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Archive for the ‘Monetary Policy’ Category

Milton Friedman wisely observed that inflation is always the result of bad monetary policy by central banks. And I echoed that point last month in remarks to the European Resource Bank meeting in Stockholm.

This topic deserves more attention, particularly given the depressing inflation numbers just released this morning by the Bureau of Labor Statistics.

Some of our friends on the left want to downplay these bad numbers. In large part, they are motivated by a desire to shield President Biden from political damage. And I sympathize with them since Biden was not in the White House when the Federal Reserve decided to dump lots of liquidity into the U.S. economy.

Here’s a chart showing the Federal Reserve’s balance sheet over the past decade. It’s easy to see the Fed’s panicked response to the pandemic in early 2020.

But I don’t sympathize with folks who claim that inflation is just something random.

Some of them want to blame Putin. Or the pandemic. Or “corporate greed.” Or maybe even space aliens.

I also wonder about this tweet from Ian Bremmer. He points out that inflation is showing up everywhere, regardless of which political party (or coalition) is running a government.

But I can’t tell what he means by his final line (“wild guess it’s not the govt”).

Is he saying that we should focus on the actions of central banks, not the partisan composition of a nation’s government? If so, I agree.

Or is he saying that we should not blame any part of government? If so, I completely disagree.

Central banks may have varying levels of day-to-day independence, but they are government entities. They were created by politicians and run by people appointed by politicians.

And inflation is happening in many nations because various central banks all made similar mistakes.

For instance, Bremmer mentions Germany and Italy. Those are euro countries and you can see that the European Central Bank made the same mistake as the Fed. It panicked at the start of the pandemic and then never fixed its mistake.

Bremmer also mentioned the United Kingdom. Well, here’s the balance sheet data from the Bank of England.

Once again, you can see a big spike in the amount of liquidity created when the BoE expanded its balance sheet.

And, just as was the case with the Fed and the ECB, the BoE did not fix its mistake once it became apparent than the pandemic was not going to cause a global economic collapse.

P.S. I suggested in the video that the ECB is partly motivated by a desire to prop up decrepit welfare states in nations such as Italy and Greece. This is a point I’ve been warning about for many, many years.

P.P.S. While Biden is not to blame for the outbreak of inflation, it’s also true that he is not part of the solution and has not used his appointment power to push the Fed in a more sensible direction.

P.P.P.S. If you have the time and interest, here’s a 40-minute video explaining the Federal Reserve’s track record of bad monetary policy.

P.P.P.P.S. If you’re constrained for time, I recommend this five-minute video on alternatives to the Federal Reserve and this six-minute video on how people can protect themselves from bad monetary policy.

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Earlier this year, I pointed out that President Biden should not be blamed for rising prices.

There has been inflation, of course, but the Federal Reserve deserves the blame. More specifically, America’s central bank responded to the coronavirus pandemic by dumping a lot of money into the economy beginning in early 2020.

Nearly a year before Biden took office.

The Federal Reserve is not the only central bank to make this mistake.

Here’s the balance sheet for the Eurosystem (the European Central Bank and the various national central banks that are in charge of the euro currency). As you can see, there’s also been a dramatic increase in liquidity on the other side of the Atlantic Ocean.

Why should American readers care about what’s happening with the euro?

In part, this is simply a lesson about the downsides of bad monetary policy. For years, I’ve been explaining that politicians like easy-money policies because they create “sugar highs” for an economy.

That’s the good news.

The bad news is that false booms almost always are followed by real busts.

But this is more than a lesson about monetary policy. What’s happened with the euro may have created the conditions for another European fiscal crisis (for background on Europe’s previous fiscal crisis, click here, here, and here).

In an article for Project Syndicate, Willem Buiter warns that the European Central Bank sacrificed sensible monetary policy by buying up the debt of profligate governments.

…major central banks have engaged in aggressive low-interest-rate and asset-purchase policies to support their governments’ expansionary fiscal policies, even though they knew such policies were likely to run counter to their price-stability mandates and were not necessary to preserve financial stability. The “fiscal capture” interpretation is particularly convincing for the ECB, which must deal with several sovereigns that are facing debt-sustainability issues. Greece, Italy, Portugal, and Spain are all fiscally fragile. And France, Belgium, and Cyprus could also face sovereign-funding problems when the next cyclical downturn hits.

Mr. Buiter shares some sobering data.

All told, the Eurosystem’s holdings of public-sector securities under the PEPP at the end of March 2022 amounted to more than €1.6 trillion ($1.7 trillion), or 13.4% of 2021 eurozone GDP, and cumulative net purchases of Greek sovereign debt under the PEPP were €38.5 billion (21.1% of Greece’s 2021 GDP). For Portugal, Italy, and Spain, the corresponding GDP shares of net PEPP purchases were 16.4%, 16%, and 15.7%, respectively. The Eurosystem’s Public Sector Purchase Program (PSPP) also made net purchases of investment-grade sovereign debt. From November 2019 until the end of March 2022, these totaled €503.6 billion, or 4.1% of eurozone GDP. In total, the Eurosystem bought more than 120% of net eurozone sovereign debt issuances in 2020 and 2021.

Other experts also fear Europe’s central bank has created more risk.

Two weeks ago, Desmond Lachman of the American Enterprise Institute expressed concern that Italy had become dependent on the ECB.

…the European Central Bank (ECB) is signaling that soon it will be turning off its monetary policy spigot to fight the inflation beast. Over the past two years, that spigot has flooded the European economy with around $4 trillion in liquidity through an unprecedented pace of government bond buying. The end to ECB money printing could come as a particular shock to the Italian economy, which has grown accustomed to having the ECB scoop up all of its government’s debt issuance as part of its Pandemic Emergency Purchase Program. …the country’s economy has stalled, its budget deficit has ballooned, and its public debt has skyrocketed to 150 percent of GDP. …Italy has had the dubious distinction of being a country whose per capita income has actually declined over the past 20 years. …All of this is of considerable importance to the world economic outlook. In 2010, the Greek sovereign debt crisis shook world financial markets. Now that the global economy is already slowing, the last thing that it needs is a sovereign debt crisis in Italy, a country whose economy is some 10 times the size of Greece’s.

Mr. Lachman also warned about this in April.

Over the past two years, the ECB’s bond-buying programs have kept countries in the eurozone’s periphery, including most notably Italy, afloat. In particular, under its €1.85 trillion ($2 trillion) pandemic emergency purchase program, the ECB has bought most of these countries’ government-debt issuance. That has saved them from having to face the test of the markets.

And he said the same thing in March.

The ECB engaged in a large-scale bond-buying program over the past two years…, as did the U.S. Federal Reserve. The size of the ECB’s balance sheet increased by a staggering four trillion euros (equivalent to $4.4 billion), including €1.85 trillion under its Pandemic Emergency Purchasing Program. …The ECB’s massive bond buying activity has been successful in keeping countries in the eurozone’s periphery afloat despite the marked deterioration in their public finances in the wake of the pandemic.

Let’s conclude with several observations.

So if politicians won’t adopt good policies and their bad policies won’t work, what’s going to happen?

At some point, national governments will probably default.

That’s an unpleasant outcome, but at least it will stop the bleeding.

Unlike bailouts and easy money, which exacerbate the underlying problems.

P.S. For what it is worth, I do not think a common currency is necessarily a bad idea. That being said, I wonder if the euro can survive Europe’s awful politicians.

P.P.S. While I think Mr. Buiter’s article in Project Syndicate was very reasonable, I’ve had good reason to criticize some of his past analysis.

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Back in 2015, I explained to Neil Cavuto that easy money creates the conditions for a boom-bust cycle.

It’s now 2022 and my argument is even more relevant.

That’s because the Federal Reserve panicked at the start of the pandemic and dumped a massive amount of money into the economy (technically, the Fed increased its balance sheet by purchasing trillions of dollars of government bonds).

As the late, great Milton Friedman taught us, this easy-money, low-interest-rate approach produced the rising prices that are now plaguing the nation.

But that’s only part of the bad news.

The other bad news is that easy-money policy sets the stage for future hard times. In other words, the Fed causes a boom-bust cycle.

Desmond Lachman of the American Enterprise Institute explains how and why the Federal Reserve has put the country in a bad situation.

Better late than never. Today, the Federal Reserve finally took decisive monetary policy action to regain control over inflation that has been largely of its own making. …The Fed’s abrupt policy U-turn is good news in that it reduces the likelihood that we will return to the inflation of the 1970s. However, this does not mean that we will avoid paying a heavy price for the Fed’s past policy mistakes in lost output and employment. …One might well ask what the Fed was thinking last year when it kept interest rates at their zero lower bound and when it let the money supply balloon at its fastest pace in over fifty years at a time especially when the economy was recovering strongly… One might also ask what the Fed thought when it continued to buy $120 billion a month in Treasury bonds and mortgage-backed securities throughout most of last year when the equity and the housing markets were on fire?

The relevant question, he explains, is whether we have a hard landing…or a harder landing.

If the Fed sticks to its program of meaningful interest rate hikes and balance sheet reduction over the remainder of this year, there would seem to be an excellent chance that we do not return to the inflation of the 1970s. However, there is reason to doubt that the Fed will succeed in pushing the inflation genie to the bottle without precipitating a nasty economic recession. One reason for doubting that the Fed will succeed in engineering a soft economic landing is that there is no precedent for the Fed has done so when it has allowed itself to fall as far behind the inflation curve as it has done today. …there is a real risk that higher interest rates might be the trigger that bursts today’s asset and credit market bubbles. Should that indeed happen, we could be in for a tough landing. Milton Friedman was fond of saying that there is no such thing as a free lunch. This is a lesson that the Fed might soon relearn as last year’s economic party gives way to a painful economic slump.

Let’s hope we have a proverbial “soft landing,” but I’m not holding my breath.

Especially with Biden pursuing other bad policies (FWIW, I don’t blame him for today’s price spikes).

P.S. As explained in this video from the Fraser Institute, Friedrich Hayek understood a long time ago that feel-good government intervention leads to a feel-bad economic hangover.

P.P.S. Here’s my video on the Federal Reserve, which also explains that there might be a good alternative.

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No sensible person wants to copy the big-spending policies of failed welfare states such as Greece.

Unfortunately, many politicians lack common sense (or, more accurately, they are motivated by short-run political ambition rather than what’s in the long-run best interest of their nations).

So if they decide that they politically benefit by spending lots of other people’s money, they have to figure out how to finance that spending.

One option is to use the central bank. In other words, finance big government with the figurative printing press.

This is what’s know as Modern Monetary Theory.

From a theoretical perspective, it’s crazy. And if Sri Lanka is any indication, it’s also crazy based on real-world evidence.

In an article for The Print, based in India, Mihir Sharma looks at that government’s foolish monetary policy.

Cranks are considered cranks for a reason. That is the lesson from Sri Lanka… How did this tiny Indian Ocean nation end up in such straits? …the Rajapaksas turned Sri Lanka’s policymaking over to cranks… The central bank governor at the time, Weligamage Don Lakshman, informed the public during the pandemic that nobody need worry about debt sustainability…since “domestic currency debt…in a country with sovereign powers of money printing, as the modern monetary theorists would argue, is not a huge problem.” Sri Lanka is the first country in the world to reference MMT officially as a justification for money printing. Lakshman began to run the printing presses day and night; his successor at the central bank, Ajith Nivard Cabraal, who also denied the link between printing money and inflation or currency depreciation, continued the policy. …Reality did not take long to set in. By the end of 2021, inflation hit record highs. And, naturally, the clever plan to “increase the proportion of domestic debt” turned out to be impossible… Proponents of MMT will likely say that this was not real MMT, or that Sri Lanka is not a sovereign country as long as it has any foreign debt, or something equally self-serving.

Professor Steve Hanke of Johns Hopkins University also discussed Sri Lanka’s crazy monetary policy in an article for National Review. And he also offered a way to reverse the MMT mistake.

This slow-motion train wreck first began in November 2019 when Gotabaya Rajapaksa won a decisive victory in the country’s presidential elections. …In total control, President Rajapaksa and his brother Mahinda, the prime minister, went on a spending spree that was financed in part by Sri Lanka’s central bank. The results have been economic devastation. The rupee has lost 44 percent of its value since President Rajapaksa took the reins, and inflation, according to my measure, is running at a stunning 74.5 percent per year. …What can be done to end Sri Lanka’s economic crisis? It should adopt a currency board, like the one it had from 1884 to 1950… Most important, the board could not loan money to the fiscal authorities, imposing a hard budget on Ceylon’s fiscal system. The net effect was economic stability — and while stability might not be everything, everything is nothing without stability.

For readers who are not familiar with currency boards, it basically means creating a hard link with another nation’s currency – presumably another nation with a decent history of monetary restraint.

It’s what Hong Kong has with the United States (even though U.S. monetary policy over time has been less than perfect).

A currency board is not quite the same as “dollarization,” which is actually adopting another nation’s currency, but it’s a way of making sure local politicians have one less way of ruining an economy.

Let’s conclude with a story from the U.K.-based Financial Times, written by Tommy Stubbington and Benjamin Parkin. They provide some grim details about Sri Lanka’s plight.

Sri Lanka owes $15bn in bonds, mostly dollar-denominated, of a total $45bn long-term debt, according to the World Bank. It needs to pay about $7bn this year in interest and debt repayments but its foreign reserves have dwindled to less than $3bn. …Sri Lanka has never defaulted and its successive governments have been known for a market-friendly approach. …Sri Lanka has previously entered 16 programmes with the IMF.

By the way, I can’t help but comment about a couple of points in the article.

The reporters claim that Sri Lanka has been “known for a market-friendly approach.”

To be blunt, this is nonsense. I’ve been dealing with international economic policy for decades and no supporter of free markets and limited government has ever claimed the country was anywhere close to being a role model for good policy.

And if you peruse the latest edition of Economic Freedom of the World, you’ll see that Sri Lanka has very low scores, far below Greece and only slightly ahead of Russia.

And you can click here to see that it has always received dismal scores.

But maybe it’s “market-friendly” by the standards of left-leaning journalists.

I also can’t resist noting that Sri Lanka has already received 16 bailouts from the International Monetary Fund, according to the article.

This is further evidence that it’s not a market-oriented nation.

And it’s also evidence that IMF intervention does not make things better. In many cases, it’s akin to sending an arsonist to put out a fire.

P.S. The Mihir Sharma article also discusses the Sri Lankan government’s crazy approach to agriculture.

Last April, the government followed through on a campaign promise to transition Sri Lanka to organic farming by banning the import and use of synthetic fertilizers. More than two-thirds of Sri Lanka’s people are directly or indirectly dependent on agriculture; economists and agronomists warned that a transition to organic farming on that scale would destroy productivity and cause incomes to crash. …Unsurprisingly, the cranks were wrong. The production of rice — the basic component of Sri Lankans’ diet — and of tea — the country’s main export — sank precipitously.

Needless to say, it’s not a good idea for politicians to deliberately hurt a nation’s agriculture sector.

Just like it’s not a good idea for politicians in places like the United States to deliberately subsidize the sector. The right approach is to be like New Zealand and have no policy.

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Looking back on the 2008 financial crisis, it seems clear that much of that mess was caused by bad government policy, especially easy money from the Federal Reserve and housing subsidies from Fannie Mae and Freddie Mac.

Many of my left-leaning friends, by contrast, assert that “Wall Street greed” was the real culprit.

I have no problem with the notion that greed plays a role in financial markets, but people on Wall Street presumably were equally greedy in the 1980s and 1990s. So why didn’t we also have financial crises during those decades?

Isn’t it more plausible to think that one-off factors may have caused markets to go awry?

I took that trip down Memory Lane because of a rather insipid tweet from my occasional sparring partner, Robert Reich. He wants his followers to think that inflation is caused by “corporate greed.”

For what it’s worth, I agree that corporations are greedy. I’m sure that they are happy when they can charge more for their products.

But that’s hardly an explanation for today’s inflation.

After all, corporations presumably were greedy back in 2015. And in 2005. And in 1995. So why didn’t we also have high inflation those years as well?

If Reich understood economics, he could have pointed out that today’s inflation was caused by the Federal Reserve and also absolved Biden by explaining that the Fed’s big mistake occurred when Trump was in the White House.

I don’t expect Reich to believe me, so perhaps he’ll listen to Larry Summers, who also served in Bill Clinton’s cabinet.

But I won’t hold my breath.

As Don Boudreaux has explained, Reich is not a big fan of economic rigor and accuracy.

P.S. Reich also blamed antitrust policy, but we have had supposedly “weak antitrust enforcement” since the 1980s. So why did inflation wait until 2021 to appear?

P.P.S. In addition to being wrong about the cause of the 2008 crisis, my left-leaning friends also were wrong about the proper response to the crisis.

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I’m more than happy to condemn Joe Biden for his bad policy proposals, such as higher tax rates, fake stimulus, red tape, and a bigger welfare state.

But as I discuss in this segment from a recent interview, he bears very little blame for today’s high inflation rate.

If you want to know who is responsible for 8.5 percent inflation, the highest in four decades, this chart tells you everything you need to know.

Simply stated, the Federal Reserve has created a lot more money by expanding its balance sheet (which happens, for example, when the central bank purchases government bonds using “open market operations”).

Notice, by the way, that the Fed dramatically expanded its balance sheet beginning in March 2020. That was almost one year before Biden was inaugurated.

At the risk of stating the obvious, Biden does not have the power of time travel. He can’t be at fault for a monetary policy mistake that happened when Trump was president.

That being said, I don’t want anyone to think that Biden believes in good monetary policy.

  • Biden has never made any sort of statement favoring monetary restraint by the Fed.
  • Neither the president not his senior advisors have urged the Fed to reverse its mistake.
  • Biden renominated Jerome Powell to be Chairman of the Fed’s Board of Governors.
  • None of Biden’s other nominees to the Federal Reserve have a track record of opposing easy money.

The bottom line is that the Fed almost surely would have made the same mistake in 2020 if Biden was in the White House.

But he wasn’t, so he gets a partial free pass.

P.S. Speaking of time travel, Paul Krugman blamed Estonia’s 2008 recession on spending cuts that took place in 2009.

P.P.S. Here’s my two cents on how people can protect themselves in an inflationary economy.

P.P.P.S. Only one president in my lifetime deserves praise for his approach to monetary policy.

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The good thing about being a policy-driven libertarian is that I don’t feel any need to engage in political spin.

I can praise Democrats who do good things and praise Republicans who do good things. And also criticize members of either party (sadly, that’s a more common task).

It also means I don’t believe in blaming politicians for things that are not their fault. For example, NBC just released a poll showing that Joe Biden has low marks for economic policy.

Some of that is appropriate (his fiscal policy is atrocious, to cite one reason), but I think the answers to this question show that the president is getting a bum rap on one issue.

Why am I letting Biden off the hook about monetary policy?

For the simple reason that the Federal Reserve (the “Fed”) deserves the blame. The central bank’s inflationary policies are the reason that prices are rising.

One can claim that Joe Biden is partly to blame because he recently re-nominated Jay Powell, the current Chairman of the Fed. But, if that’s the case, then Donald Trump also is partly to blame – or even more to blame – because he nominated Powell in the first place.

Moreover, as illustrated by this chart, the Fed’s mistake that led to rising prices occurred in early 2020.

Simply stated, the Fed pumped lots of liquidity into the system. That set the stage for today’s price increases (as Milton Friedman told us, there’s always a lag between decisions about monetary policy and changes in prices).

If you look closely, you’ll notice that this massive monetary intervention began nearly one year before Biden took office.

Given his support for Keynesian fiscal policy, I suspect Biden also believes in Keynesian monetary policy. As such, we presumably would have had the same policy if Biden had been elected in 2016.

In other words, Biden would have been just like Trump. At least on this issue.

But none of that changes the fact that Biden’s actions since becoming president have very little to do with today’s price increases.

Let’s close with a few additional observations about the aforementioned polling results.

  • The folks at NBC deserve some criticism for failing to give people the option of choosing the Federal Reserve’s monetary policy. I’m guessing this was because of ignorance rather than bias.
  • The people who blamed “corporations increasing prices” obviously didn’t pay attention in their economics classes. Rising prices are a symptom of inflation, not the cause.
  • The people who blamed Putin for inflation are even more ignorant. At the risk of stating the obvious, a Russian invasion in February of 2022 obviously wasn’t responsible for rising prices in 2021.

P.S. The inflation-recession cycle caused by bad monetary policy could be avoided if the Fed was constrained by some simple rules.

P.P.S. Or maybe, just maybe, we should reconsider the role of central banks.

P.P.P.S. For what it’s worth, very few politicians have the intelligence and fortitude to support good monetary policy.

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Yesterday’s column explained that Biden’s proposals to expand the welfare state were bad news, in part because government subsidies often lead to inefficiency and higher prices.

That’s not a smart strategy when inflation already is at 40-year highs.

President Biden did address the topic of rising prices during his speech, but his approach was so incoherent that even Larry Summers (Treasury Secretary for Bill Clinton and head of the National Economic Council for Barack Obama) felt compelled to share some critical tweets.

This is remarkable. I’ve spent the past three decades fighting against some of Summers’ bad ideas on fiscal policy (he was a big supporter of the OECD’s anti-tax competition project, for instance).

But now we’re sort of on the same side (at least on a few issues) because Biden has embraced a reckless Bernie Sanders-type agenda of budget profligacy, class-warfare taxes, regulatory excess, and crass protectionism that is too extreme for sane people on the left.

Along with a head-in-the-sand view of monetary policy.

In a column for Canada’s Fraser Institute, Robert O’Quinn and I addressed Biden’s strange comments on inflation.

Here’s some of what we wrote on that topic.

After a disastrous first year pursuing an agenda that became increasingly unpopular, President Biden had an opportunity to reset his administration in a centrist direction as part of his first State of the Union Address. But he didn’t. On every domestic issue, he catered to the Democratic Party’s hardcore left-wing activists… Inflation, as Nobel laureate Milton Friedman observed, is always and everywhere a monetary phenomenon. …In his speech, Biden ignored the true cause of inflation. Instead, he offered a grab bag of statist ideas such as aggressive antitrust enforcement, price controls on prescription drugs, and tax credits for energy conservation and green energy—policies that, whatever their merits, have little or nothing to do with inflation.

Our basic message is that Biden ignored the real cause of inflation (bad monetary policy by the Federal Reserve) and instead came up with ideas (either bad or irrelevant) to addresses the symptom(s) of inflation.

We also noted that Biden’s nominees to the Federal Reserve are underwhelming.

Moreover, he has been pushing three controversial nominees to the Federal Reserve Board—Sarah Bloom Raskin, Lisa Cook and Philip Jefferson—who lack monetary expertise and are generally regarded as inflation doves. Raskin’s primary “qualification” is her support for using the Fed’s regulatory powers to divert credit away from oil and natural gas production. Cook and Jefferson have primarily written about poverty and race, which are outside of the Fed’s legislative mandate.

What we need is a president – like Ronald Reagan – who understands that the inflation genie needs to be put back in the bottle and thus pushes the Federal Reserve in the right direction.

Instead, we have a president who thinks it’s a place where left-leaning activists should get patronage appointments.

P.S. If you have the time and interest, here’s an 40-minute video explaining the Federal Reserve’s track record of bad monetary policy.

P.P.S. If you’re constrained for time, I recommend this five-minute video on alternatives to the Federal Reserve and this six-minute video on how people can protect themselves from bad monetary policy.

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My friends sometimes tell me that libertarians are too extreme because we tend to make “slippery slope” arguments against government expansions.

I respond by pointing out that many slopes are very slippery. Especially when dealing with politicians and bureaucrats.

Today, we’re going to look at how some politicians want to push us down the slope as part of their war against cash.

I’ve already written about this topic four times (here, here, here, and here), but it’s time to revisit the topic because of what has just happened in Canada.

Kevin Williamson of National Review is properly disgusted by Prime Minister Trudeau’s decision to deploy financial repression against protesting truckers.

Prime Minister Trudeau has invoked, for the first time in his country’s history, Emergency Measures Act powers to shut down a domestic political protest, the so-called Freedom Convoy movement… Trudeau is not sending in the troops. He is cutting off the money. …And so he is using the Emergency Measures Act to invest himself with the unilateral power to freeze bank accounts and cancel insurance policies, without so much as a court order and with essentially no recourse for those he targets. Canadian banks and financial-services companies will be ordered to disable clients suspected of being involved in the protests. …Using financial regulation to crush freedom of speech isn’t financial regulation — it is crushing freedom of speech by abusing the powers of a government office. …financial regulators enjoy powers that no FDR — or Napoleon, or Lenin — ever dreamt of possessing. The opportunities for mischief are serious and worrisome — and so are the opportunities for tyranny. …When the laws are enforced exclusively (or with extra vigor) against political enemies, that is not law enforcement — that is political repression. …we don’t have to send men with jackboots and billy clubs to break up protests — we have very polite Canadian bankers to do that for us.

Kevin then points out that Trudeau’s despicable actions are a very good argument for cryptocurrency.

It can be no surprise, then, that people are looking for digital platforms that protect their anonymity and keep their communications slightly beyond the reach of the long arm of the state. …And it’s even less surprising that cryptocurrencies and other escape routes from the banking system increasingly appeal to people who are neither cartel bosses nor international men of mystery. In a world in which unpopular political views can cut an individual or an organization off from the financial main stream, such innovations are necessities.

Liz Wolfe wrote about Trudeau’s overreach for Reason and also pointed out that cryptocurrencies are a valuable tool against oppressive government.

Canadian Prime Minister Justin Trudeau invoked his country’s Emergencies Act of 1988 in an attempt to snuff out anti-vaccine mandate protests that have roiled Canadian domestic politics for weeks. Invoking the act allows Trudeau to broaden Terrorist Financing Act rules to bring crowdfunding platforms and payment processors under greater government scrutiny. …cryptocurrency exchanges and crowdfunding platforms must now report large and “suspicious” transactions to the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC), thus allowing more government surveillance of who’s forking over money to the protesters. The government will also be using its expanded powers to allow financial institutions to freeze the corporate accounts of companies that own trucks used in the blockades, while suspending their insurance… This type of situation—one in which protesters are being freezed out by crowdfunding platforms, one in which the government is threatening to suppress demonstrations and surveil financial transactions—is precisely the use case for crypto, which may be why Canadian officials namechecked it in their Terrorist Financing announcement. …crypto’s real value lies in the fact that it’s much harder to trace back to its sender, allowing pseudonymous donors to support whichever political causes they want to…the liberatory promise of crypto lies in the fact that it can bypass these intermediaries and make transactions more discreet—something Trudeau’s lackeys surely know, and seem a bit threatened by.

Amen. I don’t understand cryptocurrency and I don’t own any, but I definitely think it’s important to have alternatives given the track record of government.

By the way, worries about government over-reach existed long before Trudeau decided to launch his financial assault.

Libertarian-minded people have been concerned about this issue for a long time.

Here’s some of what Larry White wrote in 2018.

Coercive anti‐​cash policies abridge the freedom and reduce the welfare of peaceful individuals who prefer to use cash. …They compromise financial privacy and enable the prosecution of victimless crimes wherever banks are required to “know their customers” and to provide transaction records to government officials. They impose an unlegislated tax on money‐​holders, and leave them no means of escape into untaxed media of exchange, whenever the central bank decides to pursue a negative interest rate policy. They harm the livelihood of small businesspeople who rely on cash sales, particularly those serving the unbanked or operating in outdoor markets, and reduce the welfare of their (mostly poor) customers by raising transaction costs.

And here are some excerpts from William Luther’s column for Reason in the same year.

The case for cash presumes that we should be free to go about our lives so long as our actions do not harm others. It maintains that governments are not entitled to the intimate details of people’s lives. …demonetization advocates hold a progressive view of government. They think that existing laws and regulations have been rationally constructed by enlightened experts… There is, of course, an alternative view of government—one that is skeptical that laws and regulations are so rationally designed. …Some of these rules…were constructed to benefit some at the expense of others… Physical currency enables one to disobey the government. …Importantly, this argument…is a case for due process and financial privacy—bedrock jurisprudential principles in the West.

I’ll close with a few comments about what Trudeau should have done. Particularly after the road blockages lasted more than one or two days.

Instead of invoking a draconian emergency law, local Canadian governments should have used regular police powers to impose fines on truckers and- if necessary – impound their vehicles.

And if any of the truckers responded with violence, they should have been arrested and prosecuted.

For what it’s worth, this is how local governments in the United States should have responded (and should respond) to protests by Antifa and Black Lives Matter. Or to protests by any right-wing group.

The bottom line is that I’m a big believer in civil disobedience, but my tolerance drops when ordinary people are harassed, inconvenienced, and intimidated.

P.S. Luther’s point about the “progressive view of government” is not just a throwaway line. He’s referring to the mindset that first appeared during the “Progressive Era” of the early 1900s, when politicians such as Teddy Roosevelt and Woodrow Wilson decided that government was a force for good (unlike America’s Founders, who gave us a Constitution based on the notion that government was a threat to liberty and needed to be restrained).

P.P.S. Returning to more practical issues, India is a another bad example of what happens when politicians push a nation down the slippery slope.

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Every few years (2012, 2015, 2019), I warn that easy-money policies by the Federal Reserve are misguided.

But not just because such policies eventually can lead to price inflation, which now has become a problem in the United States.

Bad monetary policy also can lead to asset inflation. In other words, bubbles. And it’s no fun when bubbles burst.

The obvious lesson to be learned is that central banks such as the Fed shouldn’t try to steer the economy with Keynesian-style monetary policy.

I’m motivated to write about this issue because the Washington Post recently invited some people to offer their ideas on how to fight inflation.

Some of the ideas were worthwhile.

Some of the ideas were bad, or even awful.

If asked to contribute, what would I have suggested?

Being a curmudgeonly libertarian, I would have channeled the spirit of Milton Friedman and pointed out that bad monetary policy by central banks is the cause of inflation. Simply stated, it is appropriate to blame central banks if there are sustained and permanent increases in the overall price level.

And the only way to fix inflation is for central banks to unwind the policy mistakes that caused the problem in the first place.

Some of the respondents did mention the need for Federal Reserve to rectify its mistakes, so I’m not the only one to think monetary policy is important.

But I’m very fixated on assigning blame where it belongs, so I would not have mentioned any other factor.

For instance, in an article just published by the Austrian Economics Center in Vienna, Robert O’Quinn and I explain that bad fiscal policy does not cause inflation.

Are we seeing higher levels of price inflation because of fiscal profligacy?  Some Republican U.S. Senators and Representatives have blamed this acceleration of price inflation on Biden’s blowout of federal spending. There are many good reasons to criticize Biden’s spending spree. It is not good for the economy to increase the burden of government spending and push for higher tax rates… But that does not necessarily mean deficit spending is inflationary. …Price inflation occurs when the supply of money exceeds the demand for money… Notably, none of the mechanisms that central banks use for monetary policy (buying and selling government securities, setting interest rates paid on reserves, loans to financial institutions, etc) have anything to do with federal spending or budget deficits.  The Fed and other central banks can maintain price stability regardless of whether governments are enacting reckless fiscal policies.

In the article, we cited Japan as an example of a country with huge levels of debt, yet prices are stable.

By contrast, prices are rising in the United States because of Keynesian monetary policies by the Federal Reserve (often with the support of politicians).

What’s causing inflation, if not budget deficits and government debt? …central banks have been pursuing an inflationary policy. But they’ve been pursuing that approach not to finance budget deficits, but instead are motivated by a Keynesian/interventionist viewpoint that it is the role of central banks to “stimulate” the economy and/or prop up the financial market with easy-money policies.

I’ll close by observing that there can be a link between bad fiscal policy and inflation.

In basket-case nations such as Venezuela, Zimbabwe, and Argentina, politicians periodically use central banks to finance some of their excessive spending.

Some governments, particularly in less-developed countries, cannot easily borrow money and they rely on their central banks to finance their budget deficits. And that is clearly inflationary.

Because of changing demographics and poorly designed entitlement programs, it’s possible that the United States and other western nations eventually may get to this point.

Heck, I speculated just a couple of days ago that the European Central Bank may be doing this with Italy.

But the United States hasn’t yet reached that “tipping point.” There are still plenty of investors willing to buy the federal government’s debt (especially since the dollar is the world’s reserve currency).

The bottom line is that we should pursue good fiscal policy because it makes sense. And we should pursue good monetary policy because it makes sense. But the two are not directly connected.

P.S. On the topic of inflation, Ronald Reagan deserves immense praise for standing firm for good policy in the 1980s.

P.P.S. On the topic of the Federal Reserve, the central bank also should be criticized for interfering with the allocation of credit. And financial repression as well.

P.P.P.S. On the topic of basket-case economies, let’s hope that the American policy makers don’t embrace “modern monetary theory.”

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In the libertarian fantasy world, we would have competing private currencies. In the real world, we have a government central bank.

And central banks have a track record of bad monetary policy, so here’s my two cents on how people can try to protect their household finances.

The above video is a clip from a longer presentation I made as part of “Libertarian Solutions,” an online program put together by the folks at Liberty International.

And I should point out that I goofed around the 3:28 mark of the video, when I meant to say “not planning to take it all out in 2009” (a dumb mistake, but not as bad as the time I said “anals” rather than “annals” on live TV).

That correction aside, I was tasked with discussing how people can prosper in spite of bad government policy, and, as you can see, I did not pretend to have any uniquely brilliant investment strategies.

So I focused on explaining the risks of bad monetary policy, especially the way that central banks (and other government policies) create boom-bust cycles in the economy.

If I had more time, I could have talked about additional threats, such as the crackpot idea of “modern monetary theory.”

And I probably should have found some time to explain the notion of “financial repression” since that’s a government policy that has a very direct adverse effect on people trying to build wealth.

One final point. While I’m very hopeful that they may somehow help people protect their personal finances, you’ll notice that I didn’t recommend cryptocurrencies such as Bitcoin. This is for two reasons.

  1. I don’t know enough about how they work to competently discuss the issue.
  2. I fear that governments will have the power, desire, and ability to squash the market.

Needless to say, I hope I’m wrong about the second point.

P.S. A classical gold standard could block central banks from engaging in bad monetary policy, but returning to that type of system is almost as unlikely as a shift to private currencies.

P.P.S. While I’m obviously not a big fan of the Federal Reserve, other nations have even worse experiences with their central banks, which is why “dollarization” makes sense for many developing countries.

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I’m not a big fan of the Federal Reserve, mostly because of its Keynesian monetary policy.

Incumbent politicians often applaud when the central bank intervenes to create excess liquidity and artificially low interest rates. That’s because the Keynesian approach produces a short-run “sugar high” that seems positive.

But such policies also create boom-bust conditions.

Indeed, the Federal Reserve deserves considerable blame for some of the economy’s worst episodes of the past 100-plus years – most notably the Great Depression, 1970s stagflation, and the 2008 financial crisis.

So what’s the solution?

I’ve previously pointed out that the classical gold standard has some attractive features but is not politically realistic.

But perhaps it’s time to reassess.

In a column for today’s Wall Street Journal, Professors William Luther and Alexander Salter explain the differences between a gold standard and today’s system of fiat money (i.e., a monetary system with no constraints).

Under a genuine gold standard, …Competition among gold miners adjusts the money supply in response to changes in demand, making purchasing power stable and predictable over long periods. The threat of customers redeeming notes and deposits for gold discourages banks from overissuing… Fiat dollars aren’t constrained by the supply of gold or any other commodity. The Federal Reserve can expand the money supply as much or as little as it sees fit, regardless of changes in money demand. When the Fed expands the money supply too much, an unsustainable boom and costly inflation follow.

They then compare the track records of the two systems.

…nearly all economists believe the U.S. economy has performed better under fiat money than it would have with the gold standard. This conventional wisdom is wrong. The gold standard wasn’t perfect, but the fiat dollar has been even worse. …in practice, the Fed has failed to govern the money supply responsibly. Inflation averaged only 0.2% a year from 1790 to 1913, when the Federal Reserve Act passed. Inflation was higher under the Fed-managed gold standard, averaging 2.7% from 1914 to 1971. It has been even higher without the constraint of gold. From 1972 to 2019, inflation averaged 4%. …the Fed…has also become less predictable. In a 2012 article published in the Journal of Macroeconomics, George Selgin, William D. Lastrapes and Lawrence H. White find “almost no persistence in the variance of inflation prior to the Fed’s establishment, and a very high degree of persistence afterwards.” …One might be willing to accept the costs of higher inflation and a less predictable price level if a Fed-managed fiat dollar reduced undesirable macroeconomic fluctuation. But that hasn’t happened. Consider the past two decades. The early 2000s had an unsustainable boom, as the Fed held interest rates too low for too long.

There was also a column on this issue in the WSJ two years ago.

James Grant opined about (the awful) President Nixon’s decision to make Federal Reserve policy completely independent of the gold anchor.

Richard Nixon announced the suspension of the Treasury’s standing offer to foreign governments to exchange dollars for gold, or vice versa, at the unvarying rate of $35 an ounce. The date was Aug. 15, 1971. Ever since, the dollar has been undefined in law. …In the long sweep of monetary history, this is a new system. Not until relatively recently did any central bank attempt to promote full employment and what is called price stability (but is really a never-ending inflation) by issuing paper money and manipulating interest rates. …a world-wide monetary system based on the scientifically informed discretion of Ph.D. economists. The Fed alone employs 700 of them.

But Grant says the gold standard worked reasonably well.

A 20th-century scholar, reviewing the record of the gold standard from 1880-1914, was unabashedly admiring of it: “Only a trifling number of countries were forced off the gold standard, once adopted, and devaluations of gold currencies were highly exceptional. Yet all this was achieved in spite of a volume of international reserves that, for many of the countries at least, was amazingly small and in spite of a minimum of international cooperation . . . on monetary matters.” …Arthur I. Bloomfield wrote those words, and the Federal Reserve Bank of New York published them, in 1959.

The new approach, which Grant mockingly calls the “Ph.D. standard,” gives central bankers discretionary power to do all sorts of worrisome things.

The ideology of the gold standard was laissez-faire; that of the Ph.D. standard (let’s call it) is statism. Gold-standard central bankers bought few, if any, government securities. Today’s central bankers stuff their balance sheets with them. In the gold-standard era, the stockholders of a commercial bank were responsible for the solvency of the institution in which they held a fractional interest. The Ph.D. standard brought the age of the government bailout and too big to fail.

By the way, the purpose of today’s column isn’t to unreservedly endorse a gold standard.

Such as system is very stable in the long run but can lead to short-term inflation or deflation based on what’s happening with the market for gold. And those short-term fluctuations can be economically disruptive.

I was messaging earlier today with Robert O’Quinn, the former Chief Economist at the Department of Labor (who also worked at the Fed) and got this reaction to the Luther-Salter column.

Which is better matching the long-term growth of the economy and the demand for money? The profitability of gold mining or central bank decision-making? A good monetary rule may be better than a classical gold standard. The difficulty is sustaining a good rule.

The ;problem, of course, is that I don’t trust politicians (and their Fed appointees) to follow a good rule.

  • Especially in a world where many of them believe in Keynesian boom-bust monetary policy.
  • Especially in a world where many of them think the Fed should prop up or bailout Wall Street.
  • Especially in a world where many of them might use the central bank to finance big government.
  • Especially in a world where many of them support a “war against cash” to empower politicians.

The bottom line is that we have to choose between two imperfect options and decide which one has a bigger downside.

P.S. Since a return to a classical gold standard is highly unlikely (and because the libertarian dream of “free banking” is even more improbable), the best we can hope for is a president who 1) makes good appointments to the Fed, and 2) supports sound-money policies even when it means short-run political pain. We’ve had one president like that in my lifetime.

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In an interview with Fox Business last week, I touched on three policies (easy money from the Fed, Biden’s class-warfare tax agenda, and the ever-increasing burden of federal spending) that create risks for the economy in 2021.

I didn’t have a chance to elaborate in the interview, but it’s worth noting that Biden will inherit two of the aforementioned problems.

Trump has been profligate with our money, and he was that way even before the coronavirus became an excuse to open the budgetary spigot. Moreover, he was just like Obama in pressuring the Federal Reserve for Keynesian-style monetary policy.

Unfortunately, there’s no reason to think Biden will try to reverse those mistakes.

Indeed, he wants expand the burden of federal spending. And, regarding monetary policy, appointing Janet Yellen as Secretary of Treasury certainly suggests he is comfortable with the current approach.

And to make matters worse, he definitely wants a more punitive tax system. We will shortly learn whether Democrats take control of the Senate, which presumably would give Biden more leeway to enact his class-warfare tax agenda.

As I said in the interview, that would create economic headwinds.

P.S. I mentioned in the interview that we have “three Americas” with regards to coronavirus. I’m not sure I was completely clear, so here’s what I was trying to get across.

  1. Tourism-reliant states – They are going to be in bad shape until coronavirus is in the rear-view mirror and people feel comfortable with traveling and socializing.
  2. Lock-down states – They have higher unemployment rates because more businesses are shut down.
  3. Laissez-faire states – These are the states that generally allow businesses to remain open and have lower unemployment rates.

For what it’s worth, I think it’s best to let businesses stay open and to allow them and their customers to assess safety risks. It will be interesting to see whether any link is discovered between state policy and coronavirus rates.

P.P.S. At the risk of over-simplification, bad fiscal policy erodes the economy’s long-run growth rate. Bad monetary policy, by contrast, is what causes economic volatility and downturns.

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I’m not a fan of the European Union, which has morphed from something good (a free-trade pact) to something bad (a pro-centralization,wannabe United States of Europe that exacerbates the continent’s tax-and-spend mentality).

Indeed, that’s why I’m a huge fan of Brexit. The United Kingdom is wise to escape the sinking ship.

But notwithstanding all my critiques of the E.U., I’ve never blamed or condemned the euro currency.

Why? Because many of the nations that joined that common currency did a lousy job when they had national currencies. Italy and Greece, for instance, routinely used their central banks as printing presses to help finance bloated budgets.

And that inflation exacerbated all the other economic problems that existed.

The bottom line is that many nations would benefit if they took monetary policy away from their politicians and instead adopted the currency of a nation with a better track record.

That happened in Europe when the euro was adopted since it means – for all intents and purposes – that Mediterranean nations use a currency that is controlled by Germany.

This lesson should be applied elsewhere in the world, which is why “dollarization” can be a good idea.

Professor Steve Hanke of Johns Hopkins University wrote a good description of this concept for National Review.

Before the rise in central banking (monetary nationalism), the world was dominated by unified currency areas, or blocs, the largest of which was the sterling bloc. As early as 1937, the great Austrian economist and Nobel winner Friedrich von Hayek warned that the central banking fad, if it continued, would lead to currency chaos and the spread of banking crises. …Indeed, for most emerging‐​market countries with central banks, hot money flows are frequent and so are exchange‐​rate and domestic banking crises. What to do? The obvious answer is for vulnerable emerging‐​market countries to do away with their central banks and domestic currencies, replacing them with a sound foreign currency.  Today, 32 countries are “dollarized” and rely on a foreign currency as legal tender. …Panama, which was dollarized in 1903, illustrates the important features of a dollarized economy. …The results of Panama’s dollarized money system and internationally integrated banking system have been excellent when compared with other emerging-market countries… Emerging-market countries should follow Panama’s lead and “dollarize.” Most central banks in emerging countries produce junk currencies, banking crises, instability, and economic misery. These central banks should have been mothballed and put in museums long ago.

And there are many nations that would benefit if they used the U.S. dollar.

Back in 2018, Mary Anastasia O’Grady opined in the Wall Street Journal that Argentina should dollarize.

Another currency crisis is roiling Argentina… The question that seems to be on everyone’s lips: Why is this happening again… The answer: Because Argentina still has a central bank. To fix the problem once and for all, it should dollarize. …an IMF package can’t cure what ails the peso. This is a long-term political problem that has manifested itself in repeated economic crises since the mid-20th century. The government lives beyond its means while taxes and regulations, particularly on labor, make many businesses uncompetitive. The net effect is always the same: ballooning debt and a lethargic economy followed by devaluation or default or both. …The fastest way to restore confidence would be to put an end to the misery caused by the peso and to adopt the dollar. Argentines could then get on with the business of saving and investing in their beautiful country.

The Wall Street Journal has editorialized in favor of dollarization in Argentina.

Dollarizers face resistance from the Peronist party, which relies on the inflation tax to fund its populism when revenues run low. Yet demand for dollars suggests…popular backing for adopting the greenback as the national currency. …Panama has used the dollar as legal tender since 1904, and El Salvador and Ecuador dollarized in 2000. Ecuador did it to resolve a banking crisis and El Salvador did it to bring down interest rates. El Salvador and Panama now have the lowest domestic borrowing rates in Latin America and the longest maturities. Ecuador has price stability not seen in at least a half century.

Here’s the real shocker. As reported by Reuters, Venezuela is on the verge of dollarizing.

Venezuelan President Nicolás Maduro embraced the currency of his bitter rival the United States on Sunday, calling it an “escape valve” that can help the country weather its economic crisis… The official currency, the bolivar, has depreciated more than 90% this year, while hyperinflation in the first nine months of the year clocked in at 4,680%… “I don’t see it as a bad thing … this process that they call ‘dollarization,’” Maduro said in an interview broadcast on the television channel Televen. “It can help the recovery of the country, the spread of productive forces in the country, and the economy … Thank God it exists,” the socialist leader said.

Writing for National Review, Professor Steve Hanke explains that Maduro has no choice but to move in the right direction.

Maduro, in a rare display of good judgment, is taking a necessary step toward what I have been advocating for many years: official dollarization in Venezuela. …Venezuela’s bolivar is worthless, and its annual inflation rate is the world’s highest…2,156 percent per year. Not surprisingly, Venezuelans get rid of their bolivars like hot potatoes and replace them with U.S. dollars. So, Venezuela is, to a large extent, unofficially dollarized. Official “dollarization” is a proven elixir. I know because I operated as a state counselor in Montenegro when it dumped the worthless Yugoslav dinar in 1999 and replaced it with the Deutsche mark. I also watched the successful dollarization of Ecuador in 2001… Countries that are officially dollarized produce lower, less variable inflation rates and higher, more stable economic growth rates than comparable countries with central banks that issue domestic currencies. There is a tried-and-true way to stabilize the economy…since more than 80 percent of transactions in Venezuela take place in U.S. dollars, it doesn’t seem unreasonable to think that the approval rating would now exceed 80 percent. So, it’s not surprising that Maduro has embraced the dollarization idea. After all, the public already does.

In another column for National Review, Steve Hanke and Craig Richardson cite what’s been happening in Zimbabwe.

They begin by pointing out that part of that nation has avoided problems by using the dollar.

Zimbabwe’s economy has gone through the wringer. In just 20 short years, it has witnessed two episodes of hyperinflation. And, if that wasn’t bad enough, Zimbabwe’s real GDP per capita has plunged by 21 percent over that same period. …But,…when you enter the town of Victoria Falls, it’s as if you have walked into an alternative African economic universe. Victoria Falls is an island of stability in Zimbabwe, a country that has descended into monetary and fiscal chaos. How could this be? …Victoria Falls…has long operated under very different monetary rules. …the glue that holds Victoria Falls together is the U.S. dollar. It’s the coin of the realm in Victoria Falls. Yes, Victoria Falls is officially dollarized. It only accepts U.S. dollars for payment of property taxes and keeps its books in U.S. dollars as well.

But they also note that the entire nation enjoyed the benefits of dollarization, at least until venal politicians opted out because they wanted the power to finance more spending by printing money.

…in February 2009, a unity government was formed. …In one of its first acts, the unity government scrapped the Zimbabwe dollar and officially dollarized the country. In so doing, the printing presses were shut down; the U.S. dollar became legal tender, taxes were required to be paid in dollars, and government accounts were kept in dollars. With the imposition of a hard budget constraint, the fiscal deficit disappeared, and the economy boomed. That rebound persisted during the term of the national unity government, which lasted until July 2013. Indeed, during this period, real GDP per capita surged at an average annual rate of 11.2 percent. Zimbabwe’s period of stability was short lived, however. With the collapse of the unity government and the return of Mugabe’s ZANU-PF party, government spending and fiscal deficits surged, resulting in economic instability. To finance its deficits, the government created a “New Zim dollar,” and Zimbabwe de-dollarized. …The money supply exploded, as did inflation.

This column has focused on dollarization, but there are other currencies that are serve the same role. And there are currency boards/pegs as well.

This map from Wikipedia provides a helpful summary.

P.S. Some people will point out that the dollar doesn’t have a great track record and the the Federal Reserve has behaved imprudently. I certainly won’t argue against those observations. But if I’m a Venezuelan or Argentinian, I’d still prefer the dollar over a currency controlled by my politicians.

P.P.S. It’s probably in the interests of the United States to have more nations dollarize, which is an argument against extraterritorial policies that discourage use of the dollar.

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There will be many lessons that we hopefully learn from the current crisis, most notably that it’s foolish to give so much regulatory power to sloth-like bureaucracies such as the FDA and CDC.

Today, I want to focus on a longer-run lesson, which is how tax policy (a bias for debt over equity) and monetary policy (artificially low interest rates) encourage excessive private debt.

Are current debt levels excessive? Let’s look at some excerpts from a column in the Washington Post, which was written by David Lynch last November – before coronavirus started wreaking havoc with the economy.

Little more than a decade after consumers binged on inexpensive mortgages that helped bring on a global financial crisis, a new debt surge — this time by major corporations — threatens to unleash fresh turmoil. A decade of historically low interest rates has allowed companies to sell record amounts of bonds to investors, sending total U.S. corporate debt to nearly $10 trillion… Some of America’s best-known companies…have splurged on borrowed cash. This year, the weakest firms have accounted for most of the growth and are increasingly using debt for “financial risk-taking,”… “We are sitting on the top of an unexploded bomb, and we really don’t know what will trigger the explosion,” said Emre Tiftik, a debt specialist at the Institute of International Finance, an industry association. …The root cause of the debt boom is the decision by the Federal Reserve and other key central banks to cut interest rates to zero in the wake of the financial crisis and to hold them at historic lows for years.

Needless to say, Emre Tiftik didn’t know last November what would “trigger the explosion.”

Now we have coronavirus, and George Melloan explained a few days ago in the Wall Street Journal that the “unexploded bomb” has detonated.

The Covid-19 pandemic…will do further damage to the global economy… The danger is heightened by the heavy load of debt American corporations have piled up as they have taken advantage of low-cost borrowing. …Cheap credit brought on the heavy overload of corporate debt. The Federal Reserve has responded to the virus by—what else?—making credit even cheaper, cutting its fed funds lending rate all the way to 0%-0.25% on Sunday. …Rate cuts in response to crises are programmed into the Fed’s software. There is no compelling evidence that they are a solution or even a remedy. …the low interest rates of the past decade have ballooned all forms of debt: government, consumer, corporate. Corporate debt, the most worrisome type at the moment, stands at about $10 trillion and has made a steady climb to 47% of gross domestic product, a record level… But even cheap borrowing and securitized debt obligations have to be paid back. It becomes harder to make payments when a global health crisis is killing sales and your company is bleeding red ink. …the increased political bias toward easy money remains a problem. The Federal Reserve Act of 1913 was political from the day Woodrow Wilson signed it. It has gotten more political ever since, increasingly becoming an instrument for robbing the poor—savers and pensioners—and giving to often profligate borrowers.

Melloan’s final points deserve emphasis. There are good reasons to reconsider the Federal Reserve, and we definitely should be angry about the perverse redistribution enabled by Fed policies.

But let’s keep our focus on the topic of government-encouraged debt and how it contributes to economic instability.

It’s not just an issue of bad monetary policy. We also have a tax code that encourages companies to disproportionately utilize debt.

But the 2017 tax bill addressed that flaw, as Reihan Salam explained two years ago in an article for National Review.

…one of the TCJA’s good points…limits that the legislation places on corporate interest deductibility, which…could change the way companies in the United States do business and make the U.S. economy more stable. …By stipulating that companies cannot use the interest deduction to reduce their earnings by more than 30 percent, the law made taking on debt somewhat less attractive compared to seeking financing by offering equity to investors. …equity is more flexible in times of crisis than debt, which means that problems are less likely to spiral out of control.

That’s the good news (along with the lower corporate rate and restriction on deductibility of state and local taxes).

The bad news is that the 2017 law only partially addressed the bias for debt over equity. Companies still have a tax-driven incentive to prefer borrowing.

Here’s the Tax Foundation’s depiction of how the pre-TCJA system worked, which I’ve altered to show how the new system operates.

I’ll close with the observation that there’s nothing necessarily wrong with private debt. Families borrow to buy homes, for instance, and companies borrow for reasons such as financing research and building factories.

But debt only makes sense if it’s based on market-driven factors (i.e., will borrowing enable future benefits and will there be enough cash to make payments). And that includes planning for what happens if there’s a recession and income falls.

Unfortunately, government intervention has distorted market signals and the result is excessive debt. And now the economic damage of the coronavirus will be even higher because more companies will become insolvent.

P.S. Even the International Monetary Fund is on the correct side about the downsides of tax-driven debt.

P.P.S. In addition to eliminating the bias for debt over equity, it also would be a very good idea to get rid of the bias for current consumption over future consumption (i.e., double taxation).

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The coronavirus is a genuine threat to prosperity, at least in the short run, in large part because it is causing a contraction in global trade.

The silver lining to that dark cloud is that President Trump may learn that trade is actually good rather than bad.

But dark clouds also can have dark linings, at least when the crowd in Washington decides it’s time for another dose of Keynesian economics.

  • Fiscal Keynesianism – the government borrows money from credit markets and politicians then redistribute the funds in hopes that recipients will spend more.
  • Monetary Keynesianism – the government creates more money in hopes that lower interest rates will stimulate borrowing and recipients will spend more.

Critics warn, correctly, that Keynesian policies are misguided. More spending is a consequence of economic growth, not the trigger for economic growth.

But the “bad penny” of Keynesian economics keeps reappearing because it gives politicians an excuse to buy votes.

The Wall Street Journal opined this morning about the risks of more Keynesian monetary stimulus.

The Federal Reserve has become the default doctor for whatever ails the U.S. economy, and on Tuesday the financial physician applied what it hopes will be monetary balm for the economic damage from the coronavirus. …The theory behind the rate cut appears to be that aggressive action is the best way to send a strong message of economic insurance. …Count us skeptical. …Nobody is going to take that flight to Tokyo because the Fed is suddenly paying less on excess reserves. …The Fed’s great mistake after 9/11 was that it kept rates at or near 1% for far too long even after the 2003 tax cut had the economy humming. The seeds of the housing boom and bust were sown.

And the editorial also warned about more Keynesian fiscal stimulus.

Even if a temporary tax cuts is the vehicle used to dump money into the economy.

This being an election year, the political class is also starting to demand more fiscal “stimulus.” …If Mr. Trump falls for that, he’d be embracing Joe Bidenomics. We tried the temporary payroll-tax cut idea in the slow growth Obama era, reducing the worker portion of the levy to 4.2% from 6.2% of salary. It took effect in January 2011, but the unemployment rate stayed above 9% for most of the rest of that year. Temporary tax cuts put more money in peoples’ pockets and can give a short-term lift to the GDP statistics. But the growth effect quickly vanishes because it doesn’t permanently change the incentive to save and invest.

Excellent points.

Permanent supply-side tax cuts encourage more prosperity, not temporary Keynesian-style tax cuts.

Given the political division in Washington, it’s unclear whether politicians will agree on how to pursue fiscal Keynesianism.

But that doesn’t mean we can rest easy. Trump is a fan of Keynesian monetary policy and the Federal Reserve is susceptible to political pressure.

Just don’t expect good results from monetary tinkering. George Melloan wrote about the ineffectiveness of monetary stimulus last year, well before coronavirus became an issue.

The most recent promoters of monetary “stimulus” were Barack Obama and the Fed chairmen who served during his presidency, Ben Bernanke and Janet Yellen. …the Obama-era chairmen tried to stimulate growth “by keeping its policy rate at zero for six-and-a-half years into the economic recovery and more than quadrupled the size of the Fed’s balance sheet.” And what do we have to show for it? After the 2009 slump, economic growth from 2010-17 averaged 2.2%, well below the 3% historical average, despite the Fed’s drastic measures. Low interest rates certainly stimulate borrowing, but that isn’t the same as economic growth. Indeed it can often restrain growth. …Congress got the idea that credit somehow comes free of charge. So now the likes of Elizabeth Warren and Bernie Sanders think there is no limit to how much Uncle Sam can borrow. Easy money not only expands debt-service costs but also encourages malinvestment. …when Donald Trump hammers on the Fed for lower rates, …he is embarked on a fool’s errand.

Since the Federal Reserve has already slashed interest rates, that Keynesian horse already has left the barn.

That being said, don’t expect positive results. Keynesian economics has a very poor track record (if fiscal Keynesianism and monetary Keynesianism were a recipe for success, Japan would be booming).

So let’s hope politicians don’t put a saddle on the Keynesian fiscal horse as well.

If Trump really feels he has to do something, I ranked his options last summer.

The bottom line is that good short-run policy is also good long-run policy.

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Yesterday’s column was my annual end-of-year round-up of the best and worst developments of the concluding year.

Today I’ll be forward looking and give you my hopes and fears for the new year, which is a newer tradition that began in 2017 (and continued in 2018 and 2019).

With my glass-half-full outlook, we’ll start with the things I hope will happen.

Supreme Court strikes down civil asset forfeiture – It is nauseating that bureaucrats can steal property from citizens who have never been convicted of a crime. Or even charged with a crime. Fortunately, this disgusting practice already has attracted attention from Clarence Thomas and other sound-thinking Justices on the Supreme Court. Hopefully, this will produce a decision that ends this example of Venezuela-style government thuggery.

Good free-trade agreements for the United Kingdom – This is a two-pronged hope. First, I want a great agreement between the U.S. and the U.K., based on the principle of mutual recognition. Second, I want the best-possible agreement between the U.K. and the E.U., which will be a challenge since the political elite in Brussels has a spiteful desire to “punish” the British people for supporting Brexit.

Maduro’s ouster in Venezuela – I already wished for this development in 2018 and 2019, so this is my “Groundhog Day” addition to the list. But if I keep wishing for it, sooner or later it will happen and I’ll look prescient. But I actually don’t care about whether my predictions are correct, I just want an end to the horrible suffering for the people of Venezuela.

Here are the things I fear will happen in 2020.

A bubble bursts – I hope I’m wrong (and that may be the case since I’ve been fretting about it for a long time), but I fear that financial markets are being goosed by an easy-money policy from the Federal Reserve. Bubbles feel good when they’re expanding, but last decade should have taught us that they can be very painful when they pop.

A loss of economic liberty in Chile and/or Hong Kong – As shown by Economic Freedom of the World, there are not that many success stories in the world. But we can celebrate what’s happened in Hong Kong since WWII and what’s happened in Chile since the late 1970s. Economic liberty has dramatically boosted prosperity. Unfortunately, Hong Kong’s liberty is now being threatened from without and Chile’s liberty is now being threatened from within.

Repeal of the Illinois flat tax – The best approach for a state is to have no income tax, and a state flat tax is the second-best approach. Illinois is in that second category thanks to a long-standing provision of the state’s constitution. Needless to say, this irks the big spenders who control the Illinois government and they are asking voters this upcoming November to vote on whether to bust the flat tax and open the floodgates for an ever-growing fiscal burden. By the way, it’s quite likely that I’ll be including the Massachusetts flat tax on this list next year.

I’ll also add a special category for something that would be both good and bad.

Trump gets reelected – Because Trump is producing better tax policy and better regulatory policy, and because of my hopes for judges who believe in the Constitution’s protections of economic liberty, it would be good if he won a second term.

Trump gets reelected – Because Trump is producing worse spending policy and worse trade policy, and because of my concerns never-ending Keynesian monetary policy from the Federal Reserve, it would be bad if he won a second term.

Happy New Year, everyone.

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I’m worried. There’s a lot of talk in Washington about Trump trying to goose the economy with either Keynesian monetary policy or Keynesian fiscal policy.

It would be much better, as I discuss in this interview with Yahoo Finance, if Trump instead declared a ceasefire in the trade wars he’s started.

The interview largely revolved around trade policy and monetary policy, so I was mostly critical of Trump.

But I want to focus on the point I made midway through the discussion, when I said that Trump is undermining and offsetting some of his Administration’s good policies – most notably tax reform and regulatory easing.

As an economist, I’m frustrated by this inconsistency. It’s akin to a watching a kid get good grades in some classes and bad grades in others (and I worry his GPA is declining).

Though I suppose I shouldn’t be surprised. This is what the theory of “public choice” tells us to expect.

I can only imagine, though, how frustrating this must be for Republican political operatives. They’re focused on winning in 2020 and the President is sabotaging that goal with bad trade policy.

P.S. Toward the end of the interview, I pointed out that Trump should have gone through the World Trade Organization in his effort to curtail China’s protectionism. When the history of the Trump presidency is written, I suspect this will be viewed as a major mistake.

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Having been exposed to scholars from the Austrian school as a graduate student, I have a knee-jerk suspicion that it’s not a good idea to rely on the Federal Reserve for macroeconomic tinkering.

In this interview from yesterday, I specifically warn that easy money can lead to economically harmful asset bubbles.

 

Since I don’t pretend to be an expert on monetary policy, I’ll do an appeal to authority.

Claudio Borio of the Bank for International Settlements is considered to be one of the world’s experts on the issue.

Here are some excerpts from a study he recently wrote along with three other economists. I especially like what they wrote about the risks of looking solely at the price level as a guide to policy.

The pre-crisis experience has shown that, in contrast to common belief, disruptive financial imbalances could build up even alongside low and stable, or even falling, inflation. Granted, anyone who had looked at the historical record would not have been surprised: just think of the banking crises in Japan, the Asian economies and, going further back in time, the US experience in the run-up to the Great Depression. But somehow the lessons had got lost in translation… And post-crisis, the performance of inflation has repeatedly surprised. Inflation…has been puzzlingly low especially more recently, as a number of economies have been reaching or even exceeding previous estimates of full employment. …the recent experience has hammered the point home, raising nagging doubts about a key pillar of monetary policymaking. …Our conclusion is that…amending mandates to explicitly include financial stability concerns may be appropriate in some circumstances.

Here’s a chart showing that financial cycles and business cycles are not the same thing.

The economists also point out that false booms instigated by easy money can do a lot of damage.

Some recent work with colleagues sheds further light on some of the possible mechanisms at work (Borio et al (2016)). Drawing on a sample of over 40 countries spanning over 40 years, we find that credit booms misallocate resources towards lower-productivity growth sectors, notably construction, and that the impact of the misallocations that occur during the boom is twice as large in the wake of a subsequent banking crisis. The reasons are unclear, but may reflect, at least in part, the fact that overindebtedness and a broken banking system make it harder to reallocate resources away from bloated sectors during the bust. This amounts to a neglected form of hysteresis. The impact can be sizeable, equivalent cumulatively to several percentage points of GDP over a number of years.

Here’s a chart quantifying the damage.

And here’s some more evidence.

In recent work with colleagues, we examined deflations using a newly constructed data set that spans more than 140 years (1870–2013), and covers up to 38 economies and includes equity and house prices as well as debt (Borio et al (2015)). We come up with three findings. First, before controlling for the behaviour of asset prices, we find only a weak association between deflation and growth; the Great Depression is the main exception. Second, we find a stronger link with asset price declines, and controlling for them further weakens the link between deflations and growth. In fact, the link disappears even in the Great Depression (Graph 4). Finally, we find no evidence of a damaging interplay between deflation and debt (Fisher’s “debt deflation”; Fisher (1932)). By contrast, we do find evidence of a damaging interplay between private sector debt and property (house) prices, especially in the postwar period. These results are consistent with the prevalence of supply-induced deflations.

I’ll share one final chart from the study because it certainly suggest that the economy suffered less instability when the classical gold standard was in effect before World War I.

I’m not sure we could trust governments to operate such a system today, but it’s worth contemplating.

P.S. I didn’t like easy money when Obama was in the White House and I don’t like it with Trump in the White House. Indeed, I worry the good economic news we’re seeing now could be partly illusory.

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Being a policy wonk in a political town isn’t easy. I care about economic liberty while many other people simply care about political maneuvering. And the gap between policy advocacy and personality politics has become even larger in the Age of Trump.

One result is that people who should be allies periodically are upset with my columns. Never Trumpers scold me one day and Trump fanboys scold me the next day. Fortunately, I have a very simple set of responses.

  • If you would have loudly cheered for a policy under Reagan but oppose a similar policy under Trump, you’re the problem.
  • If you would have loudly condemned a policy under Obama but support a similar policy under Trump, you’re the problem.

Today, we’re going to look at an example of the latter.

The New York Times reported today on Trump’s advocacy of easy-money Keynesianism.

President Trump on Friday called on the Federal Reserve to cut interest rates and take additional steps to stimulate economic growth… On Friday, he escalated his previous critiques of the Fed by pressing for it to resume the type of stimulus campaign it undertook after the recession to jump-start economic growth. That program, known as quantitative easing, resulted in the Fed buying more than $4 trillion worth of Treasury bonds and mortgage-backed securities as a way to increase the supply of money in the financial system.

I criticized these policies under Obama, over and over and over again.

If I suddenly supported this approach under Trump, that would make me a hypocrite or a partisan.

I’m sure I have my share of flaws, but that’s not one of them.

Regardless of whether a politician is a Republican or a Democrat, I don’t like Keynesian fiscal policy and I don’t like Keynesian monetary policy.

Simply stated, the Keynesians are all about artificially boosting consumption, but sustainable growth is only possible with policies that boost production.

There are two additional passages from the article that deserve some commentary.

First, you don’t measure inflation by simply looking at consumer prices. It’s quite possible that easy money will result in asset bubbles instead.

That’s why Trump is flat-out wrong in this excerpt.

“…I personally think the Fed should drop rates,” Mr. Trump said. “I think they really slowed us down. There’s no inflation. I would say in terms of quantitative tightening, it should actually now be quantitative easing. Very little if any inflation. And I think they should drop rates, and they should get rid of quantitative tightening. You would see a rocket ship. Despite that, we’re doing very well.”

To be sure, many senior Democrats were similarly wrong when Obama was in the White House and they wanted to goose the economy.

Which brings me to the second point about some Democrats magically becoming born-again advocates of hard money now that Trump is on the other side.

Democrats denounced Mr. Trump’s comments, saying they showed his disregard for the traditional independence of the Fed and his desire to use its powers to help him win re-election. “There’s no question that President Trump is seeking to undermine the…independence of the Federal Reserve to boost his own re-election prospects,” said Senator Ron Wyden of Oregon, the top Democrat on the Finance Committee.

Notwithstanding what I wrote a few days ago, I agree with Sen. Wyden on this point.

Though I definitely don’t recall him expressing similar concerns when Obama was appointing easy-money supporters to the Federal Reserve.

To close, here’s what I said back in October about Trump’s Keynesian approach to monetary policy.

I also commented on this issue earlier this year. And I definitely recommend these insights from a British central banker.

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Back in January, I spoke with Cheddar about market instability and put much of the blame on the Federal Reserve. Simply stated, I fear we have a bubble thanks to years and years (and years and years) of easy money and artificially low interest rates.

To be sure, I also noted that there are other policies that could be spooking financial markets.

But I do think monetary policy is the big threat. Mistakes by the Fed sooner or later cause recessions (and the false booms that are the leading indicator of future downturns).

Mistakes by Congress, by contrast, “merely” cause slower growth.

In this next clip from the interview, I offer guarded praise to the Fed (not my usual position!) for trying to unwind the easy-money policies from earlier this decade and therefore “normalize” interest rates (i.e., letting rates climb to the market-determined level).

For those interested in the downside risks of easy money, I strongly endorse these cautionary observations from a British central banker.

My modest contribution to the discussion was when I mentioned in the interview that we wouldn’t be in the tough position of having to let interest rates climb if we didn’t make the mistake of keeping them artificially low. Especially for such a long period of time.

My motive for addressing this topic today is that Robert Samuelson used his column in the Washington Post to launch an attack against Steve Moore.

Stephen Moore does not belong on the Federal Reserve Board… Just a decade ago, the U.S. and world economies suffered the worst slumps since World War II. What saved us then were the skilled interventions of the Fed under Chairman Ben S. Bernanke… Do we really want Moore to serve as the last bulkhead against an economic breakdown? …as a matter of prudence, we should assume economic reverses. If so, the Fed chief will become a crisis manager. That person should not be Stephen Moore.

I’ve been friends with Steve for a couple of decades, so I have a personal bias.

That being said, I would be arguing that Samuelson’s column is problematic for two reasons even if I never met Steve.

  • First, he doesn’t acknowledge that the crisis last decade was caused in large part by easy-money policy from the Fed. Call me crazy, but I hardly think we should praise the central bank for dousing a fire that it helped to start.
  • Second, he frets that Steve would be bad in a crisis, which presumably is a time when it might be appropriate for the Fed to be a “lender of last resort.”* But he offers zero evidence that Steve would be opposed to that approach.

For what it’s worth, I actually worry Steve would be too willing to go along with an easy-money approach. Indeed, I look forward to hectoring him in favor of hard money if he gets confirmed.

But this column isn’t about a nomination battle in DC. My role is to educate on public policy.

So let’s close by reviewing some excerpts from a column in the Wall Street Journal highlighting the work of Claudio Borio at the Bank for International Settlements.

In a 2015 paper Mr. Borio and colleagues examined 140 years of data from 38 countries and concluded that consumer-price deflation frequently coincides with healthy economic growth. If he’s right, central banks have spent years fighting disinflation or deflation when they shouldn’t have, and in the process they’ve endangered the economy more than they realize. “By keeping interest rates very, very, very low,” he warns, “you are contributing to the buildup of risks in the financial system through excessive credit growth, through excessive increases in asset prices, that at some point have to correct themselves. So what you have is a financial boom that necessarily at some point will turn into a bust because things have to adjust.” …It’s not that other economists are blind to financial instability. They’re just strangely unconcerned about it. “There are a number of proponents of secular stagnation who acknowledge, very explicitly, that low interest rates create problems for the future because they’re generating all these financial booms and busts,” Mr. Borio says. Yet they still believe central banks must set ultralow short-term rates to support economic growth—and if that destabilizes the financial system, it’s the will of the economic gods.

Amen. I also recommend this column and this column for further information on how central bankers are endangering prosperity.

P.S. For a skeptical history of the Federal Reserve, click here. If you prefer Fed-mocking videos, click here and here.

P.P.S. I fear the European Central Bank has the same misguided policy. To make matters worse, policy makers in Europe have used easy money as an excuse to avoid the reforms that are needed to generate real growth.

P.P.P.S. Samuelson did recognize that defeating inflation was one of Reagan’s great accomplishments.

*For institutions with liquidity problems. Institutions with solvency problems should be shut down using the FDIC-resolution approach.

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When Trump imposes protectionist trade barriers, he doesn’t realize that the harm imposed on other nations is matched by damage to the U.S. economy.

As I warn in this interview, something similar could happen if the federal government convinces other nations to reject the dollar because they no longer want to acquiesce to the extraterritorial imposition of U.S. laws.

This is a wonky issue, but the bottom line is that the United States benefits enormously because the rest of the world uses the dollar.

The best article I can recommend was published earlier this year by the Cayman Financial Review. It’s a good tutorial on the issue and it explains why the United States enjoys an “exorbitant privilege” because the dollar is the world’s reserve currency.

A reserve currency is a currency that governments hold in their foreign exchange reserves to settle international claims and intervene in foreign exchange markets. …Governments overwhelmingly choose one currency – the U.S. dollar… U.S. dollar-denominated assets comprised 63.79 percent of disclosed foreign exchange reserves… The Bank for International Settlements (BIS) reported that 88 percent of all foreign exchange transactions in 2016 involve the U.S. dollar on one side. …In 2014, 51.9 percent of international trade by value and 49.4 percent of international trade by volume of transactions were invoiced in U.S. dollars. …Major internationally traded commodities such as oil are priced in U.S. dollars. …The status of the U.S. dollar as the world’s reserve currency and the resulting foreign demand for U.S. dollars creates what French Finance Minister Valéry Giscard d’Estaing described in 1965 as an “exorbitant privilege” for the United States. …While difficult to measure, empirical studies suggest the privilege is worth about ½ percent of U.S. GDP (or roughly $100 billion) in a normal year.

And Peter Coy’s column for Bloomberg does a good job of explaining why the rest of the world is tempted to abandon the dollar.

America’s currency makes up two-thirds of international debt and a like share of global reserve holdings. Oil and gold are priced in dollars, not euros or yen. …threats to be cut off from the dollar-based global payments system strike terror into the likes of Iran, North Korea, and Russia. …Political leaders who once accepted the dollar’s hegemony, grudgingly or otherwise, are pushing back. …In March, China challenged the dollar’s dominance in the global energy markets with a yuan-denominated crude oil futures contract. …French Finance Minister Bruno Le Maire told reporters in August that he wants financing instruments that are “totally independent” of the U.S. …This disturbance in the force isn’t good news for the U.S. …As it is now, when trouble breaks out, investors flood into U.S. markets seeking refuge, oddly enough even when the U.S. itself is the source of the problem, as it was in last decade’s global financial crisis. …The most immediate risk to the dollar is that the U.S. will overplay its hand on financial sanctions, particularly those against Iran and countries that do business with Iran. …European leaders, in response to what they perceive as an infringement on their sovereignty, are openly working on a payments system that would enable their companies to do business with Iran without getting snagged by the U.S. Treasury Department and its powerful Office of Foreign Assets Control. …dissatisfaction with the dollar’s dominance…is only mounting. …Lew said in 2016, “the more we condition use of the dollar and our financial system on adherence to U.S. foreign policy, the more the risk of migration to other currencies and other financial systems in the medium term grows.”

Here’s some of what I said on the issue of sanctions in a different interview.

But notice that it’s not just sanctions.

The rest of the world is irritated by FATCA and other aspects of extraterritorial taxation.

Other nations also are irked by the pointless imposition of “know your customer” rules and other anti-money laundering policies that impose heavy costs without having any impact on actual criminal behavior.

Anyhow, let’s review some additional analysis, starting with this editorial from the Wall Street Journal.

More than any recent U.S. President, Mr. Trump is willing to use economic leverage for coercive diplomacy. He’s now targeting Turkey… Turkey is vulnerable because of Mr. Erdogan’s economic mismanagement. In the runup to June elections, he blew out the fisc on entitlements and public works. …As tempting as sanctions often are, they should be used sparingly and against the right targets. They make sense against genuine rogue states like Iran and North Korea, as well as to show Vladimir Putin that there are costs… But sanctions against allies should be used only in rare cases. They would also be less risky if they weren’t piled on top of Mr. Trump’s tariff war. …If Mr. Trump is determined to use coercive economic diplomacy, including tariffs and sanctions, then the Treasury will have to be ready to deal with the collateral financial damage.

Writing for Real Money, Mike Norman is very worried.

The United States is increasingly using sanctions as a form of warfare. …It’s a form of soft warfare that targets a country’s economy and its ability to transact business and safeguard its financial wealth in today’s dollar-based economy. Do you know what the result of these sanctions will be? The dollar will get crushed. Something like 80% of all international transactions take place in dollars. The global financial system rests on a dollar architecture. That includes funds transfer, clearing, payments, etc. …How long do you think the rest of the world will operate under such a risk? A risk that at any moment if you fall out of favor with the fools in Washington your entire economy and lifeline to the world’s financial system can be shut down? That is too much risk. No country and no citizen wants that risk hanging over them.

Professor Barry Eichengreen expresses similar concerns in a column for Project Syndicate.

…the Trump administration is eroding the dollar’s global role. Having unilaterally reimposed sanctions on Iran, it is threatening to penalize companies doing business with the Islamic Republic by denying them access to US banks. The threat is serious because US banks are the main source of dollars used in cross-border transactions. …In response to the Trump administration’s stance, Germany, France, and Britain, together with Russia and China, have announced plans to circumvent the dollar, US banks, and US government scrutiny. …This doesn’t mean that foreign banks and companies will shun the dollar entirely. US financial markets are large and liquid and are likely to remain so. US banks operate globally. …But in an era of US unilateralism, they will want to hedge their bets. …there will be less reason for central banks to hold dollars in order to intervene in the foreign exchange market and stabilize the local currency against the greenback. …In threatening to punish Europe and China, Trump is, ironically, helping them to achieve their goals. Moreover, Trump is squandering US leverage.

And Michael Maharrey elaborates on the warning signs in a column for FEE.

…the U.S….weaponizes the U.S. dollar, using its economic dominance as both a carrot and a stick. …”enemies” can find themselves locked out of the global financial system, which the U.S. effectively controls using the dollar. …It utilizes the international payment system known as SWIFT…the Society for Worldwide Interbank Financial Telecommunication. …SWIFT and dollar dominance give the U.S. a great deal of leverage over other countries. …China, Russia, and Iran, have taken steps to limit their dependence on the dollar and have even been working to establish alternative payment systems. A growing number of central banks have been buying gold as a way to diversify their holdings away from the greenback. …even traditional U.S. allies have grown weary of American economic bullying. On Sept. 24, the E.U. announced its plans to create a special payment channel to circumvent U.S. economic sanctions… De-dollarization of the world economy would likely perpetuate a currency crisis in the United States, and it appears a movement to dethrone the dollar is gaining steam.

All of the above articles could be considered the bad news.

So I’ll share one small bit of good news from Coy’s column. The one thing that may save the dollar is that there aren’t any good alternatives.

The best thing the dollar has going for it is that its challengers are weak. The euro represents a monetary union… Italy’s recent woes are only the latest challenge to the euro zone’s durability. China is another pretender to the throne. But China’s undemocratic leadership is wary of the openness to global trade and capital flows that having a widely used currency requires.

I agree. Indeed, I wrote way back in 2010 and 2011 that the euro lost a lot of credibility when the European Central Bank surrendered its independence and took part in the bailouts of Europe’s welfare states.

So why jump from the dollar to the euro, especially since Europe will be convulsed by additional fiscal crises when the next recession occurs?

That being said, the moral of today’s column is that the crowd in Washington shouldn’t be undermining the attractiveness of the dollar. Here’s a chart to give you some idea of what’s been happening.

P.S. I want to close with a point about trade deficits. It turns out that being the world’s reserve currency requires a trade deficit. That was explained in the Cayman Financial Review column.

A significant part of the U.S. current account deficit and the U.S. trade deficit (whether measured as goods and services or as goods only) is attributable to the U.S. dollar’s status as the world’s reserve currency. Even if every country in the world were to practice free trade and not to engage in any currency manipulation, the United States would still record persistent current account deficits so long as the U.S. dollar remains the world’s reserve currency.

Likewise, here’s the relevant portion from the Real Money column.

Since most of of the world’s commerce is denominated in dollars and because oil was priced in dollars, it necessitated that the rest of the world ran trade surpluses with the U.S. in order to get dollars. Therefore, our trade deficits were an expression of high demand for dollars, not vice-versa. …We never understood, or at least our policy makers never understood, that we had the better part of the deal. When the rest of the world labors for low wages to build finished goods that they send to us for our paper currency, that is a benefit to us, not a cost.

Last but not least, here are excerpts from Peter Coy’s column.

…for the U.S. to supply dollars to the rest of the world, it must run trade deficits. Trading partners stash the dollars they earn from exports in their reserve accounts instead of spending them on American goods and services. …the U.S. gets what amounts to a permanent, interest-free loan from the rest of the world when dollars are held outside the U.S. As Eichengreen points out, it costs only a few cents for the U.S. Bureau of Engraving and Printing to produce a $100 bill, but other countries have to pony up $100 worth of actual goods and services to obtain one.

I share all these excerpts to reinforce my oft-made point that there is nothing wrong with a trade deficit. Not only does it represent a financial surplus (formerly known, and still often referred to, as a capital surplus), it also reflects the benefit the U.S. enjoys from having the dollar as a reserve currency.

P.P.S. This issue also reinforces my oft-made point that laws should not extend beyond borders.

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I periodically explain that you generally don’t get a recession by hiking taxes, adding red tape, or increasing the burden of government spending. Those policies are misguided, to be sure, but they mostly erode the economy’s long-run potential growth.

If you want to assign blame for economic downturns, the first place to look is monetary policy.

When central banks use monetary policy to keep interest rates low (“Keynesian monetary policy,” but also known as “easy money” or “quantitative easing”), that can cause economy-wide distortions, particularly because capital gets misallocated.

And this often leads to a recession when this “malinvestment” gets liquidated.

I’ve made this point in several recent interviews, and I had a chance to make the same point yesterday.

By the way, doesn’t the other guest have amazing wisdom and insight?

But let’s not digress.

Back to the main topic, I’m not the only one who is worried about easy money.

Desmond Lachman of the American Enterprise Institute is similarly concerned.

Never before have the world’s major central banks kept interest rates so low for so long as they have done over the past decade. More importantly yet, never before have these banks increased their balance sheets on anything like the scale that they have done since 2008 by their aggressive bond-buying programmes. Indeed, since 2008, the size of the combined balances sheet of the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England has increased by a mind-boggling US$10tn. …in recent years, if anything central bank monetary policy might have been overly aggressive. By causing global asset price inflation as well as the serious mispricing and misallocation of global credit, the seeds might have been sown for another Lehman-style economic and financial market crisis down the road. …the all too likely possibility that, by having overburdened monetary policy with the task of stabilizing output, advanced country governments might very well have set us up for the next global boom-bust economic cycle.

If you want the other side of the issue, the Economist is more sympathetic to monetary intervention.

And if you want a very learned explanation of the downsides of easy money, I shared some very astute observations from a British central banker back in 2015.

The bottom line is that easy money – sooner or later – backfires.

By the way, here’s a clip from earlier in the interview. Other than admitting that economists are lousy forecasters, I also warned that the economy is probably being hurt by Trump’s protectionism and his failure to control the growth of spending.

P.S. The “war on cash” in many nations is partly driven by those who want the option of easy money.

P.P.S. I worry that politicians sometimes choose to forgo good reforms because they hope easy money can at least temporarily goose the economy.

P.P.P.S. Easy money is also a tool for “financial repression,” which occurs when governments surreptitiously confiscate money from savers.

P.P.P.P.S. Maybe it’s time to reconsider central banks?

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Happy New Year!

We listed yesterday the good and bad policy developments of 2017, so now let’s speculate about potential victories and defeats in 2018.

Here are two things I hope will happen this year.

  • Welfare reform – If my friends and contacts on Capitol Hill are feeding my accurate information, we may see a bigger and better version of the 1996 welfare reform in 2018. The core concept would be to abolish the dozens of means-tested programs (i.e., redistribution programs targeted at low-income people) in Washington and replace them with a “block grant.” This could be good news for federal taxpayers if the annual block grant is designed to grow slowly. And it could be good news for poor people since state government would then have the ability and flexibility to design policies that help liberate recipients from government dependency.
  • Collapse of Venezuela – Given the disastrous deterioration of the Venezuelan economy, it’s difficult to envision how the Maduro dictatorship can survive the year. Yes, I know the regime is willing to use the military to suppress any uprising, but I suspect hungry and desperate people are more likely to take chances. My fingers are crossed that the corrupt government is overthrown and Venezuela becomes another Chile (hopefully without a transition period of military rule).

Here are two things I fear may happen in 2018.

  • Pulling out of NAFTA – America dodged a bullet in 2017. Given Trump’s protectionist instincts, I worried he would do something very dangerous on trade. But pain deferred is not the same thing as pain avoided. The President has made some very worrisome noises about NAFTA and it’s possible he may use executive authority to scrap a deal that has been good for the United States.
  • A bad version of Brexit – Given the statist mindset in Brussels and the continent’s awful demographics, voting to leave the European Union was the right decision for our British friends. Simply stated, it makes no sense to stay on a sinking ship, even if it sinking slowly. But the net benefits of Brexit depend on whether the United Kingdom seizes the moment and adopts pro-growth policies such as tax cuts and free-trade pacts. Sadly, those good reforms don’t appear likely and it appears instead that the feckless Tory leadership will choose to become a satellite member of the EU, which means living under the thumb of Brussels and paying for harmonization, bureaucratization, and centralization. The worst possible outcome in the short run, though at least the U.K. is better positioned to fully extricate itself in the future.

I’m adding a new feature to my hopes-and-fears column this year.

These are issues where I think it’s likely that something consequential may occur, but I can’t figure out whether I should be optimistic or pessimistic. I sort of did this last year, listing Obamacare reform and Italian fiscal crisis as both hopes and fears.

It turns out I was right to be afraid about what would happen with Obamacare and I was wrong (or too early) to think something would happen with Italy.

Here are three things that could be consequential in 2018, but I can’t figure out whether to be hopeful or fearful.

  • Infrastructure reform or boondoggle – I put an “infrastructure boondoggle” as one of my fears last year, but the President and Congress postponed dealing with the issue. But it will be addressed this year. I’m still afraid the result may be a traditional pile of pork-barrel spending, but it’s also possible that legislation could be a vehicle for market-based reform.
  • Normalization of monetary policy – I try to stay clear of monetary policy, but I also recognize that it’s a very important issue. Indeed, if I was to pick the greatest risk to the economy, it’s that easy-money policies (such as artificially low interest rates) have created a bubble. And bursting bubbles can be very messy, as we learned (or should have learned) in 2008. The Federal Reserve supposedly is in the process of “normalizing” monetary policy. I very much hope they can move in the right direction without rattling markets and/or bursting bubbles.
  • A China bubble – Speaking of macroeconomic risks, I’m very glad that China has partially liberalized and I’m ecstatic that reform has dramatically reduced severe poverty, but I also worry that the government plays far too large a role in the banking sector and interferes far too much in the allocation of capital. I’m guessing this eventually leads to some sort of hiccup (or worse) for the Chinese economy, and all I can do is cross my fingers and hope that the government responds with additional liberalization rather than the bad policies being advocated by the OECD and IMF.

By the way, I fully expect the Democrats to sweep the 2018 elections. And since the Party is now much farther to the left than it used to be, that could lead to very bad news in 2019 – particularly if Trump unleashes his inner Nixon.

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I’m rather frustrated about the lack of real results from the Republicans in Washington.

Yet Trump and some GOPers want to take credit for a rising stock market, as if that is some sort of positive reaction to their non-accomplishments.

As you can see from this interview, I don’t completely reject this hypothesis. After all, stock values are a reflection of the market’s expectations of future after-tax profits. So if investors think that good reforms – such as a lower corporate tax rate – are going to happen, then it makes sense that the value of financial assets will increase.

By the way, I can’t resist commenting on the claim from the Economic Policy Institute that the stock market is a “meaningless indicator” that has nothing to do with the well-being of workers.

That’s nonsense. Assuming we’re looking at genuine and durable increases in stock values (rather than a bubble), that’s a reflection of a growing economy, which translates into more income for workers.

In the language of economists, capital and labor are complimentary goods. More of one increases the value of the other. Which is why I told the folks at Politifact that it’s good for workers in the long run when financial assets become more valuable since that presumably means more investment.

Dan Mitchell, a scholar at the libertarian Cato Institute, agreed that “capital and labor compete for shares of income in the short run.” Over the long term, however, “there is no trade-off between corporate profits and labor income,” he said.

But let’s focus on the bigger issue of whether Trump deserves any credit for the stock market’s performance.

Ira Stoll, writing for the New York Sun, shares some very appropriate caveats.

The stock market, in other words, is like a lot of things: politicians want to take credit for it when news is good, but absolve themselves of responsibility when news is bad. One might hope for a more consistent perspective from journalists or from independent research organizations. Imagine, say, an election-day to election-day presidential job-performance dashboard that included data on measures such as stock market performance, the value of the dollar, job creation, unemployment, labor force participation, and real GDP growth. It can indeed be hard to isolate a president’s influence on all these things from other variables, such as, say, the composition of Congress. Should Mr. Obama or President Clinton get credit for the stock market booms in their terms? Or should the Republican Congresses under which they occurred? How does one accurately account for the period between the election and inauguration, when stock market gains may reflect anticipated improvements, but growth results measure existing budgets and policies?

Having given lots of reasons to be cautious, Stoll nonetheless thinks investors are buoyed by the pro-growth parts of Trump’s agenda.

…steps Mr. Trump takes — reducing regulation or slowing the growth of it, reducing corporate income tax rates, allowing more energy exploration — will outweigh any negatives. In other words, there’s a decent case that Mr. Trump does deserve at least some credit for the stock market gains.

I don’t have any objection to this analysis.

Though allow me to add another caveat to the list. As I explained when discussing the same topic back in March (see final interview) and indirectly suggested in the above interview, Trump is playing a risky game.

What if the stock market is artificially inflated because of the Fed’s easy-money policy? If that’s the case, there almost certainly will be a correction and stock values will drop.

This won’t be Trump’s fault, but he’ll then be very vulnerable when opponents argue that he should be blamed. As the old saying goes, live by the sword, die by the sword.

In my humble opinion, politicians (at least the ones who support good policy on net, and I still don’t know whether Trump is in this category) should argue for good policy because that will lead to higher per-capita income over time.

And they also should say, in the interests of accuracy, that it generally takes time to see good results.

Consider the lesson of the Reagan years. The first couple of years were a bit bumpy, both because some of Reagan’s good reforms – particularly the tax cuts – were slowly phased in and because some short-run pain was inevitable as inflation was brought under control (an overlooked and very beneficial achievement). But once his policies kicked in, the economic results were very positive.

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When I was younger, folks in the policy community joked that BusinessWeek was the “anti-business business weekly” because its coverage of the economy was just as stale and predictably left wing as what you would find in the pages of Time or Newsweek.

Well, perhaps it’s time for The Economist to be known as the “anti-economics economic weekly.”

Writing about the stagnation that is infecting western nations, the magazine beclowns itself by regurgitating stale 1960s-style Keynesianism. The article is worthy of a fisking (i.e., a “point-by-point debunking of lies and/or idiocies”), starting with the assertion that central banks saved the world at the end of last decade.

During the financial crisis the Federal Reserve and other central banks were hailed for their actions: by slashing rates and printing money to buy bonds, they stopped a shock from becoming a depression.

I’m certainly open to the argument that the downturn would have been far worse if the banking system hadn’t been recapitalized (even if it should have happened using the “FDIC-resolution approach” rather than via corrupt bailouts), but that’s a completely separate issue from whether Keynesian monetary policy was either desirable or successful.

Regarding the latter question, just look around the world. The Fed has followed an easy-money policy. Has that resulted in a robust recovery for America? The European Central Bank (ECB) has followed the same policy. Has that worked? And the Bank of Japan (BoJ) has done the same thing. Does anyone view Japan’s economy as a success?

At least the article acknowledges that there are some skeptics of the current approach.

The central bankers say that ultra-loose monetary policy remains essential to prop up still-weak economies and hit their inflation targets. …But a growing chorus of critics frets about the effects of the low-rate world—a topsy-turvy place where savers are charged a fee, where the yields on a large fraction of rich-world government debt come with a minus sign, and where central banks matter more than markets in deciding how capital is allocated.

The Economist, as you might expect, expresses sympathy for the position of the central bankers.

In most of the rich world inflation is below the official target. Indeed, in some ways central banks have not been bold enough. Only now, for example, has the BoJ explicitly pledged to overshoot its 2% inflation target. The Fed still seems anxious to push up rates as soon as it can.

The preceding passage is predicated on the assumption that there is a mechanistic tradeoff between inflation and unemployment (the so-called Phillips Curve), one of the core concepts of Keynesian economics. According to adherents, all-wise central bankers can push inflation up if they want lower unemployment and push inflation down if they want to cool the economy.

This idea has been debunked by real world events because inflation and unemployment simultaneously rose during the 1970s (supposedly impossible according the Keynesians) and simultaneously fell during the 1980s (also a theoretical impossibility according to advocates of the Phillips Curve).

But real-world evidence apparently can be ignored if it contradicts the left’s favorite theories.

That being said, we can set aside the issue of Keynesian monetary policy because the main thrust of the article is an embrace of Keynesian fiscal policy.

…it is time to move beyond a reliance on central banks. …economies need succour now. The most urgent priority is to enlist fiscal policy. The main tool for fighting recessions has to shift from central banks to governments.

As an aside, the passage about shifting recession fighting “from central banks to governments” is rather bizarre since the Fed, the ECB, and the BoJ are all government entities. Either the reporter or the editor should have rewritten that sentence so that it concluded with “shift from central banks to fiscal policy” or something like that.

In any event, The Economist has a strange perspective on this issue. It wants Keynesian fiscal policy, yet it worries about politicians using that approach to permanently expand government. And it is not impressed by the fixation on “shovel-ready” infrastructure spending.

The task today is to find a form of fiscal policy that can revive the economy in the bad times without entrenching government in the good. …infrastructure spending is not the best way to prop up weak demand. …fiscal policy must mimic the best features of modern-day monetary policy, whereby independent central banks can act immediately to loosen or tighten as circumstances require.

So The Economist endorses what it refers to as “small-government Keynesianism,” though that’s simply its way of saying that additional spending increases (and gimmicky tax cuts) should occur automatically.

…there are ways to make fiscal policy less politicised and more responsive. …more automaticity is needed, binding some spending to changes in the economic cycle. The duration and generosity of unemployment benefits could be linked to the overall joblessness rate in the economy, for example.

In the language of Keynesians, such policies are known as “automatic stabilizers,” and there already are lots of so-called means-tested programs that operate this way. When people lose their jobs, government spending on unemployment benefits automatically increases. During a weak economy, there also are automatic spending increases for programs such as Food Stamps and Medicaid.

I guess The Economist simply wants more programs that work this way, or perhaps bigger handouts for existing programs. And the magazine views this approach as “small-government Keynesianism” because the spending increases theoretically evaporate as the economy starts growing and fewer people are automatically entitled to receive benefits from the various programs.

Regardless, whoever wrote the article seems convinced that such programs help boost the economy.

When the next downturn comes, this kind of fiscal ammunition will be desperately needed. Only a small share of public spending needs to be affected for fiscal policy to be an effective recession-fighting weapon.

My reaction, for what it’s worth, is to wonder why the article doesn’t include any evidence to bolster the claim that more government spending is and “effective” way of ending recessions and boosting growth. Though I suspect the author of the article didn’t include any evidence because it’s impossible to identify any success stories for Keynesian economics.

  • Did Keynesian spending boost the economy under Hoover? No.
  • Did Keynesian spending boost the economy under Roosevelt? No.
  • Has Keynesian spending worked in Japan at any point over the past twenty-five years? No.
  • Did Keynesian spending boost the economy under Obama? No.

Indeed, Keynesian spending has an unparalleled track record of failure in the real world. Though advocates of Keynesianism have a ready-built excuse. All the above failures only occurred because the spending increases were inadequate.

But what do expect from the “perpetual motion machine” of Keynesian economics, a theory that is only successful if you assume it is successful?

I’m not surprised that politicians gravitate to this idea. After all, it tells them that their vice  of wasteful overspending is actually a virtue.

But it’s quite disappointing that journalists at an allegedly economics-oriented magazine blithely accept this strange theory.

P.S. My second-favorite story about Keynesian economics involves the sequester, which big spenders claimed would cripple the economy, yet that’s when we got the only semi-decent growth of the Obama era.

P.P.S. My favorite story about Keynesianism is when Paul Krugman was caught trying to blame a 2008 recession in Estonia on spending cuts that occurred in 2009.

P.P.P.S. Here’s my video explaining Keynesian economics.

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The War against Cash continues.

  • In Part I, we looked at the argument that cash should be banned or restricted so governments could more easily collect additional tax revenue.
  • In Part II, we reviewed the argument that cash should be curtailed so that governments could more easily impose Keynesian-style monetary policy.
  • In Part III, written back in March, we examined additional arguments by people on both sides of the issue and considered the risks of expanded government power.

Now it’s time for Part IV.

Professor Larry Summers of Harvard University is President Obama’s former top economic adviser and he’s a relentless advocate of higher taxes and bigger government. If he favors an idea, it doesn’t automatically make it bad, but it’s surely a reason to be suspicious. So you won’t be surprised to learn that he wrote a column for the Washington Post applauding the move in Europe to eliminate €500 notes. Indeed, he wants to ban all large-denomination notes.

There is little if any legitimate use for 500-euro notes. Carrying out a transaction with 20 50-euro notes hardly seems burdensome, and this would represent over $1,000 in purchasing power. Twenty 200-euro notes would be almost $5,000. Who in today’s world needs cash for a legitimate $5,000 transaction? …Cash transactions of more than 3,000 euros have in fact been made illegal in Italy, while France has placed the limit at 1,000 euros. …In contrast to the absence of an important role for 500-euro notes in normal commerce, these bills have a major role facilitating illicit activity, as suggested by their nickname —“Bin Ladens.” …Estimates by the International Monetary Fund and others of total annual money laundering consistently exceed $1 trillion. High-denomination notes also have a substantial role in facilitating tax evasion and capital flight.

Who “needs cash” for transactions, he asks, but isn’t the real issue whether people should have the freedom to use cash if that’s what they prefer?

Also, in dozens of trips to Europe since the adoption of the euro, I’ve never heard anyone refer to the €500 note as a “Bin Laden,” so I suspect that’s an example of Summers trying to demonize something that he doesn’t like.

But perhaps the most important revelation from his column is that he admits there’s no evidence that crime would be stopped by his plan to restrict cash.

To be sure, it is difficult to estimate how much crime would be prevented by stopping the creation of 500-euro notes. It would surely impose some burdens on criminals and might interfere with some transactions, which is not unimportant.

Unsurprisingly, he wants to coerce other governments into restricting high-value notes.

Europe has led on a significant security issue. But its action should be seen as a beginning, not an end. As a first follow-on, the world should demand that Switzerland stop issuing 1,000-Swiss-franc notes. After Europe’s action, these will stand out as the world’s highest-denomination note by a huge margin. Switzerland has a long and unfortunate history with illicit finance. It would be tragic if it were to profit from criminal currency substitution following Europe’s bold step. …There would be a strong case for stopping the creation of notes with values greater than perhaps $50.

Summers isn’t the only academic from Harvard who is agitating to restrict cash. Prof. Kenneth Rogoff (who’s also the former Chief Economist at the IMF) recently wrote a piece for the Wall Street Journal explaining his hostility.

…paper currency lies at the heart of some of today’s most intractable public-finance and monetary problems. …There is little debate among law-enforcement agencies that paper currency, especially large notes such as the U.S. $100 bill, facilitates crime: racketeering, extortion, money laundering, drug and human trafficking, the corruption of public officials, not to mention terrorism.

At the risk of bursting his balloon, cash played almost no role in the most notorious terrorist event, the 9-11 attacks. And Rogoff admits that bad guys would use easy substitutes.

There are substitutes for cash—cryptocurrencies, uncut diamonds, gold coins, prepaid cards.

So he then dredges up the argument that cash facilitates tax evasion.

Cash is also deeply implicated in tax evasion, which costs the federal government some $500 billion a year in revenue. According to the Internal Revenue Service, a lot of the action is concentrated in small cash-intensive businesses, where it is difficult to verify sales and the self-reporting of income.

I addressed these issues in Part I of this series, but I’ll simply add that the academic evidence shows that lower tax rates are the best way of boosting tax compliance (as even the IMF has admitted).

To his credit, Rogoff acknowledges that his preferred policy would reduce the rights of individuals.

Perhaps the most challenging and fundamental objection to getting rid of cash has to do with privacy—with our ability to spend anonymously. But where does one draw the line between this individual right and the government’s need to tax and regulate.

His main argument is that our rights should be reduced to give government more power. He especially wants central bankers to have more power to impose Keynesian monetary policy.

Cutting interest rates delivers quick and effective stimulus by giving consumers and businesses an incentive to borrow more. It also drives up the price of stocks and homes, which makes people feel wealthier and induces them to spend more. Countercyclical monetary policy has a long-established record, while political constraints will always interfere with timely and effective fiscal stimulus.

Yes, he’s right. Activist monetary policy does have a long-established track record. It played a key role in causing the Great Depression, the 1970s stagflation, and the recent financial crisis.

Hooray, Federal Reserve!

And Rogoff wants the arsonists at the Fed to have more power to create boom-bust cycles.

In principle, cutting interest rates below zero ought to stimulate consumption and investment in the same way as normal monetary policy, by encouraging borrowing. Unfortunately, the existence of cash gums up the works. If you are a saver, you will simply withdraw your funds, turning them into cash, rather than watch them shrink too rapidly. Enormous sums might be withdrawn to avoid these loses, which could make it difficult for banks to make loans—thus defeating the whole purpose of the policy. Take cash away, however, or make the cost of hoarding high enough, and central banks would be free to drive rates as deep into negative territory as they needed in a severe recession. …if a strong dose of negative rates can power an economy out of a downturn, it could bring inflation and interest rates back to positive levels relatively quickly, arguably reducing vulnerability to bubbles rather than increasing it.

Needless to say, I disagree with Rogoff and agree with Thomas Sowell that an institution that repeatedly screws up shouldn’t be given more power.

Especially since I’m concerned that the option to use bad monetary policy may actually be one of the excuses that politicians use for not fixing the problems that actually are hindering growth.

So, yes, instead of expanding their power, I want to clip the wings of the Federal Reserve and other central banks.

Now let’s consider the harm that would be caused by restricting or banning cash. Two professors from NYU Law School looked at some of the logistical issues of a shift to digital money. The echoed some of the points raised by Summers and Rogoff, but they also pointed out some downsides. Such as government being able to monitor everything we buy.

…centralization of banking under this system would also create a Leviathan with the power to monitor and control the personal finances of every citizen in the country. This is one of the chief reasons why many are loath to give up on hard currency. With digital money, the government could view any financial transaction and obtain a flow of information about personal spending that could be used against an individual in a whole host of scenarios.

It also would cause a mess because so many people around the world rely on dollars, something that’s beneficial to the U.S. Treasury and foreigners from places with untrustworthy central banks.

…a transition to digital currency might come at a large cost for the U.S. in particular, because the dollar remains the world’s de facto reserve currency. The U.S. collects enormous seigniorage revenue that accrues to the economy when the Federal Reserve prints dollars that are exported abroad in exchange for foreign goods and services. These bank notes ultimately end up in countries with less reliable central banks where locals prefer to hold U.S. currency instead of their own. Forfeiting this franchise as the world’s reserve currency might be too costly, as the U.S. currency held abroad exceeds half a trillion dollars, according to reliable estimates.

Professor Larry White of George Mason University (also a Senior Fellow at Cato) writes about what he calls “currency prohibitionists.”

The rhetoric of the anti-high-denomination gang has gotten increasingly shrill.  …Charles Goodhart in September called the European Central Bank and the Swiss National Bank “shameless” for issuing “vastly high-denomination notes,” namely the €500 and SWF 1000, “which are there to finance the drug deals.” …I have an alternative suggestion for removing $100 bills from the illegal drug trades:  Legalize the trade.  …My suggestion would reduce the demand for high-denomination currency.

Nice plug for sensible libertarian policy.

But even if one favors drug prohibition, that doesn’t mean currency prohibition will be effective.

Today’s high-denomination-currency prohibitionists, like today’s drug prohibitionists and yesterday’s alcohol prohibitionists, only think about the supply side.  But does anyone think that banning the $100 bill during Prohibition (when it had a purchasing power more than 11 times today’s, as evaluated using the CPI) and even higher denominations would have put a major dent in the rum-running business, if an army of T-Men couldn’t? …eliminating high denomination, high value notes we would make life harder” for such criminal enterprises.  No doubt.  But we would also make life harder for everyone else.  The rest of us also find high-denomination notes convenient now and again for completely legal and non-controversial purposes, like buying automobiles and carrying vacation cash compactly.  …currency prohibitionists too often regard those who defend high-denomination notes not as intellectually honest but mistaken opponents, but rather as morally suspect characters.  Larry Summers goes out of his way to smear an ECB executive from Luxembourg (who has had the temerity to ask for better evidence before accepting the case for prohibiting high-denomination notes)… The case for prohibiting large-denomination currency, to summarize, is largely based on guilt by association or on wishful thinking about the benefits of allowing greater range of action to discretionary monetary policy.

On the topic of crime and cash, an article for the WSJ debunks one of the left’s main talking points. If using cash is supposed to be a sign of criminal activity, why are the world’s two most cash-friendly nations also two of the safest and crime-free countries?

Are Japan and Switzerland havens for terrorists and drug lords? High-denomination bills are in high demand in both places, a trend that some politicians claim is a sign of nefarious behavior. Yet the two countries boast some of the lowest crime rates in the world. The cash hoarders are ordinary citizens… The current hoarding in Switzerland and Japan thus underscores one of many ways in which cash is a basic tool of economic liberty: It lets people shield themselves from monetary policies that would force their savings into weak economies that can’t attract sufficient spending or investment on their own. These economies need reforms that boost incentives to work and invest, not negative interest rates and cash limits that raid the bank accounts of law-abiding citizens.

A column by Sarah Jeong in Bloomberg explores some of the additional implications of cash restrictions.

…wherever information gathers and flows, two predators follow closely behind it: censorship and surveillance. The case of digital money is no exception. Where money becomes a series of signals, it can be censored; where money becomes information, it will inform on you. …the Department of Justice began to come under fire for Operation Choke Point…the means were highly dubious. …the DOJ got creative, and asked banks and payment processors to comply with government policies, and proactively police “high-risk” activity. Banks were asked to voluntarily shut down the kinds of merchant activities that government bureaucrats described as suspicious. The price of resistance was an active investigation by the Department of Justice. …Where paternalism is bluntly enforced through a bureaucratic game of telephone, unpleasant or even inhumane unintended consequences are bound to result. …the cashless society offers the government entirely new forms of coercion, surveillance, and censorship. …As paper money evaporates from our pockets and the whole country—even world—becomes enveloped by the cashless society, financial censorship could become pervasive, unbarred by any meaningful legal rights or guarantees.

Her observation on Operation Choke Point is very important since that campaign has been a chilling example of how government abuses its power in the financial sector.

Megan McArdle’s Bloomberg column touches on some additional concerns.

What’s not to like? Very little. Except, and I’m afraid it’s a rather large exception, the amount of power that this gives the government over its citizens. Consider the online gamblers who lost their money in overseas operations when the government froze their accounts. Now, what they were doing was indisputably illegal in these here United States, and I am not claiming that they were somehow deeply wronged. But consider how immense the power that was conferred upon the government by the electronic payments system; at a word, your money could simply vanish. …Unmonitored resources like cash…create a sort of cushion between ordinary people and a government with extraordinary powers. Removing that cushion leaves people who aren’t criminals vulnerable to intrusion into every remote corner of their lives. …If we want to move toward a cashless society — and apparently we do — then we also need to think seriously about limiting the ability of the government to use the payments system as an instrument to control the behavior of its citizens.

For what it’s worth, one way of getting the benefits of a cashless world without the risks is with private digital monies such as bitcoin.

Steve Forbes nails the issue.

Gaining attention these days is the idea of abolishing high denominations of the dollar and the euro. This concept graphically displays the astonishing stupidity–and intellectual bankruptcy–of today’s liberal economic policymakers and the economics profession. …The ostensible reason is to help in the fight against terrorists, bribers, drug dealers and tax evaders by making it more inconvenient for these bad guys to move around and store their ill-gotten cash. …The notion that such evildoers as the Mexican drug cartels and ISIS will be seriously disrupted by the absence of the Benjamin–”These sacks of cash are too heavy now. Let’s surrender!”–is so comical… Monetary expert Seth Lipsky pithily points out in the New York Post, “When criminals use guns, the Democrats want to take guns from law-abiding citizens. When terrorists use hundreds, the liberals want to deny the rest of us the Benjamins.”

Excellent point. Politicians should concentrate on restricting the freedom of bad guys, not ordinary citizens.

So what are the implications of the war against cash? They aren’t pretty.

The real reason for this war on cash–start with the big bills and then work your way down–is an ugly power grab by Big Government. People will have less privacy: Electronic commerce makes it easier for Big Brother to see what we’re doing, thereby making it simpler to bar activities it doesn’t like, such as purchasing salt, sugar, big bottles of soda and Big Macs.

Steve raises a good point about tracking certain purchases. Imagine the potential mischief if politicians had a mechanism to easily impose discriminatory taxes on disapproved products.

He also notes that the war on cash is motivated by a desire to more effectively implement an ineffective policy.

Policymakers in Washington, Tokyo and the EU think the reason that their economies are stagnant is that ornery people aren’t spending and investing the way they should. How to make these benighted, recalcitrant beings do what they’re supposed to do? The latest nostrum from our overlords is negative interest rates. If people have to pay fees to store their money, as they do to put their stuff in storage facilities, then, by golly, they might be more inclined to spend it.

And Steve correctly observes that bad monetary policy is now an excuse to not fix the problems that actually are contributing to economic stagnation.

Manipulating the value of money and controlling interest rates, i.e., the price of money, never works. Money measures value. It is a claim on services and is a tool for facilitating commerce and investing. The reason economies around the world are in the ditch–which is fueling anger, discontent and ugly politics–is structural, government-created barriers: unstable money, suffocating rules and too-high rates of taxation.

James Grant, in a column for the Wall Street Journal, is not impressed by the anti-cash agitprop and specifically debunks some of the arguments put forth by Rogoff. He starts with some very sensible observation that politicians should reform drug laws and tax laws rather than restricting our freedom to use cash.

Terrorists traffic in cash, Mr. Rogoff observes. So do drug dealers and tax cheats. Good, compliant citizens rarely touch the $100 bills that constitute a sizable portion of the suspiciously immense volume of greenbacks outstanding—$4,200 per capita. Get rid of them is the author’s message. Then, again, one could legalize certain narcotics to discommode the drug dealers and adopt Steve Forbes’s flat tax to fill up the Treasury. Mr. Rogoff considers neither policy option. Government control is not only his preferred position. It is the only position that seems to cross his mind.

Grant makes the (obvious-to-folks not-in-Washington) point that restricting cash to enable Keynesian monetary policy is akin to throwing good money after bad.

Mr. Rogoff lays the blame for America’s lamentable post-financial-crisis economic record not on the Obama administration’s suffocating tax and regulatory policies. The problem is rather the Fed’s inability to put its main interest rate, the federal funds rate, where it has never been before. In a deep recession, Mr. Rogoff proposes, the Fed ought not to stop cutting rates when it comes to zero. It should plunge right ahead, to minus 1%, minus 2%, minus 3% and so forth. At one negative rate or another, the theory goes, despoiled bank depositors will stop saving and start spending. …What would you do if your bank docked you, say, 3% a year for the privilege of holding your money? Why, you might convert your deposit into $100 bills, rent a safe deposit box and count yourself a shrewd investor. Hence the shooting war against currency. …In the topsy-turvy world of Mr. Rogoff, negative rates would be the reward to impetuousness and the cost of thrift. …Never mind that, in post-crisis America, near 0% interest rates have failed to deliver the promised macroeconomic goods. Come the next crackup, Mr. Rogoff would double down—and down.

And he echoes the insights of Austrian-school scholars about how easy-money policies are the cause of problems rather than the cure.

Interest rates are prices. They impart information. They tell a business person whether or not to undertake a certain capital investment. They measure financial risk. They translate the value of future cash flows into present-day dollars. Manipulate those prices—as central banks the world over compulsively do—and you distort information, therefore perception and judgment. The ultra-low rates of recent years have distorted judgment in a bullish fashion. True, they have not, at least in America, ignited a wave of capital investment—who needs it in a comatose economy? They have rather facilitated financial investment. They have inflated projected cash flows and anesthesized perceptions of risk (witness the rock-bottom yields attached to corporate junk bonds). In so doing, they have raised the present value of financial assets. Wall Street has enjoyed a wonderful bull market. The trouble is that the Fed has become hostage to that very bull market. The higher that asset prices fly, the greater the risk of the kind of crash that impels new rounds of intervention, new cries for government spending, bigger deficits—more “stimulus.”

Let’s close with the good news is that Switzerland doesn’t seem very interested in following Europe and the United States down the primrose path of seeking to curtail monetary freedom.

Manuel Brandenberg, a lawmaker in the Swiss canton of Zug, loves cash. …That belief in bills is shared by many of his compatriots, who have a penchant for hard currency even when electronic options are available. In a country whose wealth managers flourished thanks to banking secrecy, citizens often cherish the untraceable privacy conferred by notes and coins. “Cash is property and cash is freedom,” said Brandenberg… Unlike their neighbors, the Swiss have no plans to reconsider banknote denominations — 10, 20, 50, 100 and 200 francs. Not even the highest of 1,000 francs ($1,040). …The predilection for notes and coins is evident on the streets of Zurich, where a number of stores don’t take plastic — among them Belcafe at Bellevue, a busy transport hub in the center. …Roughly 20 percent of purchases — including large sums for jewelry — were paid in cash, then-Finance Minister Eveline Widmer-Schlumpf told parliament in 2014. …“There’s no reason to change things,” said Rickli. “I don’t want the state to know who goes to what restaurant. That’s none of the government’s business.”

Thank goodness for the “sensible Swiss.” On so many issues, Switzerland is a beacon of common sense and individual freedom.

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Although it doesn’t get nearly as much attention as it warrants, one of the greatest threats to liberty and prosperity is the potential curtailment and elimination of cash.

As I’ve previously noted, there are two reasons why statists don’t like cash and instead would prefer all of us to use digital money (under their rules, of course, not something outside their control like bitcoin).

First, tax collectors can’t easily monitor all cash transactions, so they want a system that would allow them to track and tax every possible penny of our income and purchases.

Second, Keynesian central planners would like to force us to spend more money by imposing negative interest rates (i.e., taxes) on our savings, but that can’t be done if people can hold cash.

To provide some background, a report in the Wall Street Journal looks at both government incentives to get rid of high-value bills and to abolish currency altogether.

Some economists and bankers are demanding a ban on large denomination bills as one way to fight the organized criminals and terrorists who mainly use these notes. But the desire to ditch big bills is also being fueled from unexpected quarter: central bank’s use of negative interest rates. …if a central bank drives interest rates into negative territory, it’ll struggle to manage with physical cash. When a bank balance starts being eaten away by a sub-zero interest rate, cash starts to look inviting. That’s a particular problem for an economy that issues high-denomination banknotes like the eurozone, because it’s easier for a citizen to withdraw and hoard any money they have got in the bank.

Now let’s take a closer look at what folks on the left are saying to the public. In general, they don’t talk about taxing our savings with government-imposed negative interest rates. Instead, they make it seem like their goal is to fight crime.

Larry Summers, a former Obama Administration official, writes in the Washington Post that this is the reason governments should agree on a global pact to eliminate high-denomination notes.

…analysis is totally convincing on the linkage between high denomination notes and crime. …technology is obviating whatever need there may ever have been for high denomination notes in legal commerce. …The €500 is almost six times as valuable as the $100. Some actors in Europe, notably the European Commission, have shown sympathy for the idea and European Central Bank chief Mario Draghi has shown interest as well.  If Europe moved, pressure could likely be brought on others, notably Switzerland. …Even better than unilateral measures in Europe would be a global agreement to stop issuing notes worth more than say $50 or $100.  Such an agreement would be as significant as anything else the G7 or G20 has done in years. …a global agreement to stop issuing high denomination notes would also show that the global financial groupings can stand up against “big money” and for the interests of ordinary citizens.

Summers cites a working paper by Peter Sands of the Kennedy School, so let’s look at that argument for why governments should get rid of all large-denomination currencies.

Illegal money flows pose a massive challenge to all societies, rich and poor. Tax evasion undercuts the financing of public services and distorts the economy. Financial crime fuels and facilitates criminal activities from drug trafficking and human smuggling to theft and fraud. Corruption corrodes public institutions and warps decision-making. Terrorist finance sustains organisations that spread death and fear. The scale of such illicit money flows is staggering. …Our proposal is to eliminate high denomination, high value currency notes, such as the €500 note, the $100 bill, the CHF1,000 note and the £50 note. …Without being able to use high denomination notes, those engaged in illicit activities – the “bad guys” of our title – would face higher costs and greater risks of detection. Eliminating high denomination notes would disrupt their “business models”.

Are these compelling arguments? Should law-abiding citizens be forced to give up cash in hopes of making life harder for crooks? In other words, should we trade liberty for security?

From a moral and philosophical perspective, the answer is no. Our Founders would be rolling in their graves at the mere thought.

But let’s address this issue solely from a practical, utilitarian perspective.

The first thing to understand is that the bad guys won’t really be impacted. The head the The American Anti-Corruption Institute, L. Burke Files, explains to the Financial Times why restricting cash is pointless and misguided.

Peter Sands…has claimed that removal of high-denomination bank notes will deter crime. This is nonsense. After more than 25 years of investigating fraudsters and now corrupt persons in more than 90 countries, I can tell you that only in the extreme minority of cases was cash ever used — even in corruption cases. A vast majority of the funds moved involved bank wires, or the purchase and sale of valuable items such as art, antiquities, vessels or jewellery. …Removal of high denomination bank notes is a fruitless gesture akin to curing the common cold by forbidding use of the term “cold”.

In other words, our statist friends are being disingenuous. They’re trying to exploit the populace’s desire for crime fighting as a means of achieving a policy that actually is designed for other purposes.

The good news, is that they still have a long way to go before achieving their goals. Notwithstanding agitation to get rid of “Benjamins” in the United States, that doesn’t appear to be an immediate threat. Additionally, according to SwissInfo, is that the Swiss government has little interest in getting rid of the CHF1,000 note.

The European police agency Europol, EU finance ministers and now the European Central Bank, have recently made noises about pulling the €500 note, which has been described as the “currency of choice” for criminals. …But Switzerland has no plans to follow suit. “The CHF1,000 note remains a useful tool for payment transactions and for storing value,” Swiss National Bank spokesman Walter Meier told swissinfo.ch.

This resistance is good news, and not just because we want to control rapacious government in North America and Europe.

A column for Yahoo mentions the important value of large-denomination dollars and euros in less developed nations.

Cash also has the added benefit of providing emergency reserves for people “with unstable exchange rates, repressive governments, capital controls or a history of banking collapses,” as the Financial Times noted.

Amen. Indeed, this is one of the reasons why I like bitcoin. People need options to protect themselves from the consequences of bad government policy, regardless of where they live.

By the way, if you’ll allow me a slight diversion, Bill Poole of the University of Delaware (and also a Cato Fellow) adds a very important point in a Wall Street Journal column. He warns that a fixation on monetary policy is misguided, not only because we don’t want reckless easy-money policy, but also because we don’t want our attention diverted from the reforms that actually could boost economic performance.

Negative central-bank interest rates will not create growth any more than the Federal Reserve’s near-zero interest rates did in the U.S. And it will divert attention from the structural problems that have plagued growth here, as well as in Europe and Japan, and how these problems can be solved. …Where central banks can help is by identifying the structural impediments to growth and recommending a way forward. …It is terribly important that advocates of limited government understand what is at stake. …calls for a return to near-zero or even negative interest rates…will do little in the short run to boost growth, but it will dig the federal government into a deeper fiscal hole, further damaging long-run prospects. It needs to be repeated: Monetary policy today has little to offer to raise growth in the developed world.

Let’s close by returning to the core issue of whether it is wise to allow government the sweeping powers that would accompany the elimination of physical currency.

Here are excerpts from four superb articles on the topic.

First, writing for The American Thinker, Mike Konrad argues that eliminating cash will empower government and reduce liberty.

Governments will rise to the occasion and soon will be making cash illegal.  People will be forced to put their money in banks or the market, thus rescuing the central governments and the central banks that are incestuously intertwined with them. …cash is probably the last arena of personal autonomy left. …It has power that the government cannot control; and that is why it has to go. Of course, governments will not tell us the real reasons.  …We will be told it is for our own “good,” however one defines that. …What won’t be reported will be that hacking will shoot up.  Bank fraud will skyrocket. …Going cashless may ironically streamline drug smuggling since suitcases of money weigh too much. …The real purpose of a cashless society will be total control: Absolute Total Control. The real victims will be the public who will be forced to put all their wealth in a centralized system backed up by the good faith and credit of their respective governments.  Their life savings will be eaten away yearly with negative rates. …The end result will be the loss of all autonomy.  This will be the darkest of all tyrannies.  From cradle to grave one will not only be tracked in location, but on purchases.  Liberty will be non-existent. However, it will be sold to us as expedient simplicity itself, freeing us from crime: Fascism with a friendly face.

Second, the invaluable Allister Heath of the U.K.-based Telegraph warns that the desire for Keynesian monetary policy is creating a slippery slope that eventually will give governments an excuse to try to completely banish cash.

…the fact that interest rates of -0.5pc or so are manageable doesn’t mean that interest rates of -4pc would be. At some point, the cost of holding cash in a bank account would become prohibitive: savers would eventually rediscover the virtues of stuffed mattresses (or buying equities, or housing, or anything with less of a negative rate). The problem is that this will embolden those officials who wish to abolish cash altogether, and switch entirely to electronic and digital money. If savers were forced to keep their money in the bank, the argument goes, then they would be forced to put up with even huge negative rates. …But abolishing cash wouldn’t actually work, and would come with terrible side-effects. For a start, people would begin to treat highly negative interest rates as a form of confiscatory taxation: they would be very angry indeed, especially if rates were significantly more negative than inflation. …Criminals who wished to evade tax or engage in illegal activities would still be able to bypass the system: they would start using foreign currencies, precious metals or other commodities as a means of exchange and store of value… The last thing we now need is harebrained schemes to abolish cash. It wouldn’t work, and the public rightly wouldn’t tolerate it.

The Wall Street Journal has opined on the issue as well.

…we shouldn’t be surprised that politicians and central bankers are now waging a war on cash. That’s right, policy makers in Europe and the U.S. want to make it harder for the hoi polloi to hold actual currency. …the European Central Bank would like to ban €500 notes. …Limits on cash transactions have been spreading in Europe… Italy has made it illegal to pay cash for anything worth more than €1,000 ($1,116), while France cut its limit to €1,000 from €3,000 last year. British merchants accepting more than €15,000 in cash per transaction must first register with the tax authorities. …Germany’s Deputy Finance Minister Michael Meister recently proposed a €5,000 cap on cash transactions. …The enemies of cash claim that only crooks and cranks need large-denomination bills. They want large transactions to be made electronically so government can follow them. Yet…Criminals will find a way, large bills or not. The real reason the war on cash is gearing up now is political: Politicians and central bankers fear that holders of currency could undermine their brave new monetary world of negative interest rates. …Negative rates are a tax on deposits with banks, with the goal of prodding depositors to remove their cash and spend it… But that goal will be undermined if citizens hoard cash. …So, presto, ban cash. …If the benighted peasants won’t spend on their own, well, make it that much harder for them to save money even in their own mattresses. All of which ignores the virtues of cash for law-abiding citizens. Cash allows legitimate transactions to be executed quickly, without either party paying fees to a bank or credit-card processor. Cash also lets millions of low-income people participate in the economy without maintaining a bank account, the costs of which are mounting as post-2008 regulations drop the ax on fee-free retail banking. While there’s always a risk of being mugged on the way to the store, digital transactions are subject to hacking and computer theft. …the reason gray markets exist is because high taxes and regulatory costs drive otherwise honest businesses off the books. Politicians may want to think twice about cracking down on the cash economy in a way that might destroy businesses and add millions to the jobless rolls. …it’s hard to avoid the conclusion that the politicians want to bar cash as one more infringement on economic liberty. They may go after the big bills now, but does anyone think they’d stop there? …Beware politicians trying to limit the ways you can conduct private economic business. It never turns out well.

Last, but not least, Glenn Reynolds, a law professor at the University of Tennessee, explores the downsides of banning cash in a column for USA Today.

…we need to restore the $500 and $1000 bills. And the reason is that people like Larry Summers have done a horrible job. …What is a $100 bill worth now, compared to 1969? According to the U.S. Inflation Calculator online, a $100 bill today has the equivalent purchasing power of $15.49 in 1969 dollars. …And although inflation isn’t running very high at the moment, this trend will only continue. If the next few decades are like the last few, paper money in current denominations will become basically useless. …to our ruling class this isn’t a bug, but a feature. Governments want to get rid of cash… But at a time when, almost no matter where you look in the world, the parts of it controlled by the experts and technocrats (like Larry Summers) seem to be doing badly, it seems reasonable to ask: Why give them still more control over the economy? What reason is there to think that they’ll use that control fairly, or even competently? Their track record isn’t very impressive. Cash has a lot of virtues. One of them is that it allows people to engage in voluntary transactions without the knowledge or permission of anyone else. Governments call this suspicious, but the rest of us call it something else: Freedom.

Amen. Glenn nails it.

Banning cash is a scheme concocted by politicians and bureaucrats who already have demonstrated that they are incapable of competently administering the bloated public sector that already exists.

The idea that they should be given added power to extract more of our money and manipulate our spending is absurd. Laughably absurd if you read Mark Steyn.

P.S. I actually wouldn’t mind getting rid of the government’s physical currency, but only if the result was a system that actually enhanced liberty and prosperity. Unfortunately, I don’t expect that to happen in the near future.

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I wrote yesterday that governments want to eliminate cash in order to make it easier to squeeze more money from taxpayers.

But that’s not the only reason why politicians are interested in banning paper money and coins.

They also are worried that paper money inhibits the government’s ability to “stimulate” the economy with artificially low interest rates. Simply stated, they’ve already pushed interest rates close to zero and haven’t gotten the desired effect of more growth, so the thinking in official circles is that if you could implement negative interest rates, people could be pushed to be good little Keynesians because any money they have in their accounts would be losing value.

I’m not joking.

Here’s some of what Kenneth Rogoff, a professor at Harvard and a former economist at the International Monetary Fund, wrote for the U.K.-based Financial Times.

Getting rid of physical currency and replacing it with electronic money would…eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash.

And here are some passages from an editorial that also was published in the FT.

…authorities would do well to consider the arguments for phasing out their use as another “barbarous relic”…even a little physical currency can cause a lot of distortion to the economic system. The existence of cash — a bearer instrument with a zero interest rate — limits central banks’ ability to stimulate a depressed economy.

Meanwhile, Bloomberg reports that the Willem Buiter of Citi (the same guy who endorsed military attacks on low-tax jurisdictions) supports the elimination of cash.

Citi’s Willem Buiter looks at this problem, which is known as the effective lower bound (ELB) on nominal interest rates. …the ELB only exists at all due to the existence of cash, which is a bearer instrument that pays zero nominal rates. Why have your money on deposit at a negative rate that reduces your wealth when you can have it in cash and suffer no reduction? Cash therefore gives people an easy and effective way of avoiding negative nominal rates. …Buiter’s solution to cash’s ability to allow people to avoid negative deposit rates is to abolish cash altogether.

So are they right? Should cash be abolished so central bankers and governments have more power to manipulate the economy?

There’s a lot of opposition from very sensible people, particularly in the United Kingdom where the idea of banning cash is viewed as a more serious threat.

Allister Heath of the U.K.-based Telegraph worries that governments would engage in more mischief if a nation got rid of cash.

Many of our leading figures are preparing to give up on sound money. The intervention I’m most concerned about is Bank of England chief economist Andrew Haldane’s call for a 4pc inflation target, as well as his desire to abolish cash, embrace a purely electronic currency and thus make it easier for the Bank to impose substantially negative interest rates… Imagine that banks imposed -4pc interest rates on savings today: everybody would pull cash out and stuff it under their mattresses. But if all cash were digital, they would be trapped and forced to hand over their money. …all spending would become subject to the surveillance state, dramatically eroding individual liberty. …Money is already too loose – turning on the taps would merely further fuel bubbles at home and abroad.

Also writing for the Telegraph, Matthew Lynn expresses reservations about this trend.

As for negative interest rates, do we really want those? Or have we concluded that central bankers are doing more harm than good with their attempts to manipulate the economy? …a banknote is an incredibly efficient way to handle small transactions. It is costless, immediate, flexible, no one ever needs a password, it can’t be hacked, and the system doesn’t ever crash. More importantly, cash is about freedom. There are surely limits to the control over society we wish to hand over to governments and central banks? You don’t need to be a fully paid-up libertarian to question whether…we really want the banks and the state to know every single detail of what we are spending our money on and where. It is easy to surrender that freedom – but it will be a lot harder to get back.

Merryn Somerset Webb, a business writer from the U.K., is properly concerned about the economic implications of a society with no cash.

…at the beginning of the financial crisis, there was much talk about financial repression — the ways in which policymakers would seek to control the use of our money to deal with out-of-control public debt. …We’ve seen capital controls in the periphery of the eurozone… Interest rates everywhere have been at or below inflation for seven years — and negative interest rates are now snaking their nasty way around Europe… This makes debt interest cheap for governments…and it and forces once-prudent savers to move their money into the kind of risky assets that are supposed to drive growth (and tax receipts).

Amen. She’s right that low interest rates are good news for governments and not very good news for people in the productive sector.

Last but not least, Chris Giles wrote a column for the FT and made one final point that is very much worth sharing.

Mr Haldane’s proposal to ban cash has all the hallmarks of a public official confusing what is convenient for the central bank with what is in the public interest.

Especially since the central bankers are probably undermining long-run economic prosperity with short-run tinkering.

Moreover, the option to engage in Keynesian monetary policy also gives politicians an excuse to avoid the reforms that actually would boost economic performance. Indeed, it’s quite likely that an easy-money policy exacerbates the problems caused by bad fiscal and regulatory policy.

Let’s conclude by noting that maybe the right approach isn’t to give politicians and central bankers more control over money, but rather to reduce government’s control over money. That’s one of the arguments I made in this video I narrated for the Center for Freedom and Prosperity.

P.S. By the way, Ryan McKaken at the Mises Institute identifies a third reason why politicians would prefer a cash-free society.

…the elimination of physical cash makes it easier for the state to keep track of private persons, and it assists central banks in efforts to punish saving and expand the money supply by implementing negative interest rate schemes. A third advantage of the elimination of physical cash would be to more easily control people and potential dissidents through the freezing of their bank accounts.

Excellent point. We’ve already seen how asset forfeiture allows governments to steal people’s bank accounts without any conviction of wrongdoing. Imagine the damage politicians and bureaucrats could do if they had even more control over our money.

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We’ve been suffering through the weakest recovery since the Great Depression. Labor force participation hasn’t recovered and median household income is stagnant.

So how are our benevolent and kind overseers in Washington responding?

Are they reducing the burden of spending? Nope, they just busted the spending caps (again).

Are they cutting back on red tape? No, they’re moving in the other direction.

Are they lowering taxes? With Obama in the White House, that’s not even a serious question.

But that doesn’t mean all the people in Washington is sitting on their collective hands. The folks at the Federal Reserve have been trying to goose the economy with an easy-money policy.

Unfortunately, as I argue in this recent interview, that’s not a recipe for success.

At best, an easy-money policy is ineffective, akin to “pushing on a string.” At worst, it creates bubbles and does serious damage.

Yet if you don’t like the Fed trying to manipulate the economy, you’re often perceived as a crank. And if you’re an elected official who questions the Fed’s actions, you’re often portrayed as some sort of uninformed demagogue.

I explored this issue today in The Federalist. In my column, I defended Senators Rand Paul and Ted Cruz.

Rand Paul and Ted Cruz…deserve credit for criticizing the Federal Reserve. …This irks some folks, who seem to think Fed critics are knuckle-dragging rubes and yahoos with a superstitious fealty to the gold standard.

This isn’t a debate over the gold standard, per se, but instead of fight over monetary Keynesianism vs. monetary rules.

The dispute isn’t really about a gold standard, but whether the Federal Reserve should have lots of discretionary power.  …On one side are the advocates of…the monetary component of Keynesian economics. Proponents explicitly want the Fed to fine-tune and micromanage the economy. …On the other side are folks who believe in rules to limit the Fed’s powers…because they believe discretionary power is more likely to give us bad results such as higher price inflation, volatility in output and employment, and financial instability.

And the Joint Economic Committee is on the side of rules. Here’s an excerpt from a JEC report that I cited in my article.

Well-reasoned, stable and predictable monetary policy reduces economic volatility and promotes long-term economic growth and job creation. Generally, ‘rules-based’ policies reduce uncertainties and facilitate long-term planning and investment. …Conversely, activist, interventionist, and discretionary monetary policies have been historically associated with increased economic volatility and subpar economic performance.

I then mention various rules-based methods of limiting the Fed’s discretion and conclude by commenting on the legitimacy of those who want to curtail the Federal Reserve.

Paul and Cruz may not be experts on monetary policy, just as left-wing senators doubtlessly have no understanding of the intricacies of discretionary monetary policy. But the two senators are on very solid ground, with an illustrious intellectual lineage, when they assert that it would be a good idea to constrain the Fed.

Now let’s expand on two issues. First, I mention in my article the gold standard as a potential rule to constrain the Fed. I’ve previously shared some analysis by George Selgin on this topic. He’s concluded that governments won’t ever allow its return and probably couldn’t be trusted with such a system anyway, but that doesn’t mean it doesn’t work.

Here are some excerpts from a recent article by George. Read the entire thing, but here’s the part that matters most for this discussion.

…the gold standard was hardly perfect, and gold bugs themselves sometimes make silly claims about their favorite former monetary standard. …the classical gold standard worked remarkably well (while it lasted). …it certainly did contribute both to the general abundance of goods of all sorts, to the ease with which goods and capital flowed from nation to nation, and, especially, to the sense of a state of affairs that was “normal, certain, and permanent.” The gold standard achieved these things mainly by securing a degree of price-level and exchange rate stability and predictability that has never been matched since.

And Norbert Michel of the Heritage Foundation touches on some of the same issues in a new column for Forbes.

Several candidates suggested the gold standard was a good system, and they’re all getting flak for talking about gold.

But here’s the most fascinating revelation from Norbert’s column. It turns out that even Ben Bernanke agrees with George Selgin that the classical gold standard worked very well. Norbert quotes this passage from Bernanke.

The gold standard appeared to be highly successful from about 1870 to the beginning of World War I in 1914. During the so-called “classical” gold standard period, international trade and capital flows expanded markedly, and central banks experienced relatively few problems ensuring that their currencies retained their legal value.

Both Norbert’s article and George’s article have lots of good (but depressing) analysis of how governments went off the gold standard because of World War I and then put in place a hopelessly weak and impractical version of a gold standard after the war (the politicians didn’t want to be constrained by an effective system).

So here’s Norbert’s bottom line, which is very similar to the conclusion in my column for The Federalist.

Many who favor the gold standard recognize that it provided a nominal anchor as opposed to the discretionary fiat system we have now. Maybe the gold standard isn’t the best way to achieve that nominal anchor, but we shouldn’t just dismiss the whole notion.

The second issue worth mentioning is that the best way to deal with bad monetary policy may be to have no monetary policy.

At least not a monetary policy from government. This video explains the merits of this approach.

Gee, maybe Friedrich Hayek was right and private markets produce better results than government monopolies.

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