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Very, very basic hints on how a fractional reserve and fully centralised monetary reserve monetary system works

It seems to be unnecessary but, given all it’s being said by all and sundry in the last two weeks, may I remind the kind readers of this blog that the current monetary crisis in Greece is just a textbook example of how a fully centralised monetary system works. I would have thought that the members of the recently appointed new government in Greece were well aware of the institutional and economic constraints of the euro, as well as the very much restricted range of manoeuvre a monetary union allows to its members. Let’s start with the very basics:

Under a fractional reserve and fully centralised monetary system such as ours, the ultimate source of liquidity is under the control of a central bank, the single issuer of the currency with legal tender power. The Greek economy (along with quite some other countries in the euro area) has been running persistent and quite significant current account deficits and, particularly since the outbreak of the 2007-08 financial crisis, has required the extraordinary assistance of the ECB. When no one was willing to lend out money to Greece, the ECB has not only taken part on the bail-out successive plan(s) granted to Greece but also, and most importantly, has been accepting Greek government bonds as collateral in its main refinancing operation with Greek commercial banks. The latter has been key to maintain a regular source of liquidity to the Greek economy and thus to avoid the collapse of its national monetary system and a run on Greek banks.

Along with the loans, the ECB (actually the so-called Troika with the other two institutional lenders, the EU Commission and the IMF) has imposed conditionality on the provision of the loans granted to Greece. And of course, this is the (natural) expected behaviour of any lender: those willing to lend out their money would like to be sure the borrower will be able to honour his debts. Needles to say that successive Greek governments have accepted the deal because no other international creditor was willing to make a loan to the country or to accept Greek bonds as collateral. Who else but your central bank could take such a high risk and keep on hoarding in its portfolio assets nobody wants? (By the way, all the shareholders of the ECB are contributing to these loans and supporting this continuous financial assistance in accordance to their percentage in the capital of the bank).

Now a new government in Greece is playing a quite risky game, with potentially disastrous consequences for the country. All along the campaign, Syriza has been denouncing the ‘imposition’ of the bail-out programmes and the loss of sovereignty of the Greek government in favour of the interests of the international creditors (let us leave aside the meaningless and populist rhetoric used by its dealers to refer to the bankers, capitalists and free marketeers as those wickedly pulling the strings in the shadow … ). They claim that the debt is unfair and needs to be restructured, if not partially or totally written off (may I remind one more time that a more than 50% ‘voluntary’ haircut was already accepted by private bondholders in 2012). Actually the new finance minister has been very busy in his recent road trip throughout   Europe to demand a change in the rules of the game; as if he was in a position to do so. Let me remind again few very basic facts in this regard:

- The more radical the demands of the Greek governments the more difficult it will become to find any other source of liquidity in international markets and thus the more dependent the Greeks will be on the single source of money available, the ECB. Actually the risk premium of Greek bonds has already exploded in the last two weeks and thus this situation has already materialised.

- The message that the Greek government couldn’t be willing to fulfil the conditions of the bail out programme has already increased capital flights out of the country and this shouldn’t be surprising at all (as it already happened back in 2012). And again, in this financially stressed scenario Greek banks are even more fragile and exposed to high liquidity constraints, which can only be sorted out by the assistance of the ECB (if willing to accept Greek bonds as collateral).

In this context we may well understand last week’s Mr Draghi’s reaction to the demands of the Greek government; in particular, his announcement that since next Wednesday Greek banks will no longer have access to the regular financing operations of the ECB via the ordinary discount of Greek bonds as collateral. This can only mean two things: either (hopefully) the precipitation of a new mutually beneficial deal between the new Greek government and the Troika or, if not feasible, the most likely sudden collapse of Greek banks as soon as the ECB stops providing liquidity to them on a regular basis. Well, perhaps another alternative might happen, which is the return to the national (devalued) currency (see an alternative in line with the introduction of more monetary competition in Europe here).

I do not know who advices the new Greek government on these matters but it would help to familiarise first with the very basics on money and central banking. All my best wishes to the Greeks of course!

Juan Castaneda

An old (wrong) recipe: we all want to be consumers

I should start with an apology; it’s been far too long since my last post and I haven’t attended this blog as I would have liked. There have been so many things happening around in money and central banking that I will certainly need some time to catch up. I hope the patient readers of this blog find the forthcoming entries worthy of their time.

Last Autumn I was kindly invited to attend a very interesting seminar organised by the Institute of Economic Affairs (IEA) at its headquarters in London, and chaired by S. Davies; the topic was the so-called ‘stagnation hypothesis’, recently popularised by L. Summers at the 14th IMF Research Conference. Interesting as it was I am not going to write on it today but rather on a poem (that I must confess I hadn’t read at the time) a colleague of mine at the University of Buckingham (Malcolm Rees) brought to our attention. While we were in the midst of the discussion about the best way to tackle the slow (hypothetically secular) growth of the developed economies, Malcolm used his turn to read aloud a poem written in 1934 by Patrick Barrington, ‘I want to be a consumer’, which you will find below. Following the recipes of those economists supporting the underconsumption theory back in the 1930s, of course very well-known and popular well before the publication of Keynes’ General Theory, the poem summarises the views of a boy willing to consume more for the good of the economy as a whole. Then and now we all hear these young (and not so young) ‘lads’ encouraging us all to borrow more money and simply spend or even better asking the government to do so in our own interest, so the magical multiplier of spending operates the needed miracle. I am afraid this old recipe is quite short-sighted: as the brilliant (and austere) Catalan writer (Josep Pla) famously asked in 1954 during his visit to New York and saw all the lights displayed everywhere in the city, ‘and this, who pays for it?’. Even more, if adopted as a systematic policy, will this pattern of more and more spending be sustainable? And who works and saves more so we can increase production on long term basis? Well, I guess the answers to all these questions are only implicit in the poem and I am sure the readers of this blog will certainly know that these tricky questions are not so easy to answer; but indeed essential to bear in mind so perhaps we can avoid the same policy mistakes that have brought us to the chaotic economic situation where we are still in.

Juan E. Castaneda

PS. I am afraid ‘the old lady’ is back.

‘I Want to be a Consumer’

(by Patrick Barrington. Originally published in Punch, 25th April 1934. Text taken from the blog StudyofEconomics.wordpress.com)

“And what do you mean to be?”
The kind old Bishop said
As he took the boy on his ample knee
And patted his curly head.
“We should all of us choose a calling
To help Society’s plan;
Then what do you mean to be, my boy,
When you grow to be a man?”

“I want to be a Consumer,”
The bright-haired lad replied
As he gazed up into the Bishop’s face
In innocence open-eyed.
“I’ve never had aims of a selfish sort,
For that, as I know, is wrong.
I want to be a Consumer, Sir,
And help the world along.

“I want to be a Consumer
And work both night and day,
For that is the thing that’s needed most,
I’ve heard Economists say,
I won’t just be a Producer,
Like Bobby and James and John;
I want to be a Consumer, Sir,
And help the nation on.”

“But what do you want to be?”
The Bishop said again,
“For we all of us have to work,” said he,
“As must, I think, be plain.
Are you thinking of studying medicine
Or taking a Bar exam?”
“Why, no!” the bright-haired lad replied
As he helped himself to jam.

“I want to be a Consumer
And live in a useful way;
For that is the thing that’s needed most,
I’ve heard Economists say.
There are too many people working
And too many things are made.
I want to be a Consumer, Sir,
And help to further Trade.

“I want to be a Consumer
And do my duty well;
For that is the thing that’s needed most,
I’ve heard Economists tell.
I’ve made up my mind,” the lad was heard,
As he lit a cigar, to say;
“I want to be a Consumer, Sir,
And I want to begin today.”

Pasos en favor de una mayor competencia monetaria

Hace unos meses tuve la ocasión de dar una charla sobre el sistema monetario actual y sus alternativas de mercado en el Instituto Juan de Mariana de Madrid (18 de Mayo de 2013), titulada ‘Los Bancos Centrales y la reforma monetaria pendiente’. Lo que traté de transmitir es que un sistema caracterizado por la introducción de más competencia en el mercado de la creación de dinero no ha de llevarnos al caos monetario, como muchos aún creen, sino todo lo contrario; por cierto, resulta muy chocante esta creencia y crítica a la competencia entre monedas visto cómo el actual sistema de control estatal de la moneda ha estado muy cerca de llevarnos a un auténtico caos financiero muy recientemente. Además, ese sistema monetario más competitivo no ha de ser necesariamente uno en el que desaparezca completamente el dinero actual y sea sustituido de la noche a la mañana por una miríada de emisores privados de diferentes medios de pago. Tanto algunos de los partidarios como los muchos detractores de introducir competencia en este mercado lo entienden como un sistema en que la gente llevaría algo así como tres o cuatros (o incluso más) monedas distintas para usarlas en el mercado a conveniencia. No creo fuera así, pues sería ciertamente ineficiente y costoso realizar las operaciones normales de mercado en ese escenario de múltiples monedas y precios. De hecho, cuando hubo competencia monetaria, porque la hubo en siglos pasados y en mucho países, convivían a lo sumo dos o tres monedas, pero su uso estaba bastante diferenciado en función de la naturaleza de la operación a realizar: una moneda de menor valor era destinada para los pequeños pagos del día a día, otra de mayor valor para el pago de grandes sumas e impuestos en el país y una tercera (que podía ser una moneda circulante o sólo un patrón monetario) era destinada a operaciones con terceros en el resto del mundo. Un sistema así funcionó durante muchos años en la Castilla en la Edad Moderna.

Dado el elevado grado de intervención de las autoridades económicas en la emisión y verdadero ‘manejo’ de la moneda (por ejemplo, con la política monetaria), intervención que viene de muy antiguo, concentrarse en conseguir de manera fulminante ese ideal de mercado abierto y competitivo resulta poco realista, al menos a corto y medio plazo. Pero sí que hay cambios que pueden ir haciéndose en esa dirección: desde permitir la competencia de dos monedas en paralelo en el área del euro (algo que defendemos y explicamos varios profesores aquí) hasta, ‘simplemente’, eliminar la cláusula de dinero de curso legal de la moneda nacional (estatal); la eliminación de esa auténtica barrera legal (cierto, junto con otras condiciones adicionales) permitiría dar un gran salto en favor de la creación de un mercado abierto y disputable en el que podrían competir el banco central nacional y otros emisores privados (nacionales o extranjeros) por la provisión del mejor medio para realizar transacciones y también para diferir pagos, lo que no deja de ser una forma de ahorro claro. En función de la calidad de la moneda emitida en el mercado, la demanda de una y otras variará y, con ella, la apreciación o depreciación de las mismas; de esta forma, las variaciones del tipo de cambio (flexible) en el medio y largo plazo entre las monedas sería un buen indicador del mayor o menor poder adquisitivo de las mismas. Como maravillosamente explicó Vera Smith (1936) en sus Fundamentos de la Banca Central y de la Libertad Bancaria y detalla George Selgin(*) (1988) en La libertad de emisión del dinero bancario, en un sistema abierto a la competencia, los emisores de monedas tendrían incentivos para asociarse y formar una especie de clubes de emisión de moneda en el que proveerían por si mismos los servicios esenciales para el mantenimiento del poder de compra de la moneda y la fiabilidad de los pagos hechos con ella en el mercado. Si, bajo este sistema monetario abierto a la competencia, el Estado quiere seguir monetizando sus déficits fiscales e inflar el mercado con emisiones excesivas de esa moneda, la respuesta de los usuarios será desprenderse paulatinamente de ella; lo que se reflejará en una depreciación de la moneda estatal y en la consiguiente pérdida de las ganancias por señoreaje de emisión del Estado en favor del resto de competidores. Ello sería sin duda el mejor incentivo para abandonar tales políticas inflacionistas que acaban por deteriorar la calidad de la moneda.

Pero, como decía más arriba, hasta llegar a ese sistema más competitivo mucho nos queda por mejorar el presente. Y es a ello a lo que dediqué la segunda parte de mi intervención en el Instituto Juan de Mariana; al estudio de otras reglas de emisión de los bancos centrales distintas a las actuales que pueden contribuir a mejorar la calidad del dinero que emiten. La charla fue seguida de un muy activo turno de preguntas y comentarios por parte de los asistentes que espero os resulte de interés; especialmente animada fue sin duda la discusión sobre el patrón oro clásico y su posible aplicación en la actualidad. Os dejo a continuación el vídeo y una entrevista resumen de la misma. Como siempre, los comentarios y especialmente las críticas son muy bienvenidas:

Vídeo completo de la conferencia

Entrevista resumen

Juan Castañeda

Nota: (*) G. Selgin dará una charla en Madrid el 2 de Octubre, en la Fundación Rafael del Pino. Merece muy mucho la pena ir a escucharle. Es un auténtico especialista en estos temas, es muy ameno y se explica de maravilla. Toda la información para asistir la encontraréis aquí:

http://www.frdelpino.es/selgin/

Estimates of the aboveground stock of gold (1492-2012)

Those of you who regularly follow this blog will find this topic familiar. This is because it is the second paper I have just published on this question; in the first one (2012), “The aboveground gold stock: its importance and size”, published by the GoldMoney Foundation, James Turk and myself mainly focused on the analysis of the available estimates of the stock of gold and concluded that most of them overestimated the stock of gold in 1492; which necessarily leads to a less amount of gold in the present time (the study also includes a very useful and comprehensive statistical annex).

In this one (“New estimates of the stock of gold (1492-2012)”, full text published in Moneta 156), I offer alternative estimates of the stock of gold in 1492 using different sources of (indirect) information, which include the analysis of the research made by economic historians, geologists and economists. As a result, an interval estimate of the stock of gold in 1492 is offered; one which is again much lower (see the table below) than the one implied according to the current estimates of the stock of gold and the data we have on gold production since the discovery of the Americas. Taking these new estimates as a starting point, I also include a full series on gold production since 1492 (a series collected from different sources) and a new series on the stock of gold since 1492 to 2012.

There might be several implications for the analysis of the current gold market as, according to this research, the aboveground stock of gold in our days may be around a 10% lower than the “official” figures (as published by the World Gold Council). Of course, due to the nature of this research and the lack of (much) reliable information on this issue for such a long time period, the results must be interpreted with due cautious; and I would welcome more research on this topic to refine the current estimates.

Anyhow, find below the table with the main results of the paper (in tonnes of gold):

1.World Gold Council aboveground gold stock in 2012
174,147
2.Gold production 1493-2012
157,162
3.Implied World Gold Council estimate of aboveground gold stock in 1492 (1-2)
16,985
4.Our high estimate of aboveground gold stock in 1492
1,275
5.Overstatement of the aboveground gold stock (3-4)
15,710
6.Our high estimate of aboveground gold stock in 2012 (2+4)
158,437
7.Overestimation of the current aboveground gold stock (2012) (1-6)
15,710

More details on the estimates can be found herea video with the presentation of the paper in a recent seminar organised in Madrid last May organised by Prof. G. Depeyrot as part of the activities of the Damin project, which is a world-wide research network of scholars interested in the study of precious metals and monetary issues in the 19th century.

I hope it can be of some interest. Comments very welcome.

Juan Castañeda

PS. Link to the video with the presentation of the research paper and many others: http://www.anr-damin.net/spip.php?article60

Selgin on deflation(s)

Professor G. Selgin (University of Georgia and Cato) has masterly studied the question of deflations and distinguished those benign deflations, associated with increasing productivity and economic growth, from those recessive deflations associated with stagnation in the economy, increasing unemployment and financial instability, which seems to be the only one mostly considered by all and sundry. As Hayek did it in the 20s and 30s last century, Selgin has studied in detailed this question and has emphasised the notable implications of distinguishing amongst these different types of deflations in the running of a sound monetary policy rule (see his excellent Less than zero. The case for a falling price level in a growing economy, fully available at the IEA website).

One of the main implications of his analysis of deflations for policy making is that price stabilisation (either the price level or the inflation rate) is not a desirable policy criterion if we are committed to achieving monetary stability in the long term: it can lead to excessive money growth in the expansions of the economy (thus, monetary disequilibrium), being a major pro-cyclical policy that will destabilise financial markets in the medium to the long term. Other, both theoretical and operational, critiques to price stability as a policy criterion can be found here. This is by far the main lesson that can be drawn for the recent financial crisis and its precedent years, and it will a be very useful one if we do not want to resume the same policy rules that have contributed to the recent crisis and the monetary and financial chaos in which we are still in.

Enjoy George Selgin’s video, which is a recent CNBC interview; it is an excellent and brief explanation on the nature and consequences of different  deflations: http://video.cnbc.com/gallery/?video=3000171632

Juan Castañeda

Mr. Carney, the Old Lady is not for tying

I found this caricature in The Times last Saturday (see below) and I could not resist the temptation to write a post on it. With a blog like this one, with its name, I had no other choice but to welcome and echo this caricature and its message. As I already explained in more detail here, I do believe that a  course on money and central banking could be taught by using these classical (and contemporary) caricatures as the main material of the course. They provide the political and historical context needed to properly analyse how different constraints/events have affected the policies conducted by the central banks along the modern history.

As J. Gillray masterly did it two centuries ago, here you will find again the (poor) Old Lady screaming and fighting with the authorities; represented this time not by the prime minister but by the next governor of the Bank of England, Mr. Carney. There are some other differences of course. In this new version of Gillray’s “Political-ravishment, or the old lady of Treadneedle-Street in danger!” (1797), the new governor is not taking some gold coins from her pocket but trying to keep the Lady well tied up and under his control. The Lady is obviously protesting and is struggling to free herself from the new ties imposed in the last years; ties which represent the new and extraordinary lending facilities the Bank has had to implement since the outbreak of the recent financial crisis to assist the banking system and the Government. True, many will say that the central banks, wisely acting as the lenders of last resort of the financial system, had no other alternative but to support the banking system and maintain the proper running of the payment system. Fine, I agree to some extent since, in the face of a major financial panic, the central bank must act firmly and timely to avoid the collapse of the financial system. But at some point these extraordinary policies will have to cease and the central banks will return gradually to normality in the coming years; which certainly will mean the adoption of a more orthodox monetary policy, one committed to maintaining the stability of the financial system but also the purchasing power of the currency. Let’s see if the new governor of the Bank of England succeeds and is able to extend the existing “ties” or even adopt new ones: an expansionary nominal income targeting strategy?, the adoption of a new, higher of course, inflation target?

Nothing new at all. Under the gold standard there were clear rules which prevented the central banks from printing too much money. In our days, under a fully fiat monetary system, one in which money is created out of thin air (or ex novo), those rules are even much more needed (though become blurred many times …); so, yes, somebody must tie the hands of the Government and those of its bank (i.e. the national central bank) not to overspend and overissue respectively, in order to maintain monetary stability and the purchasing power of the currency in the medium to the long term. Until relatively recently (in the interwar years), it was in the very nature of the central bank to limit the amount of money in circulation to preserve the value of its own currency in the markets. It was a profit maximising institution for quite a long time and that was the best policy to increase the demand of its money and thus its revenues (the seigniorage). However, as depicted in this caricature, this time it looks like the world is turning upside down, since it is the (next) governor of the Bank of England, the “manager” of the bank, the one who wants to impose his own (new) ties to the Old Lady to keep on running extraordinary policy measures in the UK.

Future will tell which vision prevails in the UK and elsewhere, the classical one which defines the central bank as a bank which provides essential financial services to the banking system (a sound money amongst them) or the modern view of the central bank as a major policy actor committed to a time changing basket of macroeconomic goals, either given by the government or not.

Paraphrasing Mrs. Thatcher’s very famous quote (1980), The Time‘s cartoonist has chosen a very clever title for this satirical caricature: “the Lady is not for tying (see below). Enjoy it.

Juan Castañeda

—————————————————-

Published in The Times, 4th May 2013. Business section p. 51. “The Lady’s not for tying”. By CD, after Gillray.

After_Gilray_TheTimes2013

 

A market solution for the Euro crisis

This month the Institute of Economic Affairs (London) has published a new book with a collection of essays of different authors on the crisis of the euro, edited by Philip Booth: “The Euro- the beginning, the middle … and the end?“. In these troubled times, dominated by those who only see more fiscal centralisation as the single way to overcome the euro crisis, this book is a true rarity; as, amongst others, it has several chapters with practical proposals to foster the introduction of more monetary competition to address and finally tackle some of the major problems affecting the European Monetary Union. And yes, I said “practical” proposals because, some of the chapters of the book do contain not only a description of the benefits of having more monetary competition in order to achieve more monetary stability in the medium to the long run, but also the institutional and market arrangements needed to be implemented in the current scenario in Europe.  A novelty indeed! In this regard, the proposal I support in the book (chapter 6), which consist of (1) at least the elimination of the legal tender clause and (2) the competition of the euro with the former national currencies, could be just a starting point in the right direction. Even more, we (profs. Schwartz, Cabrillo and myself) have calculated the costs of this alternative (more open) monetary regime and they are by far less than the costs we are all still paying just to maintain the current (flawed) system.

The publication of the book (12th April) was accompanied by the following (joint) statement of the contributing authors (see their names and  affiliations here):

“The euro zone as we know it must end or be radically reformed. Current mechanisms being used to manage the euro crisis are inadequate at every level. And as Cyprus shows us, the euro-zone crisis is far from over.
In new research from the Institute of Economic Affairs, The Euro: The Beginning, the Middle … and the End?, leading economists in this field, analyse the problems with the current approach being taken to resolve the euro zone crisis and argue:
  • Product and labour markets in euro-zone member states are far too rigid to respond adequately to economic shocks. The result has been high unemployment and prolonged recession in a number of euro-zone countries.
  • The EU must therefore face up to the inadequacies of its policies both in terms of the long-term structural errors in policy and of the short-term management of the euro-zone crisis.
  • There should not be a debt union of any form. Governments must be responsible for servicing their debts without bailouts.
  • Euro-zone countries must deregulate their labour markets and reduce government spending. Decentralisation and the promotion of a market economy must be at the heart of EU policy.
The report outlines several options for radical reform of monetary arrangements within the euro zone, including:
  • A complete and orderly break-up of the euro and a return to national currencies combined with the vigorous pursuit of free trade policies.
  • The suspension of Greece, and possibly other failing euro members, from all the decision-making mechanisms of the euro. These countries could then re-establish their own national currency to run in parallel with the euro. Both would be legal tender currencies with free exchange rates. Such an approach should be part of a more general agenda for decentralisation in the EU. This proposal mirrors the “hard ecu” proposal of the UK government before the euro was adopted as a single currency.
  • The enforcement of strict rules relating to government borrowing and debt that all member countries would have to meet. Member countries who did not obey the rules would not be able to take part in the decision-making mechanisms of the ECB. Furthermore, the ECB should play no part in underpinning the government debt of member countries.
  • A system of liberalised free-banking within which businesses and individuals choose the currency they wish to use.”

You can find more details on the book (and the full book free online) here, at the IEA website. The book will be presented at the IEA on the 9th of May (18:30); see more details here if you wish to attend.

I hope you find it interesting to promote the discussion on these important issues. All comments on our proposal on parallel currencies for the Euro zone will be very welcome.

Juan Castañeda

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