Interview with Martin Wolf on Monetary Reform, Part 2

Martin Wolf wrote an excellent article earlier this year on monetary reform, which can be found here .

Martin’s new book, “The Shifts and the Shocks: What we’ve learned – and have still to learn – from the financial crisis“, is available now. Martin Wolf is Chief Economics Commentator at the Financial Times. He has been visiting professor at Oxford and Nottingham universities, a fellow of the World Economic Forum in Davos, and a member of the UK’s Vickers Commission on Banking, which reported in 2011. His books include Why Globalization Works and Fixing Global Finance. In 2000, he was awarded the CBE for services to financial journalism, and in 2012 he received the Ischia International Journalism Award.

IBM recently put out a video asking, “Could Bitcoin be as transformational as the World Wide Web?” and many Silicon Valley investors are now saying similar things. What are your thoughts on digital currencies, and do you see them playing a prominent role in global commerce over the coming years and decades?

I think the honest answer to this is that I’m agnostic to sceptical. But I can’t tell you that I’m sure they’re wrong. Let me just consider the different aspects of it. So first of all, the first element as I understand, you can break Bitcoin into – it seems to me – into three aspects. There’s a new way of creating money which is depoliticised as it were which is exogenous as it were, like gold. Like mining gold. And so if you want, either a private sector or a public sector as it were. If you say the public sector wanted to create money in the way that I described, you could imagine that your worry about– so that is it, this is a technology. It’s not money it’s a technology.

It’s like gold money, it’s a technology for creating money but control its magnitude. So you could imagine and that doesn’t seem to me at all implausible, that in the future let’s suppose even the Government creating money in the way that I’ve described but the Government instead of handing in those to the Central Bank, has an algorithm. And the algorithm is known in public as it were and money is created in accordance with this algorithm and you can only change it by changing the algorithm, which is a very formal process.

Now I wouldn’t personally favour that because I think it may take serious instability because the demand for money is not stable. And because the demand for money is not stable, when people really want money, really, really want money and the algorithm is exogenous – so you can’t change it – then you’re going to have a depression. That’s of course why people like me worry about the details of the creation of money. But if you leave aside that, that’s one thing you could have a process which is automatic in that way. And it could be for private money or public money. So that’s a very interesting idea. And it clearly makes more sense than digging up– gold out of the Earth. I mean, you’ve got vast real resources, making people live a terrible life as gold miners in order to dig money out of the Earth has always struck me as basically an irrational waste of resources. So if you can do it in this other way, free, I mean, it’s digital coinage can be created freely, obviously, without any real resources. And that’s the first aspect, and I think that’s very interesting.

The second aspect is that it’s private. Now, here we get into a philosophical discussion. What is money? And there’s a tremendous debate about what makes things money. Money is, in my view, a social contrivance. I think that’s pretty clear. And which people agree to use for certain purposes. But I am quite sympathetic to the view that at least in the modern world, if we can go back the last 3,000 years I think it’s always been true by the way. But that’s another matter. That money has been state-based for a reason, which is the most important– probably the single most important use of money.

The single most important use of money is to pay your taxes in. States insist that people pay taxes in their own money. That creates a huge demand for the money of the state one lives under, and to which one owes one’s taxes. Now my view is that states are not going to hand over that function to a private entity because it loses too much for them. So they are going to insist that whatever money is, it’s something that they create and that is nation-specific. And it’s because the state will always expect money that you know that all your other fellow citizens will accept money. That’s what makes money something everybody will accept in a given society under a given state. And that’s what makes it completely– you can have complete confidence if you go out into the state, into the market with a pound, that you can buy things with pounds because everybody wants to hold pounds because it’s what allows them to play at the same level with everybody else.

Now, displacing– imagine going out into the world and trying to sell to pay with Bitcoin, the next question, will everybody accept it? It’s only money if everybody will accept it. And there has to be some basis for this trust and universal acceptability. And I’m not sure that any organ other than the state can guarantee that. So it’s a question in my mind whether a privately created money can replace state money within a given jurisdiction. And the State, I think for sure, is not going to say, “If you can pay us in Bitcoins.” They’re not going to say that. They’re going to say, “You’re going to pay us in pounds because that’s what we create and control and that defines the State.” So I understand the libertarians hope that they can overthrow the State, I understand that very well. I don’t believe there is the slightest possibility of overthrowing the State as an institution. To me, it’s a core institution of the world. It’s been a core institution of the world for about 7,000 years, minimum, and it isn’t going away.

But then I’m not a libertarian. But that’s a very fundamental issue. The third point, which is related to the second, as I said, these are questions is obviously it is possible to create money because it’s free to create, anybody can create an algorithm which allows payment in a digital coin. There is an infinite, literally infinite number of possible digital coins, digital currency. Everybody can create a digital currency and Bitcoin is the first. I can imagine that China will create one and Russia will create one, and then there might be entrepreneur but maybe sooner or later there’ll be a million of them or 10 million of them. How does one of them win?

With gold you can understand it, going back since the old way, gold had unique properties, it was scarce. It was valuable, because it was scarce it was relatively valuable. It seemed mutable, I mean in the sense it’s easy to stamp into coins. But it doesn’t tarnish and it lasts for a very long time. So it’s an incredibly attractive metal for making into a money. The only real rival over the years has been – in relatively valuable coinage – has been silver. So you’ve got gold and silver, the two– and then copper for the low-value coins. But it’s not scarce enough, so it can never go to higher-value commodities. So you’ve got really just gold and silver. But in this case, with the digital coins, as I say, they could be infinite numbers. And as soon as it becomes popular, I’d probably like to set up a business saying, “Well, I’ve got a little seigniorage. I’m going to create this and you pay me a tiny fee for it.” Or whatever it might be. So I don’t see how you stabilise on one.

The only way you could stabilise on one is – coming back to my second point – is if States do decide that’s the money. So I don’t see how a given digital coin wins. There are too many potential digital coins and it seems pretty clear to me that people and States will try to create others. So these are my three issues about digital coinage and the possibilities thereof. But as I said in the beginning I’m agnostic, I’ll be interested to see but I certainly don’t expect digital coinage to replace state created money in the near future. In the last resort, states won’t permit it.

Now I know there’s a romantic view, I wrote to Parliament about this 14 years ago , an article for Foreign Affairs, which is I still think one of the best things I’ve ever done. This is back in the late ’90s when everybody said the new cyber economy will mean that we’ll all be liberated from the heavy hand of the State, we’re going to be free, the cyber economy is beyond State control. This is the end of the State blah blah blah and I said this is utter nonesense for two reasons.

First, it is going to be a fantastic way for the State to find out what we’re doing and my god that’s true as we now know. Second more importantly, we may do commerce in cyber-space but we are physical and the State is about physical control. The State is always about physical control, it controls wherever we are, there’s a State. In some places it collapses, there’s a mess but we’re at least in the as it were, “civilised world,” there’s a state which is sort of a collective structure. And because we’re physical that State controls us. We may dislike the fact and I understand very well what people dislike which is just the reality.

Now the control exercise by the State depends on obtaining resources in order to run their legal systems and all the other things it does. Police, armies, provide people with goodies, all these other things States do. After that they need taxes and for that they need control of the monetary system. And they are not going to give it up without fighting. I mean fighting metaphorically but maybe fighting literally. So to me the idea that the State will just sort of quietly wither away and let money be taken away from it, is sort of like Marx’s fantasy that the State will wither away. And then they created Communism and never has a State been more visible. I think it’s just romantic. So at the most profound level as I said, I’m agnostic but I think that the more utopian views about what this will mean are almost certainly going to be disappointed.

Going back to the article on Positive Money. If money is created to be used for Government spending rather than largely created through the credit system then banks would essentially become intermediaries,  which implies that the central bank cannot control interest rates in the same manner as they do now. Do you have any sympathies with the idea that interest rates should be left to market forces rather being set by central bankers? I.e. the ideas of von Hayek and von Mises and that school. That they should be a purely a function of the market.

I think it follows logically. I mean von Mises and Hayek had different views as I understand it and I know something about Austrian monetary economics, but Austrian monetary economics. Well, the Austrians, I don’t follow the more contemporary ones, well some of them I do. There’s a marvellous Spanish economist who I admire greatly, but Rothbard was sort of crazy. But von Mises would go along with exactly this. Von Mises wanted to get rid of fractional reserve banking. He was actually in favour of full reserve banking, so he’s one of the people– it’s one of the interesting things about full reserve banking, the left and the right can agree on it. Different reasons. Hayek, on the other hand thought you should create private money which brings us back to the Bitcoin thing. He would be quite sympathetic to the Bitcoin, I think, though of course these ideas emerged after he died.

So Hayek and von Mises reached diametrically opposing principles from not terribly different starting points, mainly the instability of the fractional reserve system. Which of course most economists have thought about these things recognise the fraction reserve system is unstable. The banking system that we have, fractional reserve is I think a misleading way of describing it, but anyway the banking system we have is unstable. That’s just how it is. We’ve known that for more than 100 years, we just pretended in the run up to the crisis we didn’t know it and we didn’t focus on– I didn’t focus on this enough. So it was unstable. If you go the von Mises route, if you go the 100% reserve type route or state money type route, then of course the central bank controls the quantity of money, not this price. If it has a discretionary role, it could adjust the quantity in the light of what’s happening to the price. You can do it either way of course.

You could also set an interest rate and just expand money to meet the demand created by that interest rate. The setting of price and the quantity or a quantity is just– they’re just dual. It just depends which you work on. Do you work on the quantity or work on the price? You could do either, but I’m assuming that if you went for a quantity limit you let the price you set freely in the market. Where I differ from some Austrians or some commentators when they say, they say, “The price of money should be set in the market,” fine, but they seem to assume that having said that, that gets Government out of money. That’s not true at all.

As long as Government ultimately creates money – which it does, backs it through the Central Bank in our current model – then Government is always in the business. It’s only a question of how the Government agencies responsible with the Central Bank exercises its influence over monetary policy and monetary conditions or the supply of money, whatever you want call it. And the proposal we’re making is that we move to quantitative controls away from price controls. But as I said, you could personally imagine the full money policy which is indicated by what you see in the market.

So the Central Bank could look at short term interest rates in the market. It’s not setting them and it could say, “Well, short term interest rates in the market are at the moment are far too high. We’re going to expand money in by more. We’re going to have discretionary expansion of money and if short term interest rates go too low, then we’ll cut it back.” They could do that instead of having a fixed monetary rule which is the sort of Friedman view of what might be done in such a system. So the actual rule followed by the Central Bank in determining how much money to create, well that’s open. It could be a quantity rule, as I said, it could be a price rule, it could be a combination of the two.

It could be influenced by what they see in inflation, there are a lot of ways you could then– in a sense, you could run this system in many different ways and I haven’t discussed that at length nor indeed does Positive Money really. They’ve got more on this, but there are many different ways you might run such a system, even if you decide that transactions money should be essentially Government created. There’s still a question. There will be other assets in the system which are money like in some ways and they will have interest rates and you can still be very interested in what happens to them. Indeed, I think it’s all most conceivable to me that the government wouldn’t be a bit interested in what happens to them.

In a completely Austrian world, where you say the government really doesn’t care what happens in the private sector once it’s decided on 100% reserve, money and banks, then yeah. You have to follow an absolute rule of some kind and the interest rate goes wherever it goes and the government ignores it. Well, that’s a possible way of running it. The Hayekian view, I’ve never fully understood how private money would work. Well, there are various models where you could imagine private money working. They’re very tricky. The state has really withdrawn from money completely. The Central Bank has closed down, and monetary type increments, financial assets, are created by the private sector.

You can imagine that, it’s not a world as far as I can see we’ve ever lived in. That anybody has ever lived in. Even as far back as when coins were created, they always had a government role back in the– 3,000 years ago. Now I think this will be a very problematic world because I do believe there is such a thing as a natural monetary area. That is to say you have to be confident if you– you hold money because other people will accept it, that’s basically why you hold money. And that means that in a given area where you are, you need to be absolutely confident that people will accept it.

Now of course it’s true, you could imagine many moneys being use side-by-side. In some countries they have several different State moneys, especially in Switzerland you can pay with euros, you can pay with francs. You can I think probably pay in dollars. But, there’s still a limited number. How exactly it would work if we wandered around this country, and I would own NatWest pounds and somebody else has Barclay’s pounds and they will be floating freely against each other, presumably on the basis of what we thought was the soundness of NatWest or Barclay’s or whatever other bank.

I mean, I think that would turn out pretty soon to be a quite a nuisance and people would start gravitating to one of them and it would start pushing out the others and it would begin to become a monopolist. Let’s call it the Bank of England, as it were. The safest bank in the country would become the money issuer, I think, which is basically what happened with the Bank of England. That’s easily through the Bank of England. And then, of course, because it was the safest bank, all the other banks wanted to bank with it. So it’s again, Central Bank. It didn’t start off being the Central Bank, it became so. But I tend to the view– well, as I said, I don’t regard myself as expert in this. But in a world of competing private monies, you’d end up with a monopolist. And I cannot imagine, I just cannot imagine, that the state would ultimately allow this monopolist to operate freely.

It becomes too important for the whole stability of the state. Let’s suppose the monopolists, behave very well for 100 years and then falls into the hands of crooks (You might say that’s exactly what’s happened with our money, perfectly reasonable), and who start exploiting their incredibly valuable seigniorage opportunities. For their own gain. Well, if that started to happen, it would create the monstrous– it would be the possibility of the complete collapse of money, but driven by the private sector rather than the public sector. I think sooner or later, that would it wouldn’t be– people wouldn’t notice in time, the new moneys wouldn’t replace this one quickly enough, the government would intervene. I’m not personally persuaded, that’s why it’s a bit like the Bitcoin thing but in a different way. I’m not personally persuaded that a world of private moneys would be safe. A world of free banking, well that’s actually an interesting other possibility which we haven’t discussed. The free bank is always based a sovereign money of some kind. In that case, it was based on the gold standards as established by the state.

I just had one question from Steve Baker as well: he’s been discussing monetary reform for some time now and he said, in his words, “Why should the man on the Clapham omnibus care about this issue?”

That’s a very, very good question and I think the answer to that is the monetary and financial systems that we have, have malfunctioned quite seriously, well actually in a sense, forever. But if you look back over the last century, we’ve had depressions, high inflations, proto-depressions, I mean we’ve had extraordinary monetary and financial instability. And we’ve still got much more prosperous.

There’s tremendous progress going on. But we have had tremendous instability. And I think it is reasonable to ask – obviously what I’m trying to do in my book – but can’t we do better? These are man-made calamities. It’s not like the bad harvest or the plague that afflicted our ancestors so terribly, so suddenly if one portion of the population dies or the harvest, because of famine or illness. This is completely man-made calamity, the Great Depression, the inflation of the ’70s, the massive financial crises of the last six, seven years. These are man-made calamities. And they affect everybody.

Everybody whose incomes haven’t grown the way they thought they would, who are poorer than they expected to be. All these sorts of deep– all this. This affects every ordinary person. So the desire for a less unstable monetary system, monetary and financial system, is completely natural. Now, as I said at the beginning, I do think it’s always about choosing among imperfect opportunities, imperfect solutions, because the problem we’re really confronted with, in my view, is the profound reality of fundamental uncertainty. And that can’t go away. But creating a money that we can trust, and that we can trust we can use this money in any circumstances which gives us confidence, important confidence about daily life.

Whatever happens we still have some money that allows us to buy things, that’s pretty important, isn’t it? That seems to me very important, and it seems to me very important that the monetary system not be abused for private gain, or indeed public gain. That the public certainly gain in a way that exploits people. I think this is pretty important for those reasons. I’m not saying we have perfect answers. We don’t have perfect answers, but I’m absolutely sure it’s a fundamental question and it’s a duty of people interested in the issues to think about it.


  • Regional says:

    Politicians involved in monetary reform, what drugs are you on?

  • Martin Wolf seems undecided between varying the quantity of money and varying the price. I suggest the answer is thus.

    There is a fundamental defect in adjusting price, i.e. adjusting interest rates which is that that is distortionary. That is, if stimulus is needed, there is no good reason to effect stimulus just via borrowing, lending and investment, while ignoring current spending.

    On the other hand, adjusting VOLUME can be politically difficult. To take an extreme example, cutting the state pension with a view to imposing deflation would cause an outcry.

    Thus the optimum is perhaps to control demand as far as possibly by adjusting volume (in as non-distortionary a manner as possible) while using interest rate increases as a back-up – to be used perhaps just in emergencies.

  • joe bongiovanni says:

    As I’m having guests after dinner to discuss Martin’s Wolf’s book, I thought I better check in here for Part Deux, and some Libertarian-Austro perspective on his work.
    Turns out that the title of the article misled me to believe this was more on the Martin Wolf interview.
    Rather not.
    Oh well.
    But, Ralph, having read Fisher’s 1939 Program for Monetary Reform, and being that you are an adherent to a full-reserve type banking system, I’m a little surprised that you don’t favor Fisher’s reform program….. as in…. “”The intent of this proposal is to end the lawless variability in the nation’s supply of our circulating media.”” Introduction to the 1939 Program.

    So, the focus is quantity(supply) and not price, and the quantity conundrum is remedied by a legislative solution.

    IOW, to require the quantity of money to be lawfully determined, rather than a political mish-mash of supply and price incentives.


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