Financing Christmas

From all of us at TPS: Happy Holidays!

Paper Money

Matt recently brought up the deviation between exchange value and cost of production for fiat monies. Although he was specifically considering pennies, the same discussion applies to paper monies. As I wrote in the comments of the original post:

If the penny is over valued (exchange value > cost), forgery is encouraged. If the penny is under valued (exchange value < cost), it pays to repurpose existing pennies. [...] In the same way that maintaining overvalued fiat monies requires monopoly privilege, maintaining undervalued fiat monies require the prohibition of repurposing.

Here's the BBC profiling paper money from the Ming Dynasty. The first line of the BBC article reads:

This Chinese Ming dynasty banknote is inscribed with the title Great Ming circulating treasure note and a warning that counterfeiting is punishable by death.

That is one way to discourage entry and thereby maintain the exchange value.

A Question for Will Luther

Perhaps I'm overlooking something here, but I think Will can help me out.

I hear people mention that the price of producing a penny is greater than one cent. Moreover, the value of the materials used to make one penny are also greater than one cent. While I think there is something to the discrepancy between the two, I'm going to go with the latter-- the copper and zinc in a penny are worth more than one cent. And people use this as reason to get rid of the penny-- but I'm not quite certain where this eventually leads.

Free of government restriction, people would acquire these pennies, melt them down and use them for their material purpose. The money supply contracts, the copper and zinc supplies increase, and we end up at a new equilibrium. Fair enough.

But people aren't allowed to do that. It's illegal. I'm not saying that I agree with the law, but assume that people follow it and it remains in place for the indefinite future. Money system-wise, what's wrong with having a penny that's would be worth more than one cent in raw materials? What if pennies were made of gold-- what then? I suppose people could trade them as commodities expecting at some point to be able to use them as something other than pennies, but then we're back to the law and it either de jure or de facto not holding. The more valuable the penny, the stronger the incentive to get around the law-- but again, I'm curious what makes it not function as a unit of currency.

Does this penny-made-of-stuff-worth-more-than-one-cent argument necessarily need to go hand-in-hand with the ban on destroying money? If so, that's fine-- I just don't see people arguing it beyond "THE COPPER IN PENNIES IS WORTH TWO CENTS!" What am I missing here? I defer to Will's superior knowledge here and am eager to see where I've messed up.

Blockquoting X

X = Robert E. Lucas, Jr. on Keynes and the Keynesian consensus:

I think that in writing the General Theory, Keynes was viewing himself as a spokesman for a discredited profession. That’s why he doesn’t cite anyone but crazies like Hobson. He knows about Wicksell and all the “classics,” but he is at pains to disassociate his views from theirs, to overemphasize the differences. He’s writing in a situation where people are ready to throw in the towel on capitalism and liberal democracy and go with fascism or corporatism, protectionism, socialist planning. Keynes’s first objective is to say, “Look, there’s got to be a way to respond to depressions that’s consistent with capitalist democracy.” What he hits on is that the government should take some new responsibilities, but the responsibilities are for stabilizing overall spending flows. You don’t have to plan the economy in detail in order to meet this objective. And in that sense, I think for everybody in the postwar period—I’m talking about Keynesians and monetarists both—that’s the agreed-upon view: We should stabilize spending flows, and the question is really one of the details about how best to do it. Friedman’s approach involved slightly less government involvement than a Keynesian approach, but I say slightly.

Blockquoting X

X = Charles Goodhart.

In some countries which have suffered hyperinflation, ‘dollarisation’ has occurred, as in Argentina, Peru and--to some extent--Russia, and similarly with respect to the Deutschmark in Yugoslavia [...] What is remarkable in these cases is how high the inflation tax rate on domestic currencies has to climb before the public switches to an alternative foreign currency--although once such a switch has occurred, it does not reverse easily or quickly, and when the public does decide to abandon the inflating domestic paper currency, the alternative, privately chosen, good money can virtually drive out the ‘bad’ official money.

I've written a little on the network nature of money. In the future, expect to see many more posts on spontaneous switching between currencies.

Liberty Dollars Subject to Seizure

As many of you know, Bernard von NotHaus, the founder of Liberty Services, was arrested, charged, and convicted for his role in offering minted coins, gold and silver certificates, and electronic account balances intended to circulate as money. Specifically, he was found in violation of Title 18 U.S.C. § 485 (coining metal), Title 18 U.S.C. § 486 (passing coins as current money), and Title 18 U.S.C. § 371 (conspiracy to commit offense or to defraud US). NotHaus currently awaits sentencing and faces up to 15 years in jail, a $250,000 fine, and the possible forfeiture of $7 million worth of minted coins and precious metals seized in an FBI/secret service raid on his offices in November 2007.

Up until now, the focus has been on NotHaus and others immediately connected to Liberty Services--the operative phrase being "until now." As Coin World reports, Liberty Dollars held by others may be considered contraband and, as such, subject to seizure.

[Assistant special agent Glen] Kessler could not provide a blanket position the Secret Service would take toward those owning Liberty Dollars, whether one piece or significantly more.

He said if a Secret Service agent witnessed something considered to be contraband, such as Liberty Dollars, they would be duty-bound to confiscate it.

What a shame.

See also: White, Lawrence H. 2000. "A Competitor for the Fed? Alternative Currencies Face Difficulties in Achieving Critical Mass." The Freeman.

Andolfatto on Fiat Money and Somalia

David Andolfatto, from the Research Division of the Federal Reserve Bank of St. Louis, summarizes the interesting work of Ostroy, Kocherlakota, Wallace and others, who highlight the role of money as a record keeping device. He then links this literature to my paper with L.H. White on Somalia. Since we here at TPS relish in shameless self-promotion, I thought I'd send this along.

Thanks to Andolfatto for linking to our paper!

Lucas on the Recovery

Robert Lucas gave a talk recently at University of Washington on Macroeconomic recovery in the US. His slides are available.

Lucas argues that, by imitating European policies on labor markets, welfare, and taxes, the U.S. has chosen a new, lower GDP trend. If this is correct, the weak recovery we have had so far may be all the recovery we will get. He uses these two slides to support his argument. The first shows the spread in growth rates which Lucas describes as the cost of the welfare state--note the lower trend for most of Europe. The second shows the US recovery in the recent recession.

What do you think?

[HT: PJB]

Blockquoting X

X = Ben Bernanke.

The reason the Federal Reserve was founded a century ago was to try to address the problems arising from financial panics, which did, by the way, occur in an unregulated environment in the 19th century.

Discuss.

On Hayek's Proposal

My colleague Nick Snow asks, "What's so funny about peace, love, and a free market in money?" He uncovers this 1977 WSJ article, where Hayek presents his Denationalisation of Money proposal to a wider audience.

I have written critically on Hayek's proposal. Nicolas Cachanosky provides a summary of my paper.

Before asking whether there is something funny about a free market in money, a distinction should be made between inside and outside money. Under free banking, private banks provide inside money (banknotes and demand deposits) redeemable for the prevailing outside money (gold and/or silver, historically). Under central banking, private banks provide inside money (demand deposits) redeemable for the prevailing outside money (Federal Reserve notes).

After making this distinction, it is possible to see what is so funny about Hayek’s proposal. He wants private issuers to provide outside money. He wants the monetary system to work without the very constraint that made episodes of free banking successful: a contractual obligation to redeem notes for some scarce commodity. That, I believe, is laughable.

The Future Monetary System of Zimbabwe

I blogged recently about Zimbabwe's now defunct 100-trillion-dollar note. Currently, citizens of Zimbabwe are free to use US Dollars and South African Rand for their transactions. Since inflationary finance and seigniorage are often key political tools in developing countries, one should not be surprised if Zim notes make a return in the near future. New Zimbabwe reports:

Finance minister Tendai Biti says the country needs at least six months import cover and a sustainable track-record of economic growth, inflation stability and above 60 percent capacity utilisation in industry before the Zim dollar can be brought back into circulation.

However central bank chief, Dr Gideon Gono said the country should consider adopting a gold-backed currency.“There is a need for us to begin thinking seriously and urgently about introducing a Gold-backed Zimbabwe currency which will not only stable but internationally acceptable,” he said in an interview with state media.

Whether Zimbabwe will adopt a commodity-backed system remains to be seen. I think it is highly unlikely. But it is encouraging to see that option on the table.

Blockquoting X

X = John Taylor, as quoted in this WSJ article on Zimbabwe's now-defunct 100-trillion-dollar note:

No self-respecting monetary economist goes around without a 100-trillion-dollar note.

Being a trillionaire ain't what it used to be.

[HT: Dan Smith]

Blockquoting X

X = J. Bradford Delong:

The fact is that we need fewer efficient-markets theorists and more people who work on microstructure, limits to arbitrage, and cognitive biases. We need fewer equilibrium business-cycle theorists and more old-fashioned Keynesians and monetarists. We need more monetary historians and historians of economic thought and fewer model-builders. We need more Eichengreens, Shillers, Akerlofs, Reinharts, and Rogoffs – not to mention a Kindleberger, Minsky, or Bagehot.

I am pleasantly surprised that he feels this way.

What I've Been Writing

In my latest working paper, I consider the debate between Friedman and Hayek in the 1970s and 1980s following the publication of Hayek's Denationalisation of Money. Here's the abstract:

Hayek (1976, 1978, 1984, 1990) is often credited with the resurgence of interest in alternative monetary systems. His own proposal, however, received sharp criticism from Friedman (1984), Fischer (1986), and others at the outset and never gained much support among academic economists or the wider population. According to Friedman, Hayek erred in believing that the mere admission of competing private currencies will spontaneously generate a more stable monetary system. In Friedman’s view, network effects, to use the modern term, discourage an alternative system from emerging in general and prevent Hayek’s system from functioning as desired in particular. I offer new evidence provided by recent events in Somalia as support for Friedman’s initial doubts.

As some of you will no doubt recognize, this builds on my earlier work with Larry White.

Gresham's Law and Zombie Banks

From TC at NYT:

ALL of the ways forward look ugly but, sooner or later, some variation of at least one of them is likely. Unfortunately, they all share the property of lowering European bank values, whipsawing currencies, hurting business confidence and possibly ending the European Union as an effective institution for collective decisions. That’s all because the euro, in retrospect, appears to have been a misguided attempt to equalize the values for some very unequal assets, namely the bank deposits of strong countries and those of weak countries.

ATSRTWT

What I've Been Writing

As Walter Williams often remarks, “It's a poor dog that won't wag its own tail."

.tailwag

Title:
Positively Valued Fiat Money after the Sovereign Disappears: The Case of Somalia (w/ L. H. White)

Abstract:
Economists commonly invoke sovereign powers to explain the acceptance of unbacked paper money at a positive value. The government accepts or compels taxes paid in the money (makes it publicly receivable) or compels creditors to accept it (grants and enforces legal tender status). Thus fiat money is thought to rely on enforcement of a literal fiat or decree. The case of Somalia defies this account: following the state’s collapse in 1991, unbacked paper Somali shillings continued to circulate at a positive value. We explain how historical acceptance, or “inertia,” can sustain the ongoing acceptance of unbacked money even in the absence of ongoing sovereign support. Although sovereign power might be necessary to launch a fiat standard, we conclude that it is not a necessary condition for its survival.

You can download the full version here. Also, my book review of Jimmy Stewart is Dead appears in the most recent issue of Economic Affairs.

./tailwag

Masticating

Arnold Kling reports:

Michael Mandel pointed out that the large increase in household debt is not consistent with the basic necessities becoming easier to afford. I have to agree. Something to chew on.

If households get greater access to credit markets and necessities fall in price, then income effects can shift the preferences towards luxury goods.

I am far more likely to believe that households are buying more luxury goods than I am to believe that the price of necessities has increased. This would also be consistent with the observation that college students have nicer televisions and go to more exotic vacation spots than I.

Sumner on Recessions and Policies to Combat Them

Scott Sumner at TMI hits the nail on the head:

We need to stop thinking about deep slumps as a sort of random “problem” that needs to be “fixed.”  They need to be prevented; if they aren’t, they probably won’t be fixed.

ATSRTWT

Blockquoting X

X = F. A. Hayek, Denationalization of Money (pp. 83-4):

But the present political necessity ought to be no concern of the economic scientist. His task ought to be, as I will not cease repeating, to make politically possible what today may be politically impossible. To decide what can be done at the moment is the task of the politician, not of the economist, who must continue to point out that to persist in this direction will lead to disaster.

Quantitative Easing Explained

I disagree with both of the following videos. But the question I pose to TPS readers (and co-bloggers) is: which of the two videos more accurately describes your position on quantitative easing. Alternatively, feel free to post what you hate about each video.