in which lower courts are faced with the daunting task of simultaneously following <em>Humphrey’s Executor</em>, <em>Morrison</em> and the Constitution.</p> <p>In <em>Seila Law</em>, the Supreme Court should clarify the extent to which <em>Humphrey’s Executor</em> remains good law and announce a&nbsp;clear test for removal‐​doctrine cases, thus relieving the lower courts of the task of navigating a&nbsp;jumbled set of precedents and allowing them to return to what Scalia referred to as the “fountainhead” of removal doctrine: the separation of powers.</p> </div> Thu, 13 Feb 2020 11:23:41 -0500 Ilya Shapiro, Trevor Burrus https://www.cato.org/publications/commentary/resurrecting-fountainhead-removal-doctrine