Understanding digital currencies via the money tree

The Czech central bank Vice Governor, Mojmir Hampl had earlier remarked:

the positive philosophical influence of bitcoin on the conservative world of central banking. True, it is far from clear that anytime soon a full-fledged digital currency (be it blockchain based or not) will be created by a central bank (some of you may be following the debate in the Riksbank in Sweden), but the last three years have seen an explosion of research on this idea in many central banks. Bitcoin must be credited for this powerful intellectual stimulus. When so many professors at the most esteemed universities of the developed world are not thinking about potential reforms of the current monetary order, we have received a stimulus from the libertarian IT guys instead. Fine.

The intellectual stimulus has been amazing as one is getting to read so much on money and its basics.

BIS researchers gave us the money flower:

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RBI’s woes spreading from banking regulation to cash management..

It is quite surprising how cash crunches are becoming common since Demonetisation in Nov-2016. We also have issues of some denomination of currencies are not accepted like Rs 10 and small amount coins.

It is for nothing that scholars who studied money and its history advised never to interfere with money. For instance, Milton Friedman quoted John Stuart Mill:

Cash crunch in parts of India?

There are reports coming from different corners about cash crunch and empty ATMs.

• 4 states : MP, Gujarat, UP and MP
• Andhra Pradesh
• More from Gujarat
• MP Chief Minister calls it a conspiracy:

Madhya Pradesh chief minister Shivraj Singh Chouhan on Monday alleged a conspiracy aimed at creating cash crunch in the market by hoarding Rs 2000 currency notes and warned that the government will act sternly against the perpetrators.

“When demonitisation took place, markets were flooded with currency notes worth Rs 15 lakh crore. Today, Rs 16.5 lakh crore currency notes have been printed and circulated. But where are the Rs 2000 currency notes vanishing? Who is hoarding them? Who is creating currency crunch?” Chouhan asked a large gathering of farmers at Shajapur district headquarters. 

 

Cultural differences in monetary policy preferences

An interesting paper by Prof. Adriel Jost of Univ of St Gallen and Swiss National Bank.

The monetary policy preferences of a population are often explained by the country’s economic history. Based on Swiss data, this paper indicates that while different language groups may share the economic history, they demonstrate distinct monetary policy preferences. This suggests that distinct monetary policy preferences among the populations of different countries may be determined by not only their economic histories but also their distinct cultural background.

The author tries to figure the differences using several tests and datasets. For instance:

Is India a currency manipulator?

The US Treasury in its semi-annual currency report to the Congress has added India on the watchlist of currency manipulators:

Treasury has established a Monitoring List of major trading partners that merit close attention to their currency practices and macroeconomic policies. An economy meeting two of the three criteria in the 2015 Act is placed on the Monitoring List. Once on the Monitoring List, an economy will remain there for at least two consecutive Reports to help ensure that any improvement in performance versus the criteria is durable and is not due to temporary factors. As a further measure, this Administration will add and retain on the Monitoring List any major trading partner that accounts for a large and disproportionate share of the overall U.S. trade deficit even if that economy has not met two of the three criteria from the 2015 Act. In this Report, the Monitoring List comprises China, Japan, Korea, Germany, Switzerland, and India, the latter being added to the Monitoring List in this Report.

Why India has been added?

India increased its purchases of foreign exchange over the first three quarters of 2017. Despite a sharp drop-off in purchases in the fourth quarter, net annual purchases of foreign exchange reached $56 billion in 2017, equivalent to 2.2 percent of GDP. The pick-up in purchases came amidst relatively strong foreign inflows, both of foreign direct investment and portfolio investment. Notwithstanding the increase in intervention, the rupee appreciated by more than 6 percent against the dollar and by more than 3 percent on a real effective basis in 2017. India has a significant bilateral goods trade surplus with the United States, totaling $23 billion in 2017, but India’s current account is in deficit at 1.5 percent of GDP and the exchange rate is not deemed to be undervalued by the IMF. Given that Indian foreign exchange reserves are ample by common metrics, and that India maintains some controls on both inbound and outbound flows of private capital, further reserve accumulation does not appear necessary.

Hmm.

In the earlier report, Treasury had said it is watching India:

Over the first half of 2017, there has been a notable increase in the scale and persistence of India’s net foreign exchange purchases, which have risen to around $42 billion (1.8 percent of GDP) over the four quarters through June 2017. India has a significant bilateral goods trade surplus with the United States, totaling $23 billion over the four quarters through June 2017. Treasury will be closely monitoring India’s foreign exchange and macroeconomic policies.

Mint edit says India is not a currency manipulator:

How are countries accused of currency manipulation by the US Treasury actually identified? There are three parameters that are used, sometimes unthinkingly. First, a country has to run a significant trade surplus of over $20 billion with the US. Second, it is judged not by the amount of currency intervention but whether such an operation is a one-sided attempt to keep the exchange rate down, measured in terms of additional foreign exchange reserves as a percentage of gross domestic product (GDP). Third, a country should have a large current account surplus with the rest of the world. How does India fare on these three fronts?

India does have a $23 billion trade surplus with the US, though that is dwarfed by the $375 billion trade surplus that China runs with the US. Mexico, Japan and Germany have far bigger bilateral trade surpluses. The net foreign exchange purchases by the RBI in 2017 amounted to 2.2% of GDP, which is close to what Thailand, Taiwan and Switzerland have done. And India is the only one of the countries on the US Treasury list that has a current account deficit with the rest of the world. Countries such as Thailand or Mexico were considered far more likely than India to be identified as potential currency manipulators.

Do Indian policymakers have to worry? They should not in normal times. The mechanical way in which the US Treasury interprets its three main parameters for identifying currency manipulation is almost scandalous. Also remember that the US has not yet formally accused China — with its notorious mercantilism — as a currency manipulator. US President Donald Trump had promised during his election campaign to treat China like a currency manipulator. If a country such as China with a massive bilateral trade surplus with the US, a large current account surplus with the rest of the world, and historically unprecedented management of its exchange rate is still only on the watch list, then the chances of India being actually termed a currency manipulator are slim.

The problem is that these are not normal times. Trump is merrily charging into a trade war that has much of the world on tenterhooks. He believes American workers are getting pushed into a corner because of trade partners who get preferential treatment in free trade agreements, or who strategically use trade barriers, or who keep their exchange rates artificially low to promote exports to the US. The new list released by the US Treasury needs to be seen against this background.

Indian policymakers have to be sensitive, without actually overreacting, to the risk that Trump may move from rattling the sabres to actually using them. India has traditionally tried to balance between preventing excess currency appreciation on the one hand and protecting domestic financial stability on the other. Much now depends on how the Indian government and the Indian central bank respond to the implicit US threat — but the two most obvious consequences could be an appreciating rupee as well as excess liquidity that messes with the interest rate policy of the RBI.

Ira Dugal discusses on BQ:

While there is no doubt, that India is now comfortable on forex reserves, the Treasury Department’s own data shows that its reserve accretion in 2017 and level of reserves is comparable to the other trading partners of the U.S.

The report also looks at adequacy of reserves slightly differently from the RBI by measuring it mostly against short-term debt. However, in a 2015 paper, RBI staffers had pointed out that India may need to consider factors other than the traditional metrics of forex reserve adequacy. One such factor is potential volatility of foreign portfolio inflows, since such flows are a significant source of financing India’s current account deficit.

Finally, while supporting the employment generating export sector is not the RBI’s mandate, it would be justified in keeping an eye out on that aspect too. As a flexible inflation targeting central bank, growth is still broadly part of the RBI’s mandate. To the extent that the currency impacts exports, which in turn impacts growth and employment, the Indian central bank would be justified in ensuring that the value of the currency is not wildly out of line with fundamentals just because of a surge in capital flows.

The geo-politics of currency markets…

Evolution and experiences with inflation targeting in different countries..

Interesting conference and set of papers at recently concluded conference by Reserve Bank of Australia .

Reading keeps piling up.

The paper on New Zealand Inflation Targeting is important given NZ has added employment to its price stability mandate.

High-denomination Banknotes in Circulation: A Cross-country Analysis

Interesting research by Gordon Flannigan and Stephanie Parsons of Reserve Bank of Australia in the central bank’s revamped Bulletin.

They try to see the reasons behind demand for High Denomination notes in Aus, Canada and UK:

In Australia, Canada and the United Kingdom, the number of high-denomination banknotes in circulation has increased at an above-trend rate in recent years. Evidence suggests that overseas demand might be a common driver of this elevated growth. Increased domestic demand for both transaction and store-of-value purposes may also have contributed, as well as responses to changes in government and central bank policies. This research was undertaken with assistance from members of the Four Nations Distribution Working Group, in line with the group’s objective to explore banknote-related topics that are directly relevant to the member central banks.

The overseas demand is mainly from Asian countries:

A key source of overseas demand for AUD 100 and CAD 100 banknotes appears to be Asia. Liaison with the cash industries in Australia and Canada suggests that there has been an increase in the proportion of AUD 100 and CAD 100 banknotes shipped to Hong Kong and Singapore. For example, in the five years to 2016 it is estimated that 80 per cent of foreign shipments of CAD 100 banknotes were destined for Hong Kong, compared with 60 per cent in the previous five years. Further, it is estimated that shipments of CAD 100 banknotes to Hong Kong accounted for about 5 per cent of all CAD 100 banknotes on issue in 2016, significantly increasing growth in banknotes in circulation in that year. Similarly, partial data from the Australian cash industry suggest that shipments to Hong Kong and Singapore in 2016 were equivalent to about 6 per cent of all AUD 100 banknotes in circulation. The link between Asian demand and GBP 50 banknotes in circulation is less clear. GBP 50 banknotes are primarily demanded by foreign exchange wholesalers abroad, consistent with an overseas store-of-value motive (Fish and Whymark 2015). However, because the British pound is a more prominent reserve currency, offshore demand is likely to be more widespread across countries.

Hmm..

Lots of other ideas and regressions in the study.

It was also interesting to note how government policies in Australia are creating speculation around High denomination notes:

Since peaking in late 2016, growth in demand for AUD 100 banknotes has declined considerably (Graph 4). This may partly reflect heightened uncertainty among consumers and businesses about the future status of AUD 100 banknotes following the Australian Government’s announcement in December 2016 of the formation of the Black Economy Taskforce (BETF). This taskforce aims to investigate and identify where regulations and policies could be introduced to reduce activity occurring outside the tax and regulatory system (excluding illegal or criminal activities). The BETF convening announcement included, among many other options, a discussion around strong demand for AUD 100 banknotes and identified the use of cash as an area to be investigated, generating intense media interest. This announcement coincided with heightened public interest in the future of high-denomination banknotes following decisions in some jurisdictions to withdraw the legal tender status of some high-denomination banknotes (India and Venezuela) or to discontinue production and issuance (euro area).

Daily lodgements of AUD 100 banknotes into cash depots increased sharply after the BETF announcement (Graph 7). It may have been that the BETF announcement, and associated media speculation about the future of AUD 100 banknotes, contributed to uncertainty among the general public and prompted some to spend AUD 100 banknotes that were previously held as a store of value. Liaison with the cash industry has indicated that the increase in lodgements has been evident across a broad range of retail customers, has occurred in most states and has been concentrated in capital cities.

 

Waqf – an economic perspective

A nice speech from  Mr Marzunisham Omar, Assistant Governor of the Central Bank of Malaysia. It is always interesting when central bankers give a much broader perspective than just interest rates and inflation.

In this piece Mr Omar discusses Waqf which is basically endowment in Islam and how to make most of this religious norm.

First some history of Waqf:

Should RBI issue e-rupee? A global outlook..

My new piece in Mint newspaper.

The piece is written in backdrop of RBI setting up a team to study whether it should issue a digital currency. I sum up lessons from several other central banks and central bankers which have studied and spoken on the topic.

 

RBI to review desirability and feasibility to introduce a central bank digital currency

One should not just criticise the Indian central bank but even appreciate where it is due.

In the recent policy, RBI announced that it is studying  central bank digital currency (CBDC):

Rapid changes in the landscape of the payments industry along with factors such as emergence of private digital tokens and the rising costs of managing fiat paper/metallic money have led central banks around the world to explore the option of introducing fiat digital currencies. While many central banks are still engaged in the debate, an inter-departmental group has been constituted by the Reserve Bank to study and provide guidance on the desirability and feasibility to introduce a central bank digital currency. The Report will be submitted by end-June 2018.

One is looking forward to the group’s report (hope they make it public).

Given the massive craze for everything digital and cashless in India, it has been surprising all this while that RBI has been silent on things like CBDC.

RBI is more interested in setting another data centre than inform people on the banking crisis…

It is quite amazing how Indian central bank has gotten away without explaining anything in recent years. The central bank pushed demonetisation on people and showed least sympathy for people’s troubles during the period. Its so called Monetary Policy Committee (MPC) meetings which were supposed to usher transparency were as opaque as it could get. Most MPC statements released then were like “we are based in Ivory towers and do not care”.

Now, its recent monetary policy does not even mention ongoing crisis in banking. The RBI chief recently shrugged off responsibility saying it does not have power to regulate public sector banks. But we have seen similar troubles at the leading private sector bank as well.

Least you imagine that central bank officials will say something on the matter in the monetary policy on 5th April 2018. But there was nothing in the MPC statement released today.  All it says is this winding statement which hints there is no problem whatsoever in Indian economy:

Rise of cryptocurrencies could curb America’s financial power

Profs. Nicholas Ross Smith  (University of Nottingham) and Zbigniew Dumieński (University of Auckland) in this piece:

In economic terms, the replacement of the US dollar with some kind of a decentralised digital currency would obviously reduce the influence that the US’s financial institutions have on the global political economy. It would also drastically increase its costs of borrowing. This would make the US’s currently heavily indebted position untenable, removing any relative advantage it currently has.

The flow-on effects of this, from an international power perspective, would be that the US would lose some of its ability to exercise effective economic statecraft – such as sanctions, embargoes and freezing of assets.

Also, over time, the US’s prestige of being considered the unequivocal global financial leader would diminish. It would therefore lose some of its insulation from the process of broader decline as other powers rise.

So even if there is a collapse in cryptocurrency (nearing one), we atleast have ways to think about curbing US financial clout:

Paradoxically, given how it could hinder US power, the US is actually among the fastest adopters of cryptocurrencies to date. Despite some strong federal-level resistance, some US states have made it legal to pay taxes in cryptocurrencies.

Its tech hub, Silicon Valley, is also home to many of the important ongoing advances related to cryptocurrencies, making the US something of an unwitting epicentre of the current revolution.

Of course, cryptocurrencies are not without their problems. Many have grown into massive speculative bubbles that are extremely sensitive. Recently, based on fears of a looming ban on adverts by Google, the value of all the world’s cryptocurrencies dropped by more than US$60 billion in a day.

But, as commodities expert Dominic Frisby points out, even if a collapse happens, the usefulness of the technology pioneered by the cryptocurrency boom will remain. Consequently, cryptocurrencies, in some shape or form, are here to stay. And because of this, their potential subversiveness to US power will remain.

It is surprising how few people get this aspect of cryptocurrency. I agree these are highly volatile and do not have all the characteristics of traditional money. But they provide hope from the government and central bank abuse of monetary powers..

Reviewing the role of Central Bank Board in New Zealand (applies to other central banks)

Michael Reddel’s Croasking Cassandra blog is not just the goto blog on NZ economy but one can draw lessons generally as well.

In this post, he questions the role of Board of central bank of New Zealand:

The Board has not done, and is not doing, a good job.  It is set up by Parliament to serve our interests –  public, Parliament, and Minister –  but constantly seems to see itself mostly as a servant, and defender, of Bank management.  Those are two quite different roles.  The so-called Charter adds a little more to the list of concerns, and the reasons why the government, as part of the current review, should more seriously consider far-reaching structural change, reconfiguring the role of the Board and the way that public-funded review and assessment functions are undertaken.  The current model isn’t working, at least for anyone other than Bank management.

These issues of governance are much bigger and important questions than the monetary and banking rules we remain obsessed with. A central banjk may be following the most modern methods of economics but if the governance is not right, then all things eventually stand to naught over a period of time.

Royl: A new crypto coin to celebrate the royal wedding..

This bit is interesting:

Love them or loath them, there is no doubt that British Royal weddings can be very big deals, in the UK and across the world. The last one, between Prince William and Kate Middleton, was watched by an estimated two billion people in almost 200 countries with 8,500 journalists covering the event in London.

There is another one in May, in case you needed reminding, between William’s younger brother Harry and his American fiancée Meghan Markle, and to mark the event – along with the usual mountain of red white and blue merchandise – this wedding will have the “world’s first Royal themed crypto-currency,” reports the UK’s Daily Express.

 The aptly-named Royl was to launch on Tuesday and was being sold only via a public “crowd sale” event, as opposed to being first launched, as is usual, through an institutional investor-facing ICO.

The coin is being rolled out by Crown and Country Magazine that says half the money raised will go to three charities supported by the couple – Sentebale, The Invictus Games and The Royal Foundation – while the other half will be used by the magazine to help fund, what else, its special Royal Wedding edition.

Though all this is highly ironical:

A decentralized wedding gift that is going to appeal to the buyer’s financial prowess? Who could begin to argue with that?

Hmm..

Financial Benchmarks India Pvt. Ltd (FBIL): A new organisation to shape India’s government bond and forex markets

Economics textbooks that usually tell you that all you need is a buyer and seller for markets to work on their own. Financial markets are often cited as examples of such markets. But this is so far from reality. We need several systems and organisations to ensure financial transactions between buyer and seller. The so called stock exchange itself is not really a market as we know it but actually a firm which has several other supporting firms and “things” to facilitate the trades.

In this regard, it was interesting to see this recent press release from RBI.

Bank examiners’ expertise and their role in monitoring and disciplining banks during the panic of 1893

Profs Charles Calomiris and Mark Carlson in this paper (ungated older edition) figure whether bank examiners and their inspection add value:

Playing a money game: Fiat money or not…

JP Koning in his super blog plays a money game.

He starts with an initial setting and then asks whether we say we now have fiat money in the economy.

People bandy the term fiat currency around a lot, but what exactly does it mean? None of us wants to live in a Babel where people use fiat to indicate twenty different thing. So let’s try to zero in on what most people mean by playing a game called fiat-or-not. I will describe a monetary system as it evolves away from a pure commodity arrangement and you will tell me when it has slipped into being a fiat system. (The technique I am using in this post cribs from a classic Nick Rowe post).

So let’s start the game. 

There are 9 stages and not clear at which stage we can say fiat money has taken shape:

Here is a collection of unconnected thoughts on the fiat-or-not game.

A) My guess it that readers will have chosen different stages as their preferred debut for fiat money. This is a bit tragic, since with no commonly-accepted definition for the term, most debates about fiat money have been and will continue to be meaningless. 

B) We apply our definitions like cookie cutters to the real world. So if you chose step 7 (when banknotes became permanently irredeemable) as your flipping point, then 1971 would be a very important date in your scheme of the world since this is when the U.S. permanently removed gold convertibility. 

But if you chose step 9 as your transition point to fiat, then the global monetary system is not currently on a fiat standard, since central banks have neither closed their doors nor donated their assets to charity. So 1971 really isn’t an interesting date. I’m aware of only one country on a step 9 fiat standard: Somalia. Its central bank burned down yet Somali shilling banknotes continued to circulate. And ironically enough, if we choose to adopt a step 9 definition of fiat money, then bitcoin—which was designed to destroy central bank “fiat” money—is itself fiat, because it is unbacked, whereas most central bank money is not fiat.

What I’ve described is the Borges problem. Categories pre-digest the world for us. We get very different results depending on what definition we use and how we apply it to the world. 

C) I think many readers associate fiat with hyperinflatable.

D) Fiatness, fiatish? If we can’t agree on what constitutes fiat-or-not, maybe we can agree that there might be a fiat scale, from pure fiat to not fiat at all, with most monetary systems existing somewhere in between. I am already on record advocating moneyness over money, so this fits with the general them of the blog. On the other hand, fiatness seems a bit of a cop-out.

E) We don’t need gobbledygook like fiat. The term carries too much baggage. Let’s select a more precise set of words, then apply them to the real world in order to understand what our monetary systems were like, how they are now, and where we are going. Until we settle on these words, let’s avoid all conversations with the term fiat in them. 

How we just assume fiat money without really figuring what it means. JP’s post says there are several layers to the issue.

Trying to make central bankers accountable for their actions: US edition

From CNBC :

Sen. Elizabeth Warren, a Massachusetts Democrat who has been a staunch banking critic, particularly on issues relating to the Wells Fargo fake account scandal, said she wants a chance to grill Williams before he is appointed. “Mr. Williams’ track record raises several questions, including about his fitness to supervise Wall Street banks given the San Francisco Fed’s inadequate supervision of Wells Fargo during its many consumer scandals,” Warren said in a statement. “If Mr. Williams is selected, the Fed’s Board of Governors should not approve his selection until Mr. Williams and the co-chairs of the New York Fed’s search committee testify before the Senate Banking Committee about his qualifications and the process that led to his selection.”

The San Francisco Fed has been tarred with the fallout from the Wells Fargo problems. Also, Washington Mutual, which was in the San Francisco jurisdiction, was one of the highest-profile bank collapses during the financial crisis, and much of the savings and loan crisis of the late 1980s revolved around the region.

While it would be hard to place the blame for any of those failures directly at Williams’ feet, his appointment still brings up reminders of a darker place in American banking history. Wells Fargo employees, pressured by aggressive sales quotas that have since been abandoned, created some 3.5 million accounts without customer knowledge. Several high-ranking bank officials were pushed out, as were multiple board members.

“I do know the San Francisco Fed, which gave us Janet Yellen as well, has perhaps overly focused on the monetary and economic functions of the Fed and completely ignored or failed to understand the regulatory functions,” said Dick Bove, analyst at the Vertical Group. “So they have given the United States some of the worst financial disasters in history.”

The emphasized last lines just sum up. Central banks have ignored the basic regulation function all this while and preferred to get lost in the jazz world of monetary policy.

One might say this is a case of too little too late. But atleast they are trying. Making central bankers accountable for their decisions or lack of them is the least talked about aspect of central banking. The academia has barely discussed these issues and always focusing on giving the already highly independent central banks more independent. Given how banking messes have become so entrenched across the world, one is wondering what is going on.

 

Women on banknotes are associated with greater gender equality (what about banknotes in India?)

Hansika Kapoor in this superb Mint Sunday piece looks at images on banknotes. More specifically, she analyses whether having women on banknotes in different countries also reflects in higher gender equality.

There does seem to be an association:

Slovenia’s central bank governor quits after death threats

All kinds of things happening in monetary world. I had pointed how the Ukraine central bank’s governor got coffins outside the office.

Last week, Boštjan Jazbec, the Governor of Slovenia central bank quit due to death threats: