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.


Interview with Martin Wolf on Monetary Reform, Part 1

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.

How long has monetary reform been an interest of yours?

I cover more or less everything in a strange sort of way, its a slightly weird job. At least everything, predominately macro-economics to global trade development, those sort of things rather than more strictly micro-economics things. I’ve obviously always been interested in macro-economic policy and as long as I’ve done this job, anyway which is now, I’ve been at the FT for 27 years so I’ve obviously been interested.

But I suppose I was one of those people who thought by and large, and I wouldn’t wish to exaggerate this, that the system we had evolved, though very peculiar in many respects, was stable enough that one didn’t need to worry about it, and therefore didn’t need to think through the possibility of radical change. So I’ve always– I’ve been interested ever since I was a student of economics back in the ’60s, but I didn’t think that we had to go back to first principles at all. And of course, the crisis of 2007 to 12, which is still ongoing to some degree – well, it’s still ongoing – has obviously made one, almost everybody I think, ask questions about the right way to manage the economy and therefore inevitably to start thinking about monetary economics. And that’s what happened to me, along with many others.

And in your experience, is this an area that central bankers take seriously?

Most central bankers are, to the extent that they’re economists, and there are only a limited number, though far more than used to be the case, (that’s one of the big changes by the way, without much notice, they’ve increasingly– the top central bankers are actually professional economists. That wouldn’t have been true 30 years ago. It’s a very big change.) The professional economists, so we’re thinking people like Ben Bernanke and Janet Yellen and Mervyn King before that in the UK, Draghi now. They are all quite academic economists, though they have of course also some practical experience. They tend still largely to work within standard models so their radicalism is limited. However, it’s well known that at least one or two of them, Mervyn King most notably in his speeches was profoundly critical of the modern monetary and financial system.

Though there are people in the academic end who think about these things more academically, who are more radical. Another person – who actually was never a professional academic as far as I know, I am sure he wasn’t – who was also very very interested in this set of questions is Adair Turner, Chairman of the Financial Services Authority, although never a central banker. So there is some interest, but still the orthodoxy – or what I call the new orthodoxy in my new book – is still dominant. You also have to remember so that sort of discussion of intellectual background and thinking among academics. You also have to remember that most central bankers are more or less practical people, who are forced rightly to deal with the problems in front of them. Most of them have been – well, mostly in the west, or all of them – have been dealing with exceptional and unexpected problems for seven years now.

So that doesn’t allow them a great deal of time for philosophical discussion of what a completely different world might look like. And so, on the whole, they don’t do that and if they did publicly of course it would be quite destabilising because they would be suggesting that what they’re doing, they don’t believe in. Well, that is not a very sensible thing for a policy maker to say, even if they should think it. So, by and large of course, they are bound to carry out their tasks, they’re public servants, within the framework of institutions and ideas that their masters – as it were, the public, the politicians – have set for them, rather than ask these rather fundamental questions.

In your article you mentioned positive money as a possible model for monetary reform. Are there risks in giving seigniorage powers to government agencies? Do you think that the temptations to overprint may become too much for them if they were given these powers?

There are a number of dangers. And one of the lessons I’ve learned and I think it’s a fundamental lesson, it’s the way I think at the moment is a modern monetary economy, and in a way I think it’s probably the most important lesson I now think one should now draw from Keynes’ work. But it goes back further in the history, back to Wicksell I think. Is that the modern monetary economy is a very complicated animal. It cannot be seen I think just as a sort of barter economy which is the way the orthodox economics tended to think about it. Money enters into it in very complicated and difficult ways. And it’s always– I think money exists because we live in an inherently uncertain world and money is the stuff you hold because the world is uncertain. It’s a reserve of absolutely reliable purchasing power that you need beyond just transaction – it’s not just about transactions – it’s stuff you can buy things with whatever happens as it were. Money is inherently linked I think to uncertainty, the fact the we don’t know what’s going to happen.

This is, therefore, a very imperfect world compared with the sort of complete market neo-classical paradigm which is of course an artificial and non existing world. In this situation, it’s always about choosing between imperfect solutions. Highly imperfect solutions. And I think there are a number of problems with reallocating seigniorage to the Government and I think there are two fundamental ones. One is the one you mentioned that the Government will be irresponsible, and the Government irresponsibility will be bigger than the private sector’s irresponsibility which we’ve already seen. The private sector can also, as we know, push back fundamentals, create credit and debt essentially without limit as long as it’s backed by the state. And that’s exactly what has happened all across the west before the crisis. We had this giant explosion in the private sector driven leverage and it created huge problems. And I’ve argued frequently but unfortunately it tends to end up with the public sector and indeed pressure on the public sector to inflate. It’s extremely likely that in the very long run, we will end up with inflation in the developed world. To get out of the debt that the private sector ultimately created, which then became public sector debt when the private sector and financial sector imploded and the economy collapsed. So, it’s very difficult to separate out what the private sector does and what the public sector does, when you have such an interlinked, interconnected public private monetary partnership which is what we’ve had now for a long time and it’s become greater.

But there is a risk of course as you said, in handing over the power to government to create money and that’s why, I would hand – if I would do this – I would hand over the authority to create money to the central bank as defenders of government given a mandate by government to create money in a non-inflatory way. The second problem which I actually think is more important than this first one, is what happens to the financial sector in this world, and there are two problems about that. First, which is perhaps later, the first is – and they’re related – is that the private sector, financial sector which would not now be creating money narrowly, might still create, well not might but certainly would try to create near money or money substitutes. As indeed happened in the 19th century, how we got bank money and not just gold money, as it were. We got bank notes and then bank deposits as near money because what Wicksell noticed in the late 19th century and that’s because the private sector just created it.

So the question is, if the private sector creates it, won’t you just re-establish the fragility we’ve seen, likened that the huge question or problem. The second question is and I think Charles Goodhart – a very distinguished scholar in these matters at the LSE – has stressed, the second really big problem is of course private sector money, particularly the ability of banks to create advances for people to create money as it were and credit it simultaneously, gives people flexibility in the economy. It means that if they need money temporarily, they can borrow at once and offset the bank and just create it for them. Well of course, the state isn’t flexible in that way. And it allows people to economise on their money holdings. It allows people to have much less money then they might need in the course of their business activities.

So there are, I think quite profound questions about what would happen and that’s why in my book, I’ve recommended that I would like to see countries experiment with it. I’m not suggesting and indeed experimentation is – in my view – one of the most important lessons of this crisis. We don’t know what the optimal monetary and financial system is, we simply don’t. Nobody can say with confidence that they do know how it should be structured and what are the laws and regulations it should have. So I actually think instead of promoting one side of banking model fits all, that sort of Basel approach, that we should encourage countries to experiment and perhaps, a few small countries to try this sort of model and see what happens.


Interview with St. Louis Fed Vice President on Bitcoin

Dr David Andolfatto, who is Vice President of the St. Louis Fed, has been one of the most forward-looking people at central banks around the world when it comes to crypto-currencies. Here he speaks with Max Rangeley, Editor at The Cobden Centre, and gives his views on what Bitcoin means for commerce, finance, and the dollar itself.

Max: How have you found the reactions to Bitcoin within the Fed?

David: Bitcoin is barely on the radar screen for most Fed researchers and policymakers. This is to be expected, given the large size of the Fed’s balance sheet and the debate over how to conduct monetary policy with the existence of large excess reserves. But I am aware of a small group of researchers scattered throughout the Fed system that seem interested in the Bitcoin phenomenon. Some, like Francois Velde of the Chicago Fed, have written nice primers on the phenomenon. I am also aware of a cryptocurrency workshop that meets monthly at the New York Fed. The reaction of most people (who study it) might be described as “academic agnosticism” in the sense that people are curious, but not enthusiastically in favor or against the idea.

Max: How do you see Bitcoin being used in the future? Do you foresee private currencies being commonly used on the high street alongside state-backed currencies, or remaining largely online phenomena?

David: Who can say how the future will evolve, especially in this space? My best guess is that Bitcoin will find a niche market. It’s cool to use bitcoin to pay for your Starbucks latte on university campuses (this is what my university is doing). It may very well find a place on the high street, at least among some shops catering to the “cool” crowd. But for advanced economies, at least, it is hard to see how consumers will benefit directly by using bitcoins instead of dollars or pounds. As Satoshi Nakamoto wrote in his seminal 2008 paper introducing Bitcoin, “…the [current] system works well enough for most transactions…”

Max: If the use of private currencies became more widespread, do you think that central banks would ever track monetary aggregates in circulation, even if just approximately, much as M2, M3 etc are tracked now?

David: Anything is possible, but I doubt it. One issue is that there many of these “wildcat” currencies, with more appearing every day (every online game has its own currency for example, as do most social media sites). In a sense, these currencies are “local” monies (much like the local currencies that have always existed, like the Ithaca hour, for example). I’m not sure how a statistical agency could keep track of all these little local currencies, or whether it would even be worthwhile to do so. But who knows?

Max: If private currencies were to become widely used around the world, do you think that this could have an effect on the business cycle, since central banks would not have as much control over monetary factors?

David: I do not think it would have much of an effect on the business cycle, which I think is rooted more in “real” and “financial” factors, rather than “monetary” factors, per se.

Max: You mentioned in your presentation on Bitcoin that although supply is fixed, demand can fluctuate significantly, which causes volatility, would you say this is a weakness inherent in private currencies, or is there the possibility that algorithms could evolve to incorporate a degree of elasticity?

David: Remember that Bitcoin is *more* than a private currency: it is a payment system and monetary policy with *no trusted intermediary* involved. Most private currencies entail the use of trusted third parties. EVE online, for example, an online game founded in 2003 has evidently managed its money supply in a manner that keeps its value relatively stable. It may be possible to code an “elastic money supply” rule in the Bitcoin protocol, but it is not immediately clear to me how this might work. Injecting new money into the system would be easy. The tricky part would be in how to destroy money (having the algorithm debit Bitcoin wallets that are secured by private keys).

Max: You mentioned that you welcome the competition for central banks; if private currencies became widely used, could it chip away at American supremacy, a degree of which is based on the dollar, the so-called “exorbitant privilege”?

David: In my view, America supremacy is not based on the dollar. The status of the dollar simply reflects American supremacy, which is based fundamentally on the structure of that economy (something “real” not “monetary”). The America dollar already faces stiff competition from a variety of alternative candidates, including the Yen, the Euro, and gold. If gold cannot displace the USD, why would we expect Bitcoin to?


Matt Ridley on the values of Richard Cobden

Matt Ridley, in The Times [paywall restricted], considers the political relevance of the values of 19th century Liberals, including Richard Cobden.

Surely wanting government to stay out of the economy should go with wanting government to stay out of society too. They went together in the 19th century, after all. Radical liberals who campaigned against war, colonialism, slavery, politicial patronage and the established church were usually furiously free-market libertarians on economics: people such as Richard Cobden, Harriet Martineau, Herbert Spencer or WE Gladstone.

Cobden, said one of his biographers, “believed in individual liberty and enterprise, in free markets, freedom of opinion and freedom of trade.” But he also was an implacable pacifist and refused a barontcy from a monarch he disapproved of. Nobody would have dreamed of calling him a rightwinger.

Mr Ridley also suggests that these values would be useful for politicians to build a coalition around: people who want the government out of “the boardroom and the bedroom.” That is not a cause that the Cobden Centre has any business getting involved in. But it is nice to see someone noticing the relevance of Cobden’s ideas.


Statman’s tour of Britain: are average wages falling?

Incoming from Tom Paterson, chief economist at “Gold Made Simple”:

I’m currently travelling around Europe in my VW campervan with my my wife and 9 month old daughter! Well, why not!

I’ve picked up a gig at the Daily Express making short videos about the UK economy – the first one can be found here [video]:

I’ve filmed another 5 (covering the UK debt, Deficit, Govt Spending and BoE money printing)… and a new one will go live every Monday…

The Walls sausage advertisement threw me for a moment before the proper video started. Looks like a good series to watch out for.

Tom Paterson can be contacted by email here.

Free Trade

Straight talk

The Cobden Centre has no position on any proposed takeover by one pharmaceutical firm of another. On the plus side, the move by Pfizer is an instance of a global market looking for efficency gains, for which shareholders of both the US firm and its intended target, AstraZeneca, can hope to benefit. If the deal fails, hopefully this will be a spur to both companies to develop better medicines. What matters is the free movement of capital and goods, for the benefit of humanity as well as private interests.

What caught my attention is that Pfizer’s chief executive, Ian Read, carries a gold coin with him. Sadly, this isn’t because the world has suddenly returned to the gold standard, which would provide enormous efficency gains to global firms like Pfizer, which could price its products and pay for its goods in gold.

Instead, the gold coin carries a message on each side, “Straight Talk” and “Own It.” Call me an egalitarian, but I would like to see everyone carrying gold coins in their wallets. Nice to know that Mr Reid has at least some hedge against a collapsing paper currency…


Money derivative creation in the modern economy

It isn’t often that a Bank of England Quarterly Bulletin starts “A revolution in how we understand economic policy” but, according to some, that is just what Money creation in the modern economy, a much discussed article in the most recent bulletin, has done.

In the article Michael McLeay, Amar Radia, and Ryland Thomas of the Bank’s Monetary Analysis Directorate seek to debunk the allegedly commonplace, textbook understanding of money creation. These unnamed textbooks, they claim, describe how the central bank conducts monetary policy by varying the amount of narrow or base money (M0). This monetary base is then multiplied out by banks, via loans, in some multiple into broader monetary measures (e.g. M4).

Not so, say the authors. They begin by noting that most of what we think of as money is actually composed of bank deposits. These deposits are created by banks when they make loans. Banks then borrow the amount of narrow or base money they require to support these deposits from the central bank at the base rate, and the quantity of the monetary base is determined that way. In short, the textbook argument that central bank narrow or base money creation leads to broad money creation is the wrong way round; bank broad money creation leads to central bank narrow money creation. The supposedly revolutionary connotations are that monetary policy is useless, even that there is no limit to the amount of money banks can create.

In fact there is much less to this ‘revolution’ than meets the eye. Economists and their textbooks have long believed that broad money is created and destroyed by banks and borrowers(1). None that I am aware of actually thinks that bank lending is solely or even largely based on the savings deposited with it. Likewise, no one thinks the money multiplier is a fixed ratio. It might be of interest as a descriptive datum, but it is of no use as a prescriptive tool of policy. All the Bank of England economists have really done is to describe fractional reserve banking which is the way that, these days, pretty much every bank works everywhere.

But there’s an important point which the Bank’s article misses; banks do not create money, they create money derivatives. The narrow or base money issued by central banks comprises coins, notes, and reserves which the holder can exchange for coins and notes at the central bank. The economist George Reisman calls this standard money; “money that is not a claim to anything beyond itself…which, when received, constitutes payment”.

This is not the case with the broad money created by banks. If a bank makes a loan and creates deposits of £X in the process, it is creating a claim to £X of standard money. If the borrower makes a cheque payment of £Y they are handing over their claim on £Y of reserve money. The economist Ludwig von Mises called this fiduciary media, as Reisman describes it, “transferable claims to standard money, payable by the issuer on demand, and accepted in commerce as the equivalent of standard money, but for which no standard money actually exists”. They are standard money derivatives, in other words.

Banks know that they are highly unlikely to be called upon to redeem all the fiduciary media claims to standard money in a given period so, as the Bank of England economists explain, they expand their issue of fiduciary media by making loans; they leverage. Between May 2006 and March 2009 the ratio of M4 to M0, how many pounds of broad money each pound of narrow money was supporting, stood around 25:1.

But because central banks and banks create different things consumer preferences between the two, standard money or standard money derivatives, can change. In one state of affairs, call it ‘confidence’, economic agents are happy to hold these derivatives as substitutes for standard money. In another state of affairs, call it ‘panic’, those same economic agents want to swap their derivatives for the standard money it represents a claim on. This is what people were doing when they queued up outside Northern Rock. A bank run can be described as a shift in depositors’ preferences from fiduciary media to standard money.

Why should people’s preferences switch? In the case of Northern Rock people came to doubt that they would be able to actually redeem their fiduciary media for the standard money it entitled them to because of the vast over issue of fiduciary media claims relative to the standard money the bank held to honour them. Indeed, when Northern Rock borrowed from the Bank of England in September 2007 to support the commitments under its broad money expansion it increased the monetary base just as the Bank of England economists argue.

But there are limits to this. A bank will need some quantity of standard money to support its fiduciary media issue, either to honour withdrawals by depositors or settle accounts with other banks. If it perceives its reserves to be inadequate it will need to access new reserves. And the price at which it can access those reserves is the Bank of England base rate. If this base rate is relatively high banks will constrain their fiduciary media/broad money issue because the profits earned from making new loans will not cover the potential cost of the standard/narrow money necessary to support it. And if the base rate is relatively low banks will expand their fiduciary media/broad money issue because the standard/narrow money necessary to support it is relatively cheap.

Some commentators need to calm themselves. As the Bank of England paper says, the central bank does influence broader monetary conditions but it does so via its control of base rates rather than the control of the quantity of bank reserves. The reports of the death of monetary policy have been greatly exaggerated.

(1) “Banks create money. Literally. But they don’t do so by printing up more green pieces of paper. Let’s see how it happens. Suppose your application for a loan of $500 from the First National Bank is approved. The lending officer will make out a deposit slip in your name for $500, initial it, and hand it to a teller, who will then credit your checking account with an additional $500. Total demand deposits will immediately increase by $500. The money stock will be larger by that amount. Contrary to what most people believe, the bank does not take the $500 it lends you out of someone else’s account. That person would surely complain if it did! The bank created the $500 it lent you” – The Economic Way of Thinking by Paul Heyne, Peter Boettke, and David Prychitko, 11th ed., 2006, page 403. Perhaps the Bank of England economists need to read a better textbook?


Speech to the Brazilian Chamber of Commerce in London

Last week I spoke to a small group in London about the current monetary situation and the outlook for gold. The speech lasts about 20 minutes and the video can be found here:



Mark Carney’s grand experiment began today

I was grateful to the BBC World at One programme for giving me the opportunity today to comment on Mark Carney’s first Inflation Report. You can listen to what I said here.

The essence of what the Bank has announced is well known: they have begun using forward guidance to anchor both inflation and interest rate expectations as a cover for more active monetary policy.

This will usher in a new age of monetary Kremlinology.

The policy is all about the Committee’s intentions and judgments. It’s hedged about with provisos and escape routes. Journalists were quick to ask who thought what on the Committee, spotting that which thresholds are used and which judgments are made is dependent on the opinions of a few wise men.

If you read Mark Carney’s speech to the U.S. Monetary Policy Forum in New York last year, it is clear what he intends. Mark Carney apparently understands the critique of the Austrian School, but he believes it is “a counsel of despair for current problems” so he proposes to prevent the disruption easy money creates using “broader macroprudential management”.

Today’s announcement includes,

The  guidance will remain in place only if, in the MPC’s view, CPI inflation 18 to 24 months  ahead is more likely than not to be below 2.5%, medium-term inflation expectations remain  sufficiently well anchored, and the FPC has not judged that the stance of monetary policy poses a significant threat to financial stability that cannot otherwise be contained through the  considerable supervisory and regulatory policy tools of the various authorities.

In so far as we did not already, we now live in a world of extensive explicit discretionary power over both money and the financial system which ought to allocate real capital to the most productive uses. To believe this will end well is hubris.

Manipulating the expectations of millions of individuals, households, businesses and financial market participants will create herding on a mass scale. Like a loose load in a ship, that will result in severe instability.

Employment created through an “exceptionally stimulative monetary stance” will come to an end when that stimulation is withdrawn. In chasing its employment threshold, the Bank will paint the economy and society into a corner.

Inflation will take the Bank by surprise. The “slack in the economy”, on which the Bank is relying to avoid price inflation, will turn out to be wasted capital, not idle capital waiting to come back into use. Prices will rise.

I’m reminded of something I heard economist Steve Horwitz say, and I feel sure he will forgive and correct me if my notes are not faithful,

Central banks cannot solve the problems they created any more than an arsonist makes a good firefighter.

Unfortunately, Mark Carney is nevertheless about to conduct a grand experiment which will prove that this is so.


Gordon Kerr critiques the Greek bailout on Bloomberg

I was glad to see Cobden Partners’ Gordon Kerr on Bloomberg yesterday, explaining why the Greek bailout will fail:

As I wrote elsewhere, the western world may be in a second crisis of state socialism, a crisis of the welfare state. It appears that politicians’ excess spending pledges over what they could raise in taxation have been covered indirectly by chronic credit expansion since the end of Bretton Woods. As Hayek, Mises, Huerta de Soto and others have explained, that was bound to lead to a banking crisis.

If this thesis is essentially correct, it may be that Greece is simply in the vanguard of a pattern which we should expect elsewhere. That implies a need for everyone who cares about peace and prosperity to think fundamentally and without fear or favour about our plight. That’s why I am proud to be associated with both the Cobden Centre and Cobden Partners.