Thursday, August 9, 2012

Going Digital

Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and "The Coming Collapse of the Municipal Bond Market" (, 2009)

Federal Reserve Chairman Ben S. Bernanke is threatening us with "further action" if the economy does not do something or other. (He cannot remember his objective from one press conference to the next, so there is no reason anyone else should.) One view holds the chairman has done all he can, but this underestimates his options. First to follow is a summary of what he proposed in advance and what he delivered. Second, there are some options floating through central-banking channels that should not be dismissed. In conclusion, the consequence may be the end of central banking.

            Reviewing then-Federal Reserve board member (not yet chairman) Ben Bernanke's printing-press speech, he has delivered on his promises. On November 21, 2002, he proposed to drive interest rates down to zero percent. He considered interest rates at the "zero-bound" a solution to a not-as-yet visible deflation (although he and Greenspan trumpeted it). Bernanke delivered the zero-percent rates.

            Should the zero-bound solution fail at the short end of the yield curve, Bernanke "would... try to stimulate spending by lowering rates further out along the Treasury term structure--that is, rates on government bonds of longer maturities." This describes Operation Twist, his current gambit.

            "A more direct method," claimed Simple Ben, "which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt...." This is the current worldwide central-banking process of issuing far more sovereign debt than can be absorbed by functioning markets, so is bought by other central banks to hold government bond rates down. The result is dysfunctional bond, stock, commodity, and currency markets with central banks needing to absorb greater wads of currency reserves since the world's economies are growing more unbalanced, less productive, and use more government financing to fill the larger voids.

            The Federal Reserve governor continued: "Yet another option would be for the Fed to use its existing authority to operate in the markets for agency debt (for example, mortgage-backed securities issued by Ginnie Mae, the Government National Mortgage Association)." Bernanke did not, in his 2002 speech, foresee the Federal Reserve's absorption of an investment bank's (Bear Stearns) bad mortgages (Maiden Lane) in 2008. By doing so, the Federal Reserve and Tim Geithner's Treasury Department broke the law. Since they were praised rather than tossed in the clink, it is probably not a good use of time to consider the legality when evaluating what the Fed might do next.

            On May 9, 2012, the Dutch-born, American economist Willem Buiter, who holds British citizenship, published proposed monetary measures that were nutty enough for all of his citizenships to be revoked. He previously served on the Bank of England's Monetary Policy Committee and is now Citigroup's Chief Economist.

            "He's a monetary nut," opined an email after the publication of Citigroup's May 9, 2012, "What More Can Central Banks Do to Stimulate the Economy?" Well, sure he is. Bernanke's 2002 speech was not thought to pose an immediate threat, by most. It was taken seriously by those on their toes, a nearly extinct species these days.

The monetary nut is distinctly American and should never be dismissed. Near seventy years ago, George F. Warren, Cornell farm economist, came up with the beguiling theory (it beguiled FDR) that the price of gold controlled the price of commodities. John Brooks wrote in Once in Golconda: "To orthodox economists, most of Roosevelt's economists included, the Warren syllogism was a false one. Commodity prices had usually moved with gold prices, they conceded, but the catch was that commodity prices were the cause of this conjunction and gold prices the effect. Warren then, was to orthodox economists just another example of a hardy, perennial, and surprisingly numerous American species, the monetary nut."

Note that, as kooky as this Cornell economist was thought to be by establishment economists (Farm Management (1913), in the Rural Text-Book Series, was his greatest contribution to literature) Warren's false cause-and-effect held sway in the White House. Across the Atlantic, the devalue-dollars-against-gold-and-wheat-prices-will-rise theory was belittled. According to James P. Warburg in The Money Muddle (1933): "Keynes, upon whom [Irving] Fisher [Warren's accomplice - FJS]... leaned heavily for support, described the 'gyrations of the dollar' as 'more like a gold standard on the booze' than an ideally managed currency. And, horror of horrors for Warren, [Keynes] characterized as 'foolish' the idea that there is a mathematical relation between the price of gold and other things."

Yet, it was this crackpot nostrum used by President Roosevelt and Professor Warren to devalue the dollar against gold.  It did not raise commodity prices. 

Back to the Dutch-American-British-Citigroup monetary nut, Buiter proposes that all of the major central banks set nominal interest rates at zero. That is not very interesting anymore. He would also tax currencies. This is not new. Irving Fisher, a monstrous monetary nut, proposed the same in 1933.

Fisher meddled in everything, invoking the "science of economics" as justification for purifying the world: "The most vital problem of the world today is the problem of preventing racial deterioration."(1915) In 1930, he expressed satisfaction before the American Eugenics Society that 6,000 forced, surgical sterilizations were performed in California. This was "breeding out the unfit and breeding in the fit." (A phrase he often repeated). Fisher generally invoked the science of economics to quantify "the value of human capital" and "to protect the existing elite." If not, "then surely the dark ages lie ahead...for the Nordic race."(1921) Fisher is still revered today, often considered the greatest American economist. One can understand why.

A more exciting proposal by Buiter falls on page six of his 18-page blueprint for human annihilation. We should move to a "cashless society with E-money only." Buiter concedes: "There undoubtedly are legitimate reasons for households and businesses to wish to preserve anonymity in their financial dealings." Buiter liquidates these qualms, along with human privacy since "some of the main beneficiaries of the existence of state [currency]... are the grey, underground and black economies." Citigroup's chief economist goes on to blame state currency for "inadvertently subsidiz[ing] those engaged in such illegal activities as money laundering, tax evasion and funding terrorism and other criminal activities, at home and abroad. It would, in our view, be worth getting rid of currency." In other words, we are all terrorists, now.

            This Nordic wonder misses the point that the very reason he is proposing such abstract solutions is the failure of state currencies, and the reaction to taxing or eliminating them would probably be a complete break in trust. The most obvious question that seems never to be asked would rise front and center: "Why does the government hold a monopoly on money? Why is it even involved, since dollars are simply a means to buy and sell things among ourselves?" An abundance of activities would move to the black market. Buiter's plan could be enormously liberating. Buiter's and Bernanke's human capital would trade at the zero-bound.

            Buiter's digital money contains a practical aspect. He wants real interest rates to be negative. They already are, but the Flying Dutchman wants really negative interest rates. To accomplish this, the state would manage two currencies, the "dollar" and the "rallod," in Buiter's description. Read it if you like, but time would be better spent collecting your own alternative currencies:

"Clearly, the abolition of currency and the taxation of currency would take time and involve non-trivial administrative and implementation costs. But introducing a floating or managed exchange rate between commercial bank reserves with the central banks (dollars, say) and a new currency (rallod, say) could be implemented overnight. A minus 5% interest rate (annualised) on commercial bank dollar reserves with the central bank, for instance, would require the forward exchange rate of dollar reserves in terms of rallod bank notes (which carry a zero interest rate), to be five percent (at an annual rate) stronger than the spot exchange rate. If the authorities fix the next period's spot exchange rate at the same level as this period's one-period-ahead forward rate, then the certain appreciation of the dollar in terms of the rallod would make up for the interest differential in favour of the rallod. So there would be no pure arbitrage opportunities."

Buiter italicized "certain." Fisher, Bernanke, Buiter: In pursuit of certainty, they produced chaos.