Archive for the ‘Financial Markets/ Finance’ Category

Lesson from history of Rothschilds and US free banking

September 17, 2019

Lars Rhode, Governor of Denmark Central bank in this speech speaks on trust in financial services (what else to talk!).

My topic is trust and transparency in the financial system.

In recent years, the topic has surfaced again following a number of unfortunate issues that have accumulated since the financial crisis. For a long time we may have thought that this was primarily a problem that existed outside Denmark’s borders. But then cases emerged in Denmark too. There have been money laundering cases, there have been deliveries of very large banknotes to bureaux de change, and incorrect advice has been provided in connection with investment  products. The financial sector has been involved in transactions that have drained the government  coffers of many billions of kroner in dividend tax. And I am sure we could find more examples.

What these examples have in common is that they contributed to undermining trust in the financial system. Trust is low at the global level. That  has been documented by the Edelman Trust Barometer. In fact, one of the key messages in the Edelman analysis is that the financial sector is the sector that people trust the least. Danish surveys also point to low trust in the financial sector.

He picks examples from Rothschild and US free banking:

How can we learn more about the present and about how to shape the future? One way is to look back and learn from history. So I would like to start with two examples from the past.

I will begin in the 18th century. More specifically with the Rothschild family dynasty. It was founded by Mayer Amschel Rothschild. He was the head
of a poor family comprising his wife and 10 children. The family lived in Frankfurt in the late 18th century. Good ideas combined with unusual
willpower gave Mayer Rothschild a point of departure for forging business relationships with powerful men in the area. He also dispersed his
sons across Europe. The sons established their separate trading firms and were successful. Especially the son in London was doing well. He
soon became so rich that he could lend money to the Duke of Wellington. In 1814, this son became the British government’s secret banker for funding the Napoleonic wars.

My other retrospective example relates to a period of around 30 years in mid-19th century USA. Before this period, every single bank in the USA
had to have a charter through special legislation for that specific bank.  However, this changed when many states began to introduce state charters describing the general requirements to be met by banks that wanted a licence to operate. This period has been called the “free banking” era .because anyone meeting the relevant state’s banking requirements could establish a bank. 


What can we learn from these two historical examples? Firstly, I note that the people involved also took on the risk – they all had something at  stake. It was their own money – or their close business partners’ money – that was lent. That gave them an incentive for sound risk management. They were focused on behaving in such a way that their good names and reputations and their wealth were not jeopardised. That is no longer the case.

Today’s banks are so large that no individual or small group of people can own and operate a big bank. This means that there is no longer a close link between those bearing the risk, the owners, and the day-to-day management. When shares are as widely dispersed as they are in most Danish banks, everyone is responsible, which ultimately means that no-one takes on the responsibility. Being owned by everyone is the same as being owned by no-one.

Secondly, I note that the market plays an important role. It is good if clients vote with their feet.

You might ask whether things had been different today if we had learnt more from history.

Banking clearly has swung from one extreme to another. In earlier days it was common for banks to fail with minimal protection and markets voting with their feet. Now even bad banks do not fail..



Liquidity and funding for banks under resolution

September 17, 2019

Should the central bank provide liquidity to banks under resolution? A bank needs both capital and liquidity to survive. A bank fails if it has either of the two.

Torbjørn Hægeland, Executive Director of Norges Bank Financial Stability, in this speech discusses the policy options:

resolved or not, a bank not only needs sufficient capital, but also needs sufficient liquidity. Payment intermediation is a vital core function of banks. Being a bank means participating in the settlement of payments, which means the bank must be liquid. How liquid is a bank that opens on a Monday morning after being resolved over the weekend? A newly resolved bank is not necessarily liquid for various reasons.

One reason is that prior to resolution, the bank will probably have depleted almost its entire stock of liquid assets, including securities eligible as collateral for Norges Bank’s standing liquidity facilities.

Moreover, immediately after resolution, other money market participants may have doubts about the bank’s viability, despite the recapitalisation that has taken place following the decision of the resolution authority. This may be the case particularly if a long time has passed since a bank has been resolved. The market will then be unfamiliar with the bank resolution process and the profile of a resolved bank. The result may be that the bank will have difficulty borrowing in the money market.

In this situation, the bank will need liquidity assistance and will turn to the central bank as an obvious source of support. Liquidity assistance to resolved banks is an issue under consideration by a number of central banks. The ECB is currently working on this issue, as we at Norges Bank are also doing. 

The question I will focus on here today is:

How should Norges Bank react when a bank under resolution applies for emergency liquidity assistance (ELA)?



MARTIN Has Its Place: A Macroeconometric Model of the Australian Economy

September 16, 2019

A team of economists at RBA in this paper explain their macro model MARTIN:

This paper introduces MARTIN – the Reserve Bank of Australia’s (RBA) current model of the Australian economy. MARTIN is an economy-wide model used to produce forecasts and conduct counterfactual scenario analysis. In contrast to other large-scale models used at the RBA – and at many other central banks – which adhere to a narrow theoretical view of how the economy operates, MARTIN is a macroeconometric model that consists of a system of reduced form equations built to strike a balance between theoretical rigour and empirical realism.

Most of the model’s equations align closely with the way RBA staff typically interpret the behaviour of individual economic variables. However, combining these individual equations in a system can bring fresh insights that are not possible without model-based analysis. In the paper we provide an overview of the model, outline its core behavioural equations and describe its empirical properties. The Online Appendix presents the full set of model equations.


History of GDP goes beyond the usual narrative

September 16, 2019

Jacob Assa in this paper says GDP is more of a political construct and symbol of power:

Histories of Gross Domestic Product (GDP) – both critical and favorable – have become somewhat of a cottage-industry since the global financial crisis of 2008. Following the Stiglitz Commission, numerous general-audience books have appeared, describing the rise of GDP, analyzing its limitations, and offering reforms or alternatives. These histories, however, suffer from three key problems. First, nearly all begin in the 1930s, following the Great Depression and the lead-up to World War II. Very little if anything is said of the 250 preceding years, a period implicitly thought of as a pre-history of GDP. Second, and as a result of this limited chronological lens, GDP is considered to be a statistical measure, the shortcomings and merits of which are presented as technical and ascribed to the narrow objectives facing its 20th century architects. Third, the proposed reforms are meant to improve on GDP’s statistical limitations (e.g. using dashboards, accounting for unpaid care-work or environmental costs etc.).
These three problems are related, and this paper presents an alternative history of national accounting, considering geo-political and political-economy contexts going back to the 17th century. This longer and broader view reveals the exercise of estimating national income or wealth as a form of numerical rhetoric. Rather than a statistical measure, GDP is an indicator of power (for countries, classes and industries) as well as an instrument for advocating specific policies. Therefore, any critique must go beyond technical issues and fixes, and look at the political context and consequences of various historical versions of GDP, and any possible democratic reform of it.

Rothschild emerges from the shadows for the Centenary of the London Gold Fixing

September 16, 2019

Ronan Manly has a must read post in Bullionstar. 2019 marks the 100 years of fixing of world gold prices!:

This month in London marks the 100th anniversary of the first “London Gold Fixing”, the infamous daily meeting of a secretive cartel of bullion banks which has met since 1919 to set benchmark gold prices used throughout the international gold market, a meeting which continues to this day through its thinly disguised successor, the LBMA Gold Price auction.

London gold price benchmarks are critically important to the global gold market because they are used as a valuation source for everything from ISDA gold interest rate swap contracts to gold-backed Exchange Traded Funds (ETFs), and everything from OTC gold contracts to transaction reference prices used by physical bullion dealers when purchasing gold bars and gold coins from refineries and suppliers.

Since 2015, the London Gold Fixing has been known as the LBMA Gold Price following a rush by the London Bullion Market Association (LBMA) bullion banks to patch over the then scandalized  ‘Fixing’ in a smoke and mirrors and circle the wagons relaunch and renaming exercise. The collusive Gold Fixing first formally came into existence on 12 September 1919 when the Bank of England tapped its favorite bankers N.M. Rothschild & Sons to be the daily Fixing’s permanent chairman. Rothschild and the Bank of England had been joined at the hip since the early 1800s and would continue to be so in the Gold Fixing throughout the next century.

The 1919 launch of the Gold Fixing by the Bank of England and Rothschild succeeded a more informal version of a gold fixing that had existed up to the outbreak of the First World War in 1914, which consisted of a meeting of four London gold brokers Mocatta & Goldsmid, Samuel Montagu, Sharps & Wilkins, and Pixley & Abell who between them set a daily gold price at the offices of Sharps & Wilkins.

For the next 85 years from its inception in September 1919, the Gold Fixing occurred daily at Rothschild’s headquarters in New Court, St. Swithins Lane, across the road from the Bank of England, with five men from five bullion banks religiously meeting at 10:30 am each morning. After the collapse of the London Gold Pool in 1968, the Gold Fixing moved to a twice per day pricing with an extra 3:00 pm meeting added by the fixers to ‘watch over’ the US morning hours gold market.

Rothschild would remain as the Gold Fixing’s permanent chairman until May 2004 at which point the fabled investment bank mysteriously departed the gold fixing and stepped back into the shadows after 200 years in the London Gold Market. Until now that is, for in one of its rare re-appearances, the LBMA’s seminar and cocktail reception to celebrate the Gold Fixing’s centenary took place this week at, you guessed it,  NM Rothschilds’ headquarters in St Swithins Lane.

Lots of history!

250 years of history of covered bonds

September 12, 2019

On 29 Aug 1769, Frederick II led discussions on the introduction of a new financial instrument, which was later sealed by a cabinet order signed in Wrocław (Breslau) which in in Poland today. The year 2019 marks 250 years of covered bonds.

EBRD reviews this fascinating history of covered bonds:

Financial innovation is as old as the financial sector itself. But sometimes we can move forward by dusting off instruments that have been in our tool box for a long time, adapting them to modern usage and applying them, in order to address contemporary challenges. Such is the case with covered bonds.

First introduced by Frederick II of Prussia exactly 250 years ago, covered bonds have now become a major building block in efforts to build safe and efficient capital markets in many central and eastern European countries.

And perhaps it is not accidental that the forerunner of the modern covered bond framework was initiated in Breslau. Today, the city is called Wrocław and belongs to Poland – one of the countries where the EBRD has played a major role in developing the capital market as the “engine room of a modern economy”.

While the economies in this region have been growing strongly over the past 30 years, the development of capital markets was not able to fully keep up with this pace. Whereas the central and eastern European countries currently account for 8 per cent of the EU’s total GDP, their capital markets represent only 3 per cent of all listed shares and debt.

Yet, capital markets are essential for the functioning of a modern economy. In the case of central and eastern Europe, we still see an overdependence on bank finance, with associated problems such as access to finance and a persistent gap between demand and supply.

It demonstrates that capital market development is one of the key pressing challenges for these countries to secure their advances and lay the groundwork for further progress. It is here that covered bonds, as a long-term funding tool, come in.

Covered bonds are debt securities issued by banks and backed by a portfolio of mortgages. They are not a panacea, but they are an important and efficient source of long-term, low-risk funding. They can benefit issuers, investors, market participants and the public by stimulating the real economy with their vitalising impact on the housing market.

There is a book which looks at usage of covered bonds across the world economies.

Switching costs in the Finnish retail deposit market

September 11, 2019

Tuomas Takalo of Bank of Finland in this paper:

I calibrate switching cost for the Finnish retail deposit market by using the approach developed by Oz Shy (2002). It turns out that switching costs faced by deposit customers of the main banks are high, ranging from 200 euros to nearly 1,400 euros. Over the past 20 years, switching costs have increased by roughly 50% in real terms, but in relation to average account balance, switching costs have not essentially changed. I conjecture that differences in the switching costs among the Finnish banks might be explained by differences in their loyalty programs.

Switching costs look really high for Indian depositors too and need to be worked out…

When people worried over surveillance powers of e-money way back in 1975..

September 10, 2019

Came across this interesting publication : Computers and People written way back in 1975 (HT: JP Koning blog).  In the publication, several people have written on computers and applications in 1975.

Paul Armer, Center for Advanced Study in the Behavioral Sciences at Stanford Univ writes on Computer Technology and Surveillance.

His take on Electronic Fund transfer (ETFs) is quite interesting and should be read by one and all. ETFs were just beginning to take shape back then.

Let me now turn to a new topic. Several times I have” referred to situations where the technology under discussion was developed for reasons other
than surveillance, but it happens that it is useful for surveillance purposes. As a prime example of this I want to talk about electronic funds transfer
systems. I can’t give you a detailed definition of an electronic funds transfer system (usually referred to as EFTS) because the system hasn’t been built.
Its final form will be an outcome of intensive com- petition, and also of government regulation. But the general form is reasonably clear. Terminals
will exist in stores, hotels, restaurants, etc. (where they are referred to as point-of-sale terminals), and in financial institutions, including un- attended terminals miles from the nearest office of the institution. In short, terminals will be at any location apt to have a large number of non-trivial financial transactions.

To give you an idea of how powerful a surveillance system an EFTS would be, consider the following. In 1971 a group of experts in computers, communication,
and surveillance was assembled and given the following task: Suppose you are advisors to the head of the KGB, the Soviet Secret Police. Further, suppose
that you are given the assignment of designing a system for the surveillance of all citizens and visitors within the boundaries of the USSR. Further,
the system is not to be too obtrusive or obvious.

Not only would it handle all the financial accounting and provide· the statistics crucial to a centrally planned economy; it was the best surveillance system we could imagine within the constraint that it not be obtrusive. That exercise was almost four years ago, and it was only a two-day effort. I am sure we could add some bells and whistles to increase its effectiveness somewhat.

But the fact remains that this group decided that if you wanted to build an unobtrusive system for surveillance, you couldn’t do much better than an EFTS.

Naturally, the EFTS proponents believe that laws could be written to prevent abuse of the system. I am less sanguine. I’m not concerned about the
bankers invading my privacy or using the system for surveillance purposes; but I am afraid that EFTS system operators may be unable to resist pressures
from government to let the EFTS be used for surveillance. There are in existence today computer systems which could be used in exactly this way, although
the number of financial transactions involved is comparatively small. What I haVe in mind here are the credit authorization systems of National BankAmericard, Master Charge, American Express, and various check authorization systems. All can have individual accounts flagged. If an individual tries to make a purchase, or tries to cash a check, the system is interrogated. If the account has a special flag the police (or whoever) can be notified where that individual is at that very instant.

Check authorization systems are especially subject to such abuse because they depend on the police for information about bad check passers and for information on forgers for their computer data bases. I have no doubt that such systems have already been so abused. 

He quotes Orwell’s 1984:

Why should we be so concerned about surveillance? I don’t think I can put it any better than Henry Goldberg did in a recent ” 1984 is really a state of mind. If
you are always tied to the consequences of your past activity, you will probably adopt a ‘don’t stick your neck out’ attitude. This would create a pressure towards conformity, which would, in turn, lead to a society in which creativity would be an early victim and the democratic ideal of a citizenry with
control over its own destiny would not flourish for long.

In a recent speech Professor Philip B. Kurland pointed out that we will not celebrate the 200th anniversary of the U.S. Constitution until 1987,
and that before we can do so, we must successfully get past 1984. He further said that if he were in charge of some Bicentennial celebration, he would
require all participants to read Orwell’s “1984” to show what the new nation was created to avoid. I would extend the advice to those concerned about
electronic funds transfer systems. And to “1984” I would add the recently published “The War Against the Jews – 1933 to 1945″ and Tom Houston’s memo on domestic intelligence, which was issued to all American intelligence agencies in President Nixon’s name on July 23, 1970. The book “1984” shows what might happen; the latter two documents detail actual events.

It is amazing how people foresaw all these things when these ideas were just coming up. Yet, very little attention is paid to issues of privacy and surveillance when it comes to digital payments….

British stock markets from 1829-1929

September 10, 2019

Interesting piece by Gareth Campbell, Richard Grossman and John Turner:

Although long-run stock market data are an important indicator, obtaining them is challenging. This column constructs new long-run broad-based indices of equities traded on British securities markets for the period 1829-1929 and combines them with a more recent index to examine the timing of British business cycles and compare returns on home and foreign UK investment. One finding is that the capital gains index of blue-chip companies appears to be a good bellwether of macroeconomic behaviour.

Can we use these stock market indices to understand British macroeconomic fluctuations over the long run? We use Chadha et al.’s (2000) catalogue of business cycle peaks and troughs from 1857 to 1954, and the OECD indicators on reference turning points from 1955 to 2018.  We construct business cycle diagrams in the style of Burns and Mitchell (1946). For each of the business cycles, we rebase the blue-chip index to be 100 at the cycle peak and then focus on the four-year period around this point. We then take the average value of the rebased index each month across all of the business cycles (Figure 4).

Figure 4 Blue-chip index performance over the business cycle, 1857-2018

The capital gains index of blue-chip companies appears to be a good bellwether of macroeconomic behaviour. During the two years prior to the business cycle peak, the index increases by an average of 10.7%. The index peaks one month before the peak of the business cycle, and then declines steadily thereafter. The index bottoms out 20 months following the cyclical peak, losing an average of about 7.0% from its peak value.

Superb bit of history…


Who let the economist out?

September 9, 2019

This is an ouch piece by Jinoy Jose P in Business Line.  It reviews the recent book by Binyamin Appelbaum, of The New York Times: The Economists’ Hour: How the False Prophets of Free Markets Fractured Our Society.

Why did God create economists? “To make weather forecasters look great.” Jokes apart, the jury is still out on whether economists have made any significant and meaningful contribution towards greater common good, especially whether they have really been able to foresee or forestall economic crises. As they say, most of the tom-tommed economists have been so ‘successful’ at predicting financial crises that they have forecast 11 of the past eight financial crises in the past 40 years.

What’s funnier is that despite all the mighty mishaps that wrecked economies, businesses and, most importantly, lives of billions of common people across the world, economists command immense clout in policy-making worldwide and many of their ‘chic’ and controversial decisions continue to wreak socio-economic havoc.

This is not to say all economists are fake and all of economics is hokum. From Adam Smith, Karl Marx and John Maynard Keynes to Amartya Sen and Thomas Piketty, there have been an eclectic mix of economists whose ideas have changed the world in unimaginable ways,helping lift millions out of poverty. But not many of them won awards or went on to chair panels that created policies. In fact, a lot of them are still underrated and most of the overrated and popular economists are, sadly, doing counterproductive work that create economic disparity and inequality in society.

Popular among them are the champions of the free market. As Binyamin Appelbaum, an editorial board member of The New York Times, writes in his well-timed and well-researched new book, The Economists’ Hour: How the False Prophets of Free Markets Fractured Our Society, “the triumph of free-market economics is sometimes illustrated by a satellite image of the Korean peninsula at night, the southern half illuminated by electricity, the northern half black as the surrounding ocean.”

Which means, lying adjacent to all the glossy prose we read about the success of the free market in bringing prosperity to its benefactors is the story of a dark continent of extreme inequalities and poverty that nobody really cares about.

The 2008 crisis wrecked the profession of economists and the effects of it continue…

Future of cash in Switzerland is bright even as cashless payments become more important

September 6, 2019

SNB released a new CHF 100 note and its chief gave a speech.

He says cash and digital cash are complementary:

The digital transformation taking place in our economy is also affecting developments in the payments arena. As part of its statutory mandate, the SNB must not only ensure the supply and distribution of cash but also facilitate and secure the operation of cashless payment systems. A well-functioning payment system is critical for our economy.

Technological progress is also changing customers’ expectations and needs in terms of  cashless payments – for instance as regards speed and user-friendliness. In this area too, the SNB is a participant in innovation. Specifically, we are ensuring that Swiss Interbank Clearing (SIC) – our country’s powerful infrastructure for transacting cashless payments in Swiss francs – continues to work quickly and efficiently and thus remains as attractive as possible.

Promoting and ensuring both the supply of cash and the smooth functioning of cashless payments is no contradiction. The various payment methods satisfy the differing needs of our population. Our latest survey on payment methods, published in May 2018, showed that the public’s use of – and affinity for – cash remains high. It also confirmed that the Swiss population like to be given the choice between paying cashless or paying with notes and coins.

Banknote circulation in our country has increased steadily in recent years. Cash is used and valued for a variety of reasons, and not just out of habit or reluctance to adopt new technology. Cash can be used everywhere and is less dependent on technical infrastructure. Cashless payments are likely to become more important over time. I am nevertheless convinced that the future of cash, and thus of our new banknote series, is bright.


Profile of Atif Mian

September 6, 2019

IMF’s Finance and Development Sep-2019 edition profiles Atif Mian who is increasingly worried over our addiction to debt:

Everyone knows someone who buys more than he or she can afford. This has been characterized mockingly as millennials spending beyond their means on avocado toast and expensive lattes, often borrowing to fund those wants. But in the modern era, dependence on credit isn’t a sign of profligacy, according to Atif Mian, a Princeton professor of economics, public policy, and finance. Rather, he argues, excessive borrowing is evidence of an economic system that has become distorted by widening income inequality.

“It’s almost as though the modern economy has become addicted to credit,” Mian says. “We need to understand how, and why, that happened.”

The 44-year-old Pakistani-American has done much to shed fresh light on our modern-day addiction to debt, and in the process, to proffer a new thesis for the greatest economic downturn in more than half a century. He and coauthor Amir Sufi, a University of Chicago finance professor, offer a novel take on the Great Recession in their 2014 book, House of Debt. The book helped land Mian on that year’s list of the world’s 25 most influential young economists, compiled by the IMF.

The authors parse vast amounts of data to show that a dramatic rise in household debt among borrowers least able to repay helped precipitate the greatest global financial crisis since the Great Depression. In their book, they argue that policymakers erred by focusing excessively on the banking system and in bailing out banks, not borrowers.

Sufi says their research has helped put household debt much more prominently on the radar of the IMF, the Federal Reserve, the Bank of England, and central banks of Australia, China, and Israel.

In the five years since the book’s publication, Mian and Sufi have broadened the scope of their research, focusing on household debt and economic inequality. Their more recent work links the worsening of household debt since 1980 to the rise of the superrich. They connect increased income inequality to the concentration of vast amounts of wealth, which has flooded the economic system with easy credit that fuels consumption, rather than contributing to economic growth through real investment.


What Martin Luther and history of printing technology can teach us about bitcoin..

September 6, 2019

Max Gulker has a fascinating piece on why bitcoin supporters (maximalists) need to be patient. They need to learn from history of printing technology and how Martin Luther used printing to further his cause:

….somewhat counterintuitively, if blockchain and the concept of cryptocurrencies truly has world-changing potential, we should still have very little idea how to use it. Blockchain is a foundational technology, useful primarily for the applications (like Bitcoin) built to run on top of it. As the dot-com crash illustrated, the discovery process of just what apps people want can be a painful one. But history shows the road from foundational technology to world-changing applications can be much bumpier still.

In the 1440s Johannes Gutenberg developed a printing press capable of mass producing books, and though people knew it was going to be huge it took nearly a century to answer the questions of why and how. That process required not only market experimentation, but a catalyst in the form of one of history’s greatest social disruptions.

In his book Brand Luther, historian Andrew Pettegree gives a fascinating look at the role the Protestant Reformation, particularly its founder Martin Luther and his city of Wittenberg, played in the rise of books as we know them. These events coalesced right when they needed to, for the printing industry had just endured the bursting of a bubble.

After its initial rollout, printing presses became the must-have item for Europe’s wealthy nobility. Within decades (lightning speed by the standards of the era) there were over 200 printing presses scattered across Europe. But what then? To our modern sensibilities, virtually inseparable from books and the printed word, that question seems absurd.

One key missing piece was understanding the economics of the printed word. The wealthy owned plenty of books, but their creation for centuries had been a one-to-one transaction between collector and scribe. Neither the increasingly literate general public, nor the entrepreneurs behind the first printing presses, had any concept of buying a book, going home and reading it.

Like railroads and the internet centuries later, the bubble burst. Nobility supplying the capital lost interest and more than half of Europe’s presses shut down. And even among the survivors it was only twelve presses in major cities that did the vast majority of pre-Reformation printing.

Printing in these early years began to prosper not by disrupting the old order but by serving it. They printed books that were then ornately illustrated by hand, making the production of books as luxury items a bit more efficient. And of particular importance in these urban centers were far more mundane projects done for church and state, such as informational fliers, and quite ironically, indulgences.

A key part of Luther’s initially renegade theology was communicated with ordinary people in their own language. Pettegree shows how this catalyzed the publishing industry to take a major step toward what we know today. Luther became the first bestselling author, publishing books, pamphlets, and his translation of the Bible in German. 

Until that time it was customary not to list the book’s author on the cover or front page unless it was a revered figure from antiquity. But Luther, his theological associates, and the blooming Wittenberg publishing industry perceptively understood the concept of branding. In addition to Luther’s name right up front, they developed a specific look across multiple titles that would become familiar and stand out to people in an ordinary stall.

Same applies to bitcoin too:

Fast forward to today and we rightly expect change to happen faster than it did during the Renaissance. But we still need markets to teach us how to use novel technologies. Bitcoin maximalists who often tout free markets start sounding a lot like central planners when they posit that Bitcoin is and must be the only use of blockchain technology and the only money used across the globe. Given Bitcoin was the first application of blockchain technology, introduced alongside it, the maximalists do not have history on their side.

The other question Pettegree’s book leaves for technology watchers today is that of a catalyst. Many Bitcoin proponents, from the sensible to the maximalist, are libertarians who would like to see a similarly large sea change in society. But the fact is that in 2019, the vast majority of people don’t share these views, and have no problem with their government fiat money.

If, for whatever reason, public opinion shifts either gradually or seismically toward a libertarian outlook, cryptocurrencies might have a similar catalyst. But rather than Bitcoin, at least as we know it, a libertarian reformation of sorts would fuel innovation to create the private currency or currencies most useful for a future we can’t come close to predicting. Rather than protecting a preselected champion, we should all be competition and innovation maximalists.

Hoping Europeans will not be tempted by “treacherous promises of Facebook’s siren call” of Libra..

September 2, 2019

One of the hardest hitting speeches on Libra by Yves Mersch of the European Central Bank.

He starts quoting Madison:

In 1787, during the debates on adopting the US Constitution, James Madison stated that “[t]he circulation of confidence is better than the circulation of money”. It’s telling that Madison chose to use public trust in money as the yardstick for trust in public institutions – money and trust are as inextricably intertwined as money and the state. Money is an “indispensable social convention” that can only work if the public trusts in its stability and acceptability and, no less importantly, if the public has confidence in the resolve of its issuing authorities to stand behind it, in bad times as well as in good.

Madison’s 18th century remark on the link between money and trust has lost none of its relevance in the 21st century. The issue of trust in money has resurfaced in the public debate on privately issued, stateless currencies, such as bitcoin, and their promise to serve as reliable substitutes for public money. Today’s conference is neither the place nor the time for me to repeat my past statements on the shortcomings of cryptocurrencies[1] and why they do not fulfil the basic tests of what constitutes “money”.

Instead, I will today talk about Libra, Facebook’s newly announced private currency. It is scheduled for release in the first half of 2020 by the very same people who had to explain themselves in front of legislators in the United States and the European Union on the threats to our democracies resulting from their handling of personal data on their social media platform.

He says there are 3 qs:

There are three key questions here. First, how does Libra differ from other private currencies and from public money? Second, what legal and regulatory challenges does it pose? And third, in the light of its mandate, what position should a central bank like the ECB take towards Libra?

The remainder of my speech will be dedicated to these three questions, not with a view to conclusively answering them, but merely to raise awareness of some of the risks of Libra, to question its main premises and, in the process, to highlight the perils of entrusting the smooth processing of payments, the savings of citizens and the stability of the global monetary and financial systems to unaccountable private entities with a questionable track record in matters of trust.

He thrashes Libra on all premises barring the innovations in brings towards payments. But that is something which ECB and other central banks can do without Libra:

In the context of the smooth operation of payment systems, the ECB takes a close interest in market innovations that seek to replace the euro with alternative settlement currencies or create new and autonomous payment channels. Although some of Libra’s aims are legitimate, reductions in cross-border fund transfer costs and other efficiency gains can also be obtained through established instant payment solutions. The Eurosystem recently launched the TARGET Instant Payment Settlement service, or TIPS – a pan-European, 24/7 settlement service for instant payments. By operating in central bank money, and by being embedded in TARGET2, TIPS provides a high-performance payment solution that is safer and more economical than questionable, market-based retail payment innovations.

At the end, he says money and state sovereignty are linked to each other. He obviously ignores the history of free banking where stateless money did exist and ran successfully too in places like Canada. He calls Facebook’s promises as treacherous which is a very strong criticism:

In the field of money, history bears testament to two basic truths. The first is that, because money is a public good, money and state sovereignty are inexorably linked. So the notion of stateless money is an aberration with no solid foundation in human experience. The second truth is that money can only inspire trust and fulfil its key socioeconomic functions if it is backed by an independent but accountable public institution which itself enjoys public trust and is not faced with the inevitable conflicts of interest of private institutions.

Of the various forms that money has taken throughout history, those that have best fulfilled their purpose and proven the most credible have invariably benefited from strong institutional backing. This backing guarantees that they are reliably available, that their value is stable and that they are widely accepted. Only an independent central bank with a strong mandate can provide the institutional backing necessary to issue reliable forms of money and rigorously preserve public trust in them. So private currencies have little or no prospect of establishing themselves as viable alternatives to centrally issued money that is accepted as legal tender.

The stance of central banks towards modern forms of money is bound to evolve with time, and central bankers have embraced technological developments in the field of money and will continue to explore helpful new innovations. But the rise of cryptocurrencies and other forms of privately issued instruments that can only fulfil some, but not all, of the functions of money is unlikely to fundamentally upset the two truths I just described. If anything, it will serve as a useful reminder of central banks’ pivotal role as responsible stewards of public trust in money, and stress the need for vigilance towards phenomena capable of undermining public trust in the financial system.

I sincerely hope that the people of Europe will not be tempted to leave behind the safety and soundness of established payment solutions and channels in favour of the beguiling but treacherous promises of Facebook’s siren call.

Hmm..Central bankers hitting hard at cryptos not really reflecting on their own track record of money management…

Saving Venezuela: Requires both sanctions and negotiations

August 28, 2019

Andres Velasco, former Finance Minster of Chile writes:

Venezuela was once the pride and democratic example of Latin America. It can be that once again: a free, stable, and productive country, where citizens live in safety and peace – but only if the international community provides support in at least three key areas.


First, it should immediately recognize the need for large debt reduction, rather than attempting to postpone the inevitable for years. Second, the IMF and the other multilaterals will have to provide emergency balance-of-payments support. And, third, grants will be needed to meet urgent humanitarian needs and to prevent foreign debt from building up too fast once again.

But none of this can happen unless and until Venezuela gets a new, legitimate government with full control of the situation on the ground. On-and-off negotiations between the Maduro and Guaidó camps – the most recent rounds of which were sponsored by Norway – have gone nowhere. Maduro’s representatives walked away from the negotiating table earlier this month, claiming that they would not keep talking while the United States ratcheted up sanctions.

Dialogue will indeed be necessary to end the Venezuelan catastrophe. But the international community should not make the mistake of treating talks as a meeting of two parties of good will in need of friendly encouragement to subordinate their differences. Maduro heads a dictatorial regime that inflicts violence and suffering on a daily basis. The representatives of the National Assembly – Guaidó’s camp – are democratically elected officials who have been on the receiving end of that violence. Talks will not bear fruit unless the world’s democracies apply maximum diplomatic pressure on Maduro.

That raises the thorny issue of sanctions. Earlier this month, US President Donald Trump signed an executive order prohibiting all economic transactions with Venezuelan state entities and froze the assets of the Venezuelan government and of a number of Venezuelan officials. Some critics worried, understandably, about the effects on Venezuela’s poor. Others fretted over the possible indirect effect on local private firms, most of which are already on the verge of collapse.

But even those of us who find the Trump administration deeply distasteful must recognize that the case for severe sanctions is strong. Maduro will not leave power out of the goodness of his heart. The recent revelation – confirmed by US and Venezuelan officials – that high-level contacts have been taking place behind closed doors suggests that international pressure is beginning to yield results.

Besides, there is no guarantee that the regime would use additional resources to feed a starving population. During the second quarter of 2019, in the middle of an unprecedented domestic crisis and already under strict sanctions, government-owned oil company PDVSA amortized $800 million to Russia’s Rosneft. Maduro’s priorities are clear.

Given the cataclysmic political, economic, and humanitarian crisis underway, the moral imperative is to act now. Venezuela was once the pride and democratic example of Latin America. It can be that once again: a free, stable, and productive country, where citizens live in safety and peace.

It is really difficult to imagine human obsession with power over centuries. How can some of these people push so many people towards all kinds of crisis and deprivation?

Israel as a safe haven for emerging markets..

August 27, 2019

Bank of Israel Governor at Jackson Hole conference reviewed the Israel economy. He points how it had become a safe haven of sorts due to its stability.

Israel is an interesting case study. We are a relatively strong small open economy that is obviously also influenced by external shocks. In Israel, for example, it was perceived during the nineties and early 2000’s that interest rates must be significantly higher than in the US, otherwise capital outflows would emerge followed by a depreciation and inflation. However, in this round, and in spite of having kept rates very low, Israel faced capital inflows following the US rate hikes, as it was perceived as an “emerging markets safe haven”, and appreciation pressures emerged—a marked change from past-patterns. This corresponds with the risk perspective that Sebnem Kalemli-Ozcan presented here earlier, as a spillover of the US monetary policy, and with Governor Carney’s speech emphasizing the importance of the sources of shocks to EMEs. This shift, which was only partially offset by a sustained accommodative monetary policy, reflects the structural change in the fundamentals of the Israeli economy, including the continuous expansion of employment; the current account surpluses; the decline in the debt-to-GDP ratio since the Fiscal Stabilization program in 2003.

The strong fundamentals of Israel’s economy manifest themselves in financial markets, and are intimately related to the perceived absolute and relative resilience of the economy. Figure 2 is taken from Du And Schreger’s (2016) paper on “Local Currency Sovereign Risk”, which introduces a new measure of emerging market sovereign credit risk, and compares the development of sovereign risk in a few emerging markets between 2005 and 2014. It shows that Israel’s sovereign credit risk is low, with exceptionally low variance compared to the other countries—emphasizing the “safe haven” status within emerging and even advanced economies.


Economic, Fiscal and Financial Governance in the Euro Area

August 26, 2019

Jean Claude Trichet, former chief of European Central Bank reviews the experiences so far in Euro area.

He says we need to be a bit more patient with Euroarea. It s hardly as bad as people make it out to be:

1. Contrary to many negative predictions, the euro, as a currency, is a remarkable success in terms of credibility, stability and resilience. This resilience is due, in particular, to a large popular support.
2. The euro area is more of a success in terms of real growth measured during the period starting from its inception until today. But the appreciation must be more nuanced as regards nominal and real convergence inside the single currency area.
3. In a medium- and long-term perspective, EMU calls for further significant reinforcing its economic, fiscal and financial governance.
4. Drawing a number of lessons from the crisis, the ECB actively participated in what I call “conceptual convergence” of policy making in advanced economies’ central banks.

Overall, the success of the euro and of the euro area in terms of credibility,resilience, flexibility, popular support and real growth during its first 20 years is
impressive. It justifies reasonable optimism as regards the long-term success of this unique, ambitious, historic endeavor of the Europeans.

To consolidate this long-term success, a lot of hard work remains to be done as is always the case when a bold historic endeavor is in the making. The single market with a single currency of the U.S. was not  achieved in a short span of time. Neither in 20 years, nor even in 40 years! From the Coinage Act of 1792 to the Federal Reserve Act of 1913, there is a maturing process of around 120 years. And since the issuance of the first federal note in 1914 and today, an
additional period of 105 years.

Review of Jackson Hole Conference 2019: Are central bankers staring at a bigger hole for economies?

August 26, 2019

The annual Jackson Hole Conference for the year 2019 was held over the weekend. The theme this year was Challenges for Monetary Policy. In 1999 there was a similar theme of New Challenges for Monetary Policy.

Here is my piece reviewing the key speeches and papers in the event. There could not be a more trying time for central banks and select economists to chalk think about economic growth and development.

CRR and SLR as macroprudential tools: Some Historical Lessons

August 22, 2019

Nice paper by Eric Monnet (Banque de France) and Miklos Vari (IMF):

Liquidity regulations similar the current Basel III Liquidity Coverage Ratio (LCR) have been used from the 1930s to the 1980s in many countries as monetary policy tools. They took the form of required deposits at the central bank (“cash reserve requirements”) or minimum holdings of liquid securities (“securities reserve requirements”). As with the LCR, these two types of liquidity requirements (cash and securities) were computed as a percentage of short-term deposits.

India obviously had Cash Reserve Ratio since 1935 and SLR since 1949 and continues to have both these ratios.

Our paper presents three contributions.

First, based on detailed readings of historical central banks’ reports and documents, we describe how and why liquidity ratios were used in many
countries (especially Europe) from the 1930s to the 1980s , following the American experience. By emphasizing the distinction between “securities-reserve requirements” and “cash-reserve requirements,” we provide details on central bank practices whose history is largely unknown, and shed light on the dual nature of liquidity ratios as prudential and monetary policy tools.

Second, we show how “securities reserve requirements” were at the crossroad of monetary policy and sovereign debt management. It explains why they were phased out by central banks in the 1980s, as they had been associated with the so-called “financial repression” era (Reinhart and Sbrancia (2015)). Securities-reserve requirements were typically used in a period when banks held a large share of government bonds, and they reinforced such phenomenon. Central banks increased liquidity ratios during times of restrictive monetary policy in order to prevent banks from selling government securities, which were the main type of assets eligible to fulfill the requirement. As such, banks were discouraged to shift their assets from government securities to corporate loans.

Third, we build a theoretical model, and show that the mechanisms previously described can be rationalized with a simple model of the interbank market. By this, our paper introduces a new mechanism in the current literature on liquidity regulation and sheds new light on the history of monetary policy.

Hmm. Even without CRR and SLR, RBI has been using macropru policies much before they became buzzword. See these 2010 speeches by Shyamala Gopinath of RBI and James Caruna of BIS. 

SLR in particular has long been seen as a villain and something which led to financial repression. Several RBI Governors and other officials have written to either remove SLR or bring it to zero. Similar story was played in West too but much earlier than RBI.

How banks lobby and capture regulations..

August 21, 2019

Superb paper by Deniz O Igan and Thomas Lambert:

In this paper, we discuss whether and how bank lobbying can lead to regulatory capture and have real consequences through an overview of the motivations behind bank lobbying and of recent empirical evidence on the subject. Overall, the findings are consistent with regulatory capture, which lessens the support for tighter rules and enforcement. This in turn allows riskier practices and worse economic outcomes.

The evidence provides insights into how the rising political power of banks in the early 2000s propelled the financial system and the economy into crisis.

While these findings should not be interpreted as a call for an outright ban of lobbying, they point in the direction of a need for rethinking the framework governing interactions between regulators and banks. Enhanced transparency of regulatory decisions as well as strenghtened checks and balances within the decision-making process would go in this direction.

I think in other sectors regulatory capture is not as straight forward. In financial sector it is blatant. You see central bankers and securities regulators join financial firms pretty freely.

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