All posts tagged Free Banking

“Good E-money” can solve Zimbabwe’s ‘coin problem’

The New York Times reports on the Zimbabwe’s so-called “coin problem”:

“When Zimbabweans say they are waiting for change, they are usually talking about politics. After all, the country has had the same leader since 1980.

But these days, Robson Madzumbara spends a lot of time quite literally waiting around for change. Pocket change, that is. He waits for it at supermarkets, on the bus, at the vegetable stall he runs and just about anywhere he buys or sells anything.

“We never have enough change,” he said, manning the vegetable stall he has run for the past two decades. “Change is a big problem in Zimbabwe.”

For years, Zimbabwe was infamous for the opposite problem: mind-boggling inflation. Trips to the supermarket required ridiculous boxloads of cash. By January 2009, the country was churning out bills worth 100 trillion Zimbabwean dollars, which were soon so worthless they would not buy a loaf of bread.

But since Zimbabwe started using the United States dollar as its currency in 2009, it has run into a surprising quandary. Once worth too little, money in Zimbabwe is now worth too much.

“For your average Zimbabwean, a dollar is a lot of money,” said Tony Hawkins, an economist at the University of Zimbabwe.

Zimbabweans call it “the coin problem.” Simply put, the country hardly has any. Coins are heavy, making them expensive to ship here. But in a nation where millions of people live on a dollar or two a day, trying to get every transaction to add up to a whole dollar has proved a national headache.”

This is of course is a very visible monetary disequilibrium – the demand for coins simply is outpacing the supply of coins. As a consequence Zimbabwe is now struggling with a quasi-deflationary problem. Somewhat paradoxically taking recent Zimbabwean monetary history into account.

Monetary history is full of this kind of “coin problems” that we now have in Zimbabwe and there are numerous solutions to the problem. In the NYT article one such solution is suggested is that the Zimbabwe government should start minting coins again. However, in Zimbabwe nobody is willing to accept in coins made produced by the government and who can blame them for that?

Good E-money

However, there is another solution that would make a lot more sense and that is simply to allow for private minting of coins. George Selgin in his 2010 masterpiece “Good Money” describe how Britain’s ‘coin problem’ in the 1780s was solved. Here is the book description:

“In the 1780s, when the Industrial Revolution was gathering momentum, the Royal Mint failed to produce enough small-denomination coinage for factory owners to pay their workers. As the currency shortage threatened to derail industrial progress, manufacturers began to mint custom-made coins, called “tradesman’s tokens.” Rapidly gaining wide acceptance, these tokens served as the nation’s most popular currency for wages and retail sales until 1821, when the Crown outlawed all moneys except its own.”

In fact we are already seeing this happening in Zimbabwe in a very primitive form – again from the NYT:

“Zimbabweans have devised a variety of solutions to get around the change problem, none of them entirely satisfactory. At supermarkets, impulse purchases have become almost compulsory. When the total is less than a dollar, the customer is offered candy, a pen or matches to make up the difference. Some shops offer credit slips, a kind of scrip that has begun to circulate here.”

So credit slips, candy, pens and matches are used as coins. Obviously this is not a very good solution. Mostly because the “storage” quality of these quasi-coins is very bad. The quality of candy after all deteriorates rather fast is you walk around with it in your pockets for a couple of days.

Among the problems in Zimbabwe is also that there is really not any local “manufacturers” that would be able to issue coins which would be trusted by the wider public and as the general “trust” level in Zimbabwean society is very low it is questionable whether any local “agent” would be able to produce a trustworthy coin.

However, a solution might be found in another African country – Kenya. In Kenya the so-called M-pesa has become a widely accepted “coin”. The M-pesa is mobile telephone based payments. Today it is very common that Kenyans use there cell phone to make payments in shops with M-pesa – even with very small amounts. Hence, one can say that this technological development is making “normal” coins irrelevant. You don’t need coins in Kenya. You can basically pay with M-pesa anywhere also in small village shops. M-pesa is Good Money – or rather Good E-Money.

Therefore, the Zimbabwean authorities should invite international telecoms operators to introduce telephone based payments in Zimbabwe. The mobile penetration in Zimbabwe is much lower than in Kenya, but nonetheless even in very poor Zimbabwe mobile telephones are fairly widespread. Furthermore, if it could help solve the “coin problem” more Zimbabwean’s would likely invest in mobile phones.

Hence, if private telecom operators were allowed to introduce (lets call it) M-Mari (Mari is shona for ‘money’ as Pesa is swahili for money) then the coin problem could easily be solved. In Kenya M-pesa is backed by Kenyan shilling. In Zimbabwe it M-Mari could be backed by US dollars (or something else for that matter).

The future African monetary regime – M-pesa meets Bitcoin

This might all seem like fantasy, but the fact remains that there today are around 500 million cell phones in Africa and there is 1 billion Africans. In the near future most Africans will own their own cell phone. This could lay the foundation for the formation of what would be a continent wide mobile telephone based Free Banking system.

Few Africans trust their governments and the quality of government institutions like central bankers is very weak. However, international companies like Coca Cola or the major international telecom companies are much more trusted. Therefore, it is much more likely that Africans in the future (probably a relatively near future) would trust money (or near-money) issued by international telecom companies – or Coca Cola for that matter.

In fact why not imagine a situation where Bitcoin merges with M-pesa so you get mobile telephone money backed by a quasi-commodity standard like the Bitcoin? I think most Africans readily would accept that money – at least their experience with government issued money has not exactly been so great.

14 Comments
by Lars Christensen on April 26, 2012  •  Permalink
Posted in Bitcoin, Free Banking, George Selgin, M-pesa
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Posted by Lars Christensen on April 26, 2012

https://marketmonetarist.com/2012/04/26/good-e-money-can-solve-zimbabwes-coin-problem/

Atlas Sound Money Project Interview with George Selgin

See this new excellent interview with George Selgin. I think it is harder to find any bigger expert on Free Banking theory and Free Banking history than George. Great stuff – even though I do not agree with everything (yes, believe it of not – I do not agree with everything George is saying).

George in the interview recommends that the Fed should introduce a NGDP target rule as a second best to his preferred solution to abolish the Fed. George thinks that a NGDP target rule could be introduced as a Bitcoin style computer algorithm – similar to what he suggests in his recent paper on Quasi-Commodity money (in the paper he discuss a Free Baning solution rather than a central bank solution). I personally think that a Quasi-Commodity standard could be the future for Free Banking money, but I think Scott Sumner’s suggestion for a futures based NGDP targeting regime would work better as long as you maintain central banks.

8 Comments
by Lars Christensen on April 23, 2012  •  Permalink
Posted in Bitcoin, Free Banking, George Selgin
Tagged , , ,

Posted by Lars Christensen on April 23, 2012

https://marketmonetarist.com/2012/04/23/atlas-sound-money-project-interview-with-george-selgin/

Central bank rituals and legitimacy

One of the most interesting aspects of US monetary policy since 2008 is that while Ben Bernanke certainly is not ignorant of economic history or monetary theory it seems like the Fed under his leadership has not responded nearly as aggressive to the crisis as one should have expected if one from reading Bernanke’s academic work. Furthermore, one can question why the Bank of Japan for more than a decade has failed to seriously address the deflationary pressures in the Japanese economy. Similarly why have central banks in for example the Baltic States, Bulgaria and Denmark maintained an unwavering support for keeping their currencies pegged to euro while the euro crisis has continued to escalate?

Scott Sumner has sometimes – I guess in frustration – suggested that central bankers are just stupid and this is the reason why mistaken monetary policies are continued for years. I on the other hand have suggested that one should look for a public choice based explanation for central bank behavior and that particularly William Nishanen’s Bureaucrat theory would be relevant. I have also suggested that the success of monetary policy during the Great Moderation has created a certain level of ignorance among policy makers and commentators about monetary policy.

However, there might be an additional explanation for the behavior of central bankers and that has to do with ensuring the the legitimacy of central banks (this could of course be said to be related to my Nishanenian explanation). I found a interesting discussion of this topic in a 1969 paper by Kenn Boulding – “The Legitimacy of Central Banks”.

Here is Boulding’s introduction:

The problem of legitimacy is one of the most neglected aspects of the study of social systems. There may be good reasons for this, for it is inevitably a hot subject. One can hardly discuss the legitimacy of anything without seeming to threaten it, for a great deal of legitimacy depends on things being taken for granted and not talked about at all. The more one looks at the dynamics of social systems, however, the more it becomes clear that the dynamics of legitimacy is one of the most important elements in the total long-run dynamics of society. It certainly ranks with such things as population and demographic movements, and even with technological change with which it is closely intertwined. Its importance can be seen in the remark that if a person or institution loses legitimacy it loses everything. It can no longer maintain itself in the social system. No amount of wealth, that is exchange capability, or power, that is, threat capability, can keep an institution alive if there is a widespread denial of the legitimacy of its role in society. This is because the performance of any continuous and repeated role requires an acceptance of its legitimacy on the part of those role occupants whose roles are related to it. A role in the social system is a focal point or node of inputs and outputs of many different kinds, the output of one role being the input of another. Inputs, therefore, depend on the willingness of other role occupants to give outputs, and they will not do this continuously unless there is legitimacy. Where people feel that certain outputs are illegitimate they will eventually find ways of stopping them. The corresponding inputs will likewise stop. To use a rather crude illustration, a bandit can take your money once, but anyone who wants to take it every week either has to be a landlord or a tax collector, or perhaps even a bank.

There are a considerable number of sources of legitimacy,and the functions which relate the determinants of legitimacy to its amount are extremely complex. They are certainly non-linear and they exhibit discontinuities which are to say the least disconcerting. Sometimes an institution, the legitimacy of which seems to be absolutely unques- tioned, collapses overnight. All of a sudden we reach some kind of a “cliff” in the legitimacy function and the institution suddenly becomes illegitimate. The same thing perhaps can even happen the other way, in which institutions quite suddenly become legitimate after having been illegitimate, A good example of the former is the collapse of the monarchy, beginning in the 17th century. The legitimacy of monarchy survived the Cromwellian war in England, largely because an ancient legitimacy is like a capital stock, it takes a great deal of spending before it can be exhausted. At the time of Louis XIV in the following century one might have thought that the legitimacy of monarchy was absolutely unquestioned and secure. In the following century, however, it collapsed everywhere and the only monarchs who survived were those who abandoned their power and became symbols of legitimacy, like the British, Dutch and Scandinavian monarchs. On the other side, abortion has been an institution which has been regarded as highly illegitimate and now in the face of the population problem seems to be acquiring a quite sudden legitimacy.

Sorry for the long quote, but Boulding’s discussion seem highly relevant for central banks and their behavior during the present crisis. Today (nearly) nobody dare suggesting that we could do without central banks. Take Denmark. In Denmark there is massive public support for the rather irrational institution of monarchy and only few Danes would seriously question the legitimacy of the monarchy. However, even fewer Danes would question the legitimacy of the Danish central bank. However, as history has shown support for institutions can disappear overnight. It is therefore, in the institutional interests of Kings (in the case of Denmark the Queen) and central bankers to insure that their legitimacy is maintained. Obviously we don’t have only to talk about the legitimacy of the central bank but also for example the legitimacy of certain policy rules for example inflation targeting or a fixed exchange rate regime.

Boulding discusses a number of sources of legitimacy:

The first consists of the payoffs of the institution in question:

If an institution provides good terms of trade with those who are related to it, up to a point this contributes to its legitimacy, especially in the long run. The case is clearer on the negative side. An institution which has very poor payoffs, demands a great deal of input from other people and gives very little output to them, is likely to have its legitimacy eventually eroded on this account. 

Therefore, a central bank which fails to “deliver” will eventually become illegitimate. The same can be said for a policy rule like inflation targeting. If inflation targeting stops working (as certainly is the case for example in the euro zone) then public support for it will  be eroded and sooner or later the central bank will have to give it up. However, the central bank is crucially dependent on the legitimacy and it therefore also be in the central bank’s bureaucratic interest to continue to claim that “everything is fine” despite this is in clearly conflict with reality. As Boulding explain: “therefore, a strong tendency to “throw good money after bad” and to continue making sacrifices for some institution, even after some possibly expected long-run payoffs have failed to materialize.”

The second source of legitimacy is age. The Danish monarchy’s legitimacy certainly has a lot to do with the fact that it has been around forever and the same goes for the legitimacy of many central banks. The Federal Reserve will have been around for a 100 years next year. In Denmark the present exchange rate regime has more or less been in place since 1982. Similarly, New Zealand was the first country introduce inflation targeting in 1988. There is no doubt that age provide significant legitimacy to different monetary regimes around the world and the despite of the seriousness of the crisis few well-established monetary regimes have really got under pressure.

The third source of legitimacy is mystery. In the words of Boulding: “Something which is not understood but which is dimly perceived as obscurely grand and magnificent, acquires an aura of legitimacy in the minds of those who do not understand it. The temples and impressive ceremonies of religion, the “state” of kings, the mystique of the brass hat and the military leader, the sanctity of priesthoods of all kinds and even the mystery of science and the laboratory are all related to this aspect of legitimacy”

This I think makes a lot of sense in the case of monetary institutions. Few people understand monetary theory and central banks are generally perceived as very complicated and even mysteries by most ordinary people. The mystery can only be maintained through the “temples”, “ceremonies” and the “brass hat”. Just think of a rate announcement from the ECB. There is a lot of ceremony to that. The same phrases are repeated again an again – and the central bankers all look the same in their dark suits and white shirts and ties (I look like that everyday as well – even though I occasionally would wear a bow-tie and probably are more comfortable with colours than most central bankers are…) As part of maintaining the mystery central bankers of course will also be careful in not questioning these rituals.

A forth source of legitimacy consists of the alliance of an institution with other legitimacies. Boulding terms this the “the legitimacy syndrome”. Just think of the relationship between the ECB and the European Commission. The languages and thinking of the two institutions are very similar. Think of now Prime Minister Mario Monti in Italy – he might as well have been ECB chief instead of the other Mario (Draghi). The thinking, the appearance and the norms very much seem to be the same. There are also strong alliances between central banks in different countries – one central bank would very rarely criticize another central bank. The Swedish Riksbank with its flexible inflation targeting and floating exchange rate regime would be very careful in for example avoiding saying anything bad about the Danish fixed exchange regime.

Concluding, the survival of monetary regimes crucially dependents on the legitimacy of these regimes. This legitimacy can be maintained in many ways by central banks. Among these are the need for mystery and alliances with other legitimate institutions. I think that this should be kept in mind when we are discussing why central banks fail to do the “right thing”.

Kenneth Boulding end his paper with a warning to central banks and it rings as true today as it did in 1969:

“I am pretty certain, however, that whatever mutation may supplant the existing system has not yet been made, but if the legitimacy of the system rests firmly on its payoffs then the social invention which will supplant it, if it ever comes, should be welcomed with joy rather than fear. It is only what I do not now mind calling the fraudulent legitimacies which fear competition.”

10 Comments
by Lars Christensen on April 21, 2012  •  Permalink
Posted in Monetary institutions
Tagged , ,

Posted by Lars Christensen on April 21, 2012

https://marketmonetarist.com/2012/04/21/central-bank-rituals-and-legitimacy/

Nixon was a crook and Arthur Burns was a failed central banker

Back from my trip to Riga and Stockholm and two books had arrived in the mail from Amazon.

The first one “Inside The Nixon Administration – the Secret Diary of Arthur Burns 1969-1974” (Edited by Robert Ferrell, 2010). The second one is Larry White’s “Free Banking in Britain” (yes, dear readers believe it or not I did not read it before…).

Obviously I have not read the two books yet, but they are in some odd way complementary – the one is about how central banking can become hugely politicized and the second is about how to avoid that the monetary regime is politicized.

I did peak a little into the pages of the Burns diary. Burns who of course was Federal Reserve governor while Nixon was US president wrote a diary with notes from all its meetings with Nixon. I must admit that I am in total shock about how extreme the polarization of the US monetary policy was in the Nixon years. The man surely was a crook. One of the worst. However, from the little I have read Burns diary also clearly shows how misguided his views of monetary policy were. Again and again the diary mentions how he think price and wage controls are necessary to curb inflation, while Nixon at the same time is demanding money printing to be stepped up. Surely a bizarre duo – one a failed economist and one a crook. Very scary indeed.

So what is the lesson? Politics and money is a deadly cocktail and that is why you want to restrict both central bankers and a politicians when it comes to monetary policy.

If any of my readers have read these books I would be very happy to hear your opinion about them.

 

5 Comments
by Lars Christensen on April 19, 2012  •  Permalink
Posted in Free Banking, Larry White, Monetary institutions, Reading recommendations, Uncategorized
Tagged , , ,

Posted by Lars Christensen on April 19, 2012

https://marketmonetarist.com/2012/04/19/nixon-was-a-crook-and-arthur-burns-was-a-failed-central-banker/

Is Market Monetarism just market socialism?

The short answer to the question in the headline is no, but I can understand if somebody would suspect so. I will discuss this below.

If there had been an internet back in the 1920s then the leading Austrian economists Ludwig von Mises and Friedrich Hayek would have had their own blogs and so would the two leading “market socialists” Oskar Lange and Abba Lerner and in many ways the debate between the Austrians and the market socialists in the so-called Socialist Calculation Debate played out as debate do today in the blogosphere.

Recently I have given some attention to the need for Market Monetarists to stress the institutional context of monetary institutions and I think the critique by for example Daniel Smith and Peter Boettke in their recent paper “Monetary Policy and the Quest for Robust Political Economy” should be taken serious.

Smith’s and Boettke’s thesis is basically that monetary theorists – including – Market Monetarists tend to be overly focused on designing the optimal policy rules under the assumption that central bankers acts in a benevolent fashion to ensure a higher good. Smith and Boettke argue contrary to this that central bankers are unlikely to act in a benevolent fashion and we therefore instead of debating “optimal” policy rules we instead should debate how we could ultimately limit central banks discretionary powers by getting rid of them all together. Said in another way – you can not reform central banks so they should just be abolished.

I have written numerous posts arguing basically along the same lines as Boettke and Smith (See fore example here and here). I especially have argued that we certainly should not see central bankers as automatically acting in a benevolent fashion and that central bankers will act in their own self-interests as every other individual. That said, I also think that Smith and Boettke are too defeatist in their assessment and fail to acknowledge that NGDP level targeting could be seen as step toward abolishing central banks altogether.

From the Smith-Boettke perspective one might argue that Market Monetarism really is just the monetary equivalent of market socialism and I can understand why (Note Smith and Boettke are not arguing this). I have often argued that NGDP targeting is a way to emulate the outcome in a truly competitive Free Banking system (See for example here page 26) and that is certainly a common factor with the market socialists of the 1920s. What paretian market socialists like Lerner and Lange wanted was a socialist planned economy where the allocation would emulate the allocation under a Walrasian general equilibrium model.

So yes, on the surface there as some similarities between Market Monetarism and market socialism. However, note here the important difference of the use of “market” in the two names. In Market Monetarism the reference is about using the market in the conduct of monetary policy. In market socialism it is about using socialist instruments to “copy” the market. Hence, in Market Monetarism the purpose is to move towards market allocation and about monetary policy not distorting relative market prices, while the purpose of market socialism is about moving away from market allocation. Market Monetarism provides an privatisation strategy, while market socialism provides an nationalisation strategy. I am not sure that Boettke and Smith realise this. But they are not alone – I think many NGDP targeting proponents also fail to see these aspects .

George Selgin – who certainly is in favour of Free Banking – in a number of recent papers (see here and here) have discussed strategies for central bank reforms that could move us closer to Free Banking. I think that George fully demonstrates that just because you might be favouring Free Banking and wanting to get rid of central banks you don’t have to stop reforms of central banking that does not go all the way.

This debate is really similar to the critique some Austrians – particular Murray Rothbard – had of Milton Friedman’s proposal for the introduction of school vouchers. Rothbard would argue that Friedman’s ideas was just clever socialism and would preserve a socialist system rather than break it down.

However, even Rothbard acknowledged in For a New Liberty that  Friedman’s school voucher proposal was “a great improvement over the present system in permitting a wider range of parental choice and enabling the abolition of the public school system” (I stole the quote from Bryan Caplan). Shouldn’t Free Banking advocates think about NGDP level targeting in the same way?

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Posts on central bank as (or not) central planning:

Maybe Scott should talk about Hayek instead of EMH
It’s time to get rid of the ”representative agent” in monetary theory
Guest blog: Central banking – between planning and rules
When central banking becomes central planning

18 Comments
by Lars Christensen on April 11, 2012  •  Permalink
Posted in Daniel Smith, Free Banking, George Selgin, MM Research agenda, Monetary institutions, Peter Boettke, Reading recommendations
Tagged , ,

Posted by Lars Christensen on April 11, 2012

https://marketmonetarist.com/2012/04/11/is-market-monetarism-just-market-socialism/

Googlenomics and the popularity of Bitcoin

Lasse Birk Olesen’s guest post about Bitcoin inspired me to do a bit of Googlenomics. I simply had a look at searches in Google for ‘Bitcoin’ using Google Insight.

The “bubble” that Lasse talked about in 2011 is certainly also visible in google searches. Have a look on this graph.

Since June 2011 the search activity for Bitcoin, however, has gone down somewhat, but is still at a somewhat higher level than prior to the 2011 spike. So judging from a bit of Googlenomics Bitcoin is still alive – whether it is kicking is another question.

I am still not sure what to make of Bitcoin as an alternative currency. However, any monetary theorist should take the development in the Bitcoin market serious as it might tell us something about not only the Bitcoin itself, but also about the general monetary developments. It would for example be very interesting to see a study of what determines the exchange rate for Bitcoins against other currencies.

Furthermore, if anybody is aware of any serious academic studies of the Bitcoin market I would be very interesting in hearing from you (lacsen@gmail.com).

Everybody interested not only in Bitcoin, but more generally in what George Selgin has termed Quasi-Commodity money should have a look here. Scott Sumner as a somewhat different, but equally relevant in a post today.

I will not in anyway promise to give more attention to the Bitcoin phenomon. That is not the is not the purpose of my blog, but I do promise that to the extent that I think the Bitcoin market can teach us more about monetary theory and monetary policy in general I surely will follow up on these developments in the future.

1 Comment
by Lars Christensen on April 6, 2012  •  Permalink
Posted in Bitcoin, Free Banking, George Selgin, Googlenomics, Lasse Birk Olesen
Tagged , , , , ,

Posted by Lars Christensen on April 6, 2012

https://marketmonetarist.com/2012/04/06/googlenomics-and-the-popularity-of-bitcoin/

Guest post: Bitcoin, Money and Free Banking (by Lasse Birk Olesen)

Lee Kelly in a recent guest post here on The Market Monetarist discussed the implication of excess demand for money for the development of barter and Free Banking. I found Lee’s discussion extremely interesting and think that it could be interesting to see how monetary disequilibrium actually could work as a catalyst for the development of alternative monetary systems – for example the development of so-called local currencies in Greece.

One of the most interesting developments in recently years in the fields of alternative monetary systems is Bitcoin. I am no expect on Bitcoin and I have certainly not made up my mind about the implications of Bitcoin so I have asked the founder of BitcoinNordic.com Lasse Birk Olesen to do a guest post about Bitcoin. I am happy that Lasse has accepted the challenge.

Lars Christensen

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Guest post: Bitcoin, Money and Free Banking
by Lasse Birk Olesen, founder of BitcoinNordic.com

Started in 2009, the decentralized means of exchange for the internet known as Bitcoin has been gaining traction every year since. With no central institution backing it, with no one knowing whether to classify it as currency or as commodity, and their inherent nature making them hard to regulate, Bitcoin has been the subject of much controversy. This post is a short summary of what I have learned about Bitcoin and serves as an introduction to the concept, its economic properties, and a couple of its potential implications for the financial infrastructure of the world.

How does it work? Consider a special type of e-mail that cannot be copied. This means that when you forward this e-mail to someone else, you must lose it from your own inbox. Now also consider that there exists only a finite amount of these special e-mails, and no one can create more of them. Because of these properties, people have started considering these e-mails as valuable. These unique e-mails are of course called Bitcoins.

The above is a technically incorrect description of how Bitcoin works (see The Economist for a more accurate and technical overview). But it is a useful analogy for a quick understanding of the concept, and it is not too far from the actual end-user experience.

Value
As Bitcoins have no physical manifestation and no use besides as a medium of exchange, many economists (some citing Mises’ regression theorem) have predicted their value to be a bubble driven by novelty and hype, just waiting for an inevitable burst.

And the Bitcoin price definitely did experience a bubble in the summer of 2011. Going from 1 USD/BTC to 30 USD/BTC in just 2 months from April to June and then dropping back to 2 USD/BTC in November, most of the Bitcoin critics would probably have bet that the show was over. But over the next couple of months the exchange rate went back to 5 USD/BTC and has remained in that area since.

While the exchange rate is not in itself an indicator of the success of Bitcoin, it is of course an indicator of the market’s expectation of the future success of Bitcoin. If Bitcoin enjoys widespread adoption its exchange rate is bound to rise as demand increases.

But while the Bitcoin critics are right that most historical money such as gold had other uses before they became accepted as money, as Mises’ regression theorem states, this does not mean that it is the only way a viable money can come into existence.

Historical examples of money with no other uses exist. One is the case of large rocks known as rai stones which were used for trade between the islands of Micronesia. The rocks, definitely too large for use as tools, derived their value solely from being a means of exchange. In other words, the only reason to value them was because everyone else did.

Properties as money
And so is the case with Bitcoin. With no institution guaranteeing their value, with no guaranteed exchange rate to traditional currencies, Bitcoins’ value stems only from their use as a means of exchange. But unlike the rai stones, which were difficult to transport, Bitcoins ace almost all of the requirements traditionally set forth for good money:

  • Scarce: No more than 21 million will ever exist
  • Divisible: Each of the 21 million can be divided infinitely
  • Fungible: One Bitcoin is as good as the next
  • Mobile: Can be sent from New York to Tokyo in 10 seconds for an infinitesimal fee
  • Durable: Will remain intact as long as anyone uses the system

In addition, Bitcoin is the first electronic cash system being completely decentralized and semi-anonymous. No one needs to know who you pay or how many you own. Adding these properties together gives you a unique money system that the world has not seen before. It streamlines many financial operations, and it can open up entirely new markets that had been impossible until now. This uniqueness is what drives the support of the Bitcoin community and gives each coin value. No other system currently allows you to transfer value to the other side of the world in seconds practically for free and without identifying yourself.

As a store of value, however, Bitcoins are still a very poor money, as the mentions of the exchange rate above shows. But with the existence of liquid exchanges to traditional currencies in multiple countries it retains its use as an international transfer of value. And if Bitcoin sees widespread adoption the exchange rate will become less volatile as market depth increases.

Free banking
The inherently decentralized and semi-anonymous nature of Bitcoin makes it hard to regulate. You cannot punish a violator of your country’s laws if you do not know who he is. And you cannot shut down a system if it doesn’t have a point of attack. Trying to close decentralized networks such as Bitcoin is like cutting off Hydra’s heads: Cut one and two new ones grow as the entertainment industry has already realized in combating file sharing networks.

This means that Bitcoin will potentially enable free banking in Bitcoins even if government regulation doesn’t allow it as banks can keep accounts and transactions hidden.

At the moment, there is little to no banking activity in the Bitcoin economy. Lending is done on a peer-to-peer basis between forum users across the world. Because of the difficulty in assigning credit ratings to internet nicknames, interest rates are naturally high in this very interesting and unregulated developing market.

If Bitcoin adoption grows, we should expect actual banks, with or without government banking licenses, to appear to judge borrowers based on face to face interactions instead of internet forum posts.

A common misconception is that fractional reserve banking is impossible with Bitcoins. But just as fractional reserve banking can be done with gold it can be done with Bitcoins.

Less banking
In addition to new opportunities for free banking, I predict that given a larger adoption of Bitcoin we will also see less private banking. The main reason most people store fiat money in banks is not to get interest on their small amount of savings. They do it to for security and to be able to participate in the electronic economy – that is, to be able to shop online and avoid the need to carry around cash and use credit cards instead.

Bitcoins are incredibly flexible when it comes to storage. They can be stored on any digital or analog medium, encrypted by cryptography stronger than used in online banking, and backed up to an infinite amount of locations. They can even be saved in your brain. If your assets are in Bitcoin you no longer need a bank for safeguarding.

And as they are inherently digital, you don’t need a bank to act as a gateway for you to spend them in the electronic economy. Stored on your smartphone you could carry them to a restaurant and pay the bill using your phone instead of a card.

People having less reasons to store their money in banks will contribute to a higher real interest rate. On the other hand, the deflationary nature of Bitcoin will encourage savings and contribute to a lower interest rate. I cannot predict which will be the dominating effect (note: corrected slightly compared to earlier version).

Bitcoin-enforced contracts
An interesting development is the creation of Bitcoin-enforced contracts. For an example of how this could work consider you bought a car for a small down payment and has agreed to make more payments once a month. With the car being connected to the Bitcoin network, it could check for new payments to the seller’s Bitcoin address every month. If your monthly payment has not arrived the car will refuse to start.

One could also imagine this happening today with a deactivation system remote controlled by the car seller. But what if the seller deactivated your car after you had already made all your payments? With a Bitcoin-enforced contract you don’t need to trust the seller, you only need to trust the Bitcoin network of which everyone can check the source code.

Also, scripts can be embedded into Bitcoin transactions which opens up for even more contractual possibilities. One use of this is for pooling resources towards a common good, i.e. to fund the creation of something with positive externalities.

Say your neighborhood wants to buy an empty lot to turn it into a park. Normally someone will start raising money, but what happens if he doesn’t get enough to actually complete the project? Can you trust him to give you your money back? Instead, you can make your donation to his Bitcoin address with the condition that the money is returned to you if not X amount has been sent by others to the same address before Y date. The Bitcoin network will enforce this without you needing to trust the person accepting the donation or even a third party.

The future
As seen in the above section on contracts, Bitcoin is more than a better means of exchange. People discover new uses for the technology every month.

One can conceive of several threats to Bitcoin’s survival and widespread adoption: Could a flaw in the design be discovered that leaves the system open to counterfeiting? It’s very unlikely since it hasn’t been discovered yet even as there is a large financial incentive to do so. And if it happens, the system allows for large structural repairs while carrying on using the same coins. Will the world find no utility in larger adoption of Bitcoin? Unlikely as the financial infrastructure of today belongs to the pre-internet era. For instance, it shouldn’t take days and cost tens of dollars to move value from Europe to the US or Asia.

Perhaps the biggest threat would be from a technically superior Bitcoin 2 that could replace the current system and leave original Bitcoins worthless. As Bitcoin has the momentum, Bitcoin 2 would need to be vastly improved. And as with anything new, the change will not happen in the blink of an eye. Some will be risk takers and make early investments in Bitcoin 2 while others will stick with the good ol’ familiar Bitcoin for a longer time.

I remain optimistic on behalf of Bitcoin. And it certainly is an incredibly exciting experiment that no matter the outcome will have an impact on the theory of money.

More:
Bitcoin myths
An overview of exchange markets
Historical exchange rates
Merchants that accept Bitcoin as payment
The Economist with an overview of the technical workings of Bitcoin

© Copyright (2012) Lasse Birk Olesen

——

Related posts:

Googlenomics and the popularity of Bitcoin
Guest post: Nick Rowe, Barter, and Free Banking (By Lee Kelly)
Selgin on Quasi-Commodity Money (Part 1)
George Selgin outlines strategy for the privatisation of the money supply
M-pesa – Free Banking in Africa?
Scott Sumner and the Case against Currency Monopoly…or how to privatize the Fed

33 Comments
by Lars Christensen on April 6, 2012  •  Permalink
Posted in Bitcoin, Lasse Birk Olesen, Lee Kelly, MM Research agenda, Monetary institutions
Tagged , , ,

Posted by Lars Christensen on April 6, 2012

https://marketmonetarist.com/2012/04/06/guest-post-bitcoin-money-and-free-banking-by-lasse-birk-olesen/

Guest post: Nick Rowe, Barter, and Free Banking (By Lee Kelly)

I have for some time wanted the young and talented Lee Kelly to write a guest post for The Market Monetarist. I am happy that he now has done so. Anybody who follows the market monetarist blogs will be familiar with Lee’s name and his always insightful comments.

So thank you Lee and I hope you in the future will write many more posts for my blog.

Lars Christensen

—————-

Guest post: Nick Rowe, Barter, and Free Banking

By Lee Kelly

Nick Rowe recently wrote about the increasing use of barter and makeshift monies during recessions. The market monetarist explanation for the last recession describes how attempts to engage in mutually beneficial exchange are frustrated by a shortage of money; this suggests that people would seek alternatives–such as barter and makeshift monies – to realise desired transactions. While such incentives would be expected to increase with the severity of the shortage, there are unfortunately too many other factors at play to draw precise quantitative predictions. That said, if there were no increase in barter or even a decrease, then I would tentatively consider the market monetarist explanation falsified, and it would require one heck of a good counterargument for me to reverse that judgement.

Alex Tabarrok has presented some evidence comparing the Great Depression and the recent recession. Evidence that barter and makeshift monies increased during the Great Depression is very strong–market monetarism passes the test. However, evidence regarding the last recession is less conclusive; there are suggestions of an increase in barter and makeshift monetary arrangements but nothing substantial.

Although I wouldn’t have expected anything comparable to the Great Depression, like Tabarrok, I’m surprised at just how weak of an effect appears to have been. My own observations are of a slight increase in barter, and the relative success of Bitcoin during the recession is suggestive, but there is little more than anecdotal evidence to go on for now. The evidence–or lack thereof–presented by Tabarrok should pose an interesting challenge to market monetarists.

In any case, my purpose here is actually to explain a little about the underlying theory of this explanation and how it dovetails with an arguments for free banking. An increasing use of barter and makeshift monies in during a shortage of money takes on a whole different meaning when viewed from the perspective of free market in money and banking. But first, let me try and keep everyone on the same page by clarifying just what is meant by a ‘shortage of money’ or an ‘excess demand for money’?

What is an Shortage or Excess Demand for Money?

The term ‘shortage’ has a precise meaning in economics. A shortage occurs when the market price of some good is below its equilibrium price. In such cases, there are more people willing to buy at the prevailing price than are willing to sell, leaving an excess demand. Holding supply and demand constant, the market normally clears such disequilibria by increasing prices until shortages are eliminated. However, a shortage may persist indefinitely when there is a price ceiling, i.e. an upper limit to some price usually mandated by a government. If the equilibrium price of some good is greater than its price ceiling, then rising prices are unable to entirely eliminate shortages.

Normally, when demand is frustrated by a price ceiling, the excess goes somewhere else. For example, a binding price ceiling on apples would frustrate demand, leaving some people who want to buy apples unable to find willing sellers at the prevailing price. What do people who want apples do instead? Maybe they buy pears, oranges, bananas, or whatever–probably something that serves a similar purpose. In any case, the excess demand for apples spills over into higher demand for other kinds of fruit.

Money is special. All else being equal, an increase in the demand for money is automatically a shortage of money. An excess demand for money cannot be cleared by increasing its price, because money doesn’t have a price of its own. To reach equilibrium, every other price must haphazardly grope its way there by a roundabout path of deflation. A shortage of money is unlike a shortage of anything else, because money is the medium of exchange. An excess demand for apples will probably just result in more spending on other fruit, but an excess demand for money results in less spending altogether. With an insufficient quantity of the medium of exchange to facilitate desired transactions, potential output is sacrificed–this manifests as the temporary lull in economic activity called a recession.

Barter and Makeshift Monies From a Free Banking Perspective

The relation between a shortage of money and barter is similar to the relation between a shortage of cars and cycling. Suppose the government imposes a binding price ceiling on cars and supply is elastic. While there will always be some driving and some cycling, the shortage of cars results in people cycling more than if the supply of and demand for cars were in equilibrium. However, cycling cannot substitute for all journeys that would otherwise be taken by car, and so those journeys simply never happen. Likewise, only a fraction of transactions frustrated by a shortage of money can be completed using substitutes like barter or makeshift monies.

What does this have to do with free banking? In a world where central banks operate an effective monopoly over money, there is only one monetary policy. If the central bank pursues bad monetary policy, then the economy is constantly rocked by surpluses or shortages of money. But what if people had a better alternative than barter or makeshift monies? What if there were multiple competing issuers of money? What if our eggs weren’t all in one basket?

Free banking theory envisions a world where each money issuer has their own “monetary policy”, and a shortage or surplus created by one issuer is a profit opportunity for all others. When attempts to engage in mutually beneficial exchange are frustrated by a shortage of money, then people will seek alternatives. In an ideal free banking scenario, those alternatives are readily available monies created by institutions poised to soak up any excess demand for money. A free banking system is, in this way, robust against errors of monetary policy that can devastate an economy dependent on a central bank.

No system is perfect, and I’m aware of the futility of advocating free banking. However, I’m very much in favour of theorising about free banking. It is often only when ideas are contrasted with alternatives that we tease out hidden assumptions. Insights that seem deep and elusive from one perspective can become trivial and obvious from another.

Normally, economists understand market failure and government intervention in the light of ideal markets, but all such norms are reversed when it comes to money and banking. Many insights that are hard to come with conventional thinking, such as nominal GDP targeting, are relatively straightforward when understood in the light of free banking. The idea that people will seek alternatives to a given money when it’s suffering from a shortage of surplus is not just implicit in free banking, but is at the the core of what it means for there to be monetary competition in the first place.

© Copyright (2012) Lee Kelly

10 Comments
by Lars Christensen on March 31, 2012  •  Permalink
Posted in Deflation, Free Banking, Guest blog, Guest post, Lee Kelly, Nick Rowe
Tagged , ,

Posted by Lars Christensen on March 31, 2012

https://marketmonetarist.com/2012/03/31/guest-post-nick-rowe-barter-and-free-banking-by-lee-kelly/

NGDP level targeting – the true Free Market alternative

Tyler Cown a couple of days ago put out a comment on “Why doesn’t the right-wing favor looser monetary policy?”

Tyler has three answers to his own question:

1. There is a widespread belief that inflation helped cause the initial mess (not to mention centuries of other macroeconomic problems, plus the problems from the 1970s, plus the collapse of Zimbabwe), and that therefore inflation cannot be part of a preferred solution.  It feels like a move in the wrong direction, and like an affiliation with ideas that are dangerous.  I recall being fourteen years of age, being lectured about Andrew Dickson White’s work on assignats in Revolutionary France, and being bored because I already had heard the story.

2. There is a widespread belief that we have beat a lot of problems by “getting tough” with them.  Reagan got tough with the Soviet Union, soon enough we need to get tough with government spending, and perhaps therefore we also need to be “tough on inflation.”  The “turning on the spigot” metaphor feels like a move in the wrong direction.  Tough guys turn off spigots.

3. There is a widespread belief that central bank discretion always will be abused (by no means is this view totally implausible).  “Expansionary” monetary policy feels “more discretionary” than does “tight” monetary policy.  Run those two words through your mind: “expansionary,” and “tight.”  Which one sounds and feels more like “discretion”?  To ask such a question is to answer it.


There is a lot of truth in what Tyler is saying. I especially like #2. There seem especially among US conservative and libertarian intellectuals a need to be “tough”. The dogma seems to be “no pain, no gain”. This obviously is an idiotic position. It seems like the tough guys have forgotten that sometimes there are indeed gains to be made with little or no pain. Just remember what the supply siders like Arthur Laffer taught us – sometimes you can cut tax rates and increase revenues. In fact most market reforms are exactly about that – economists call it a Pareto improvement. Unlike other monetary policy rules NGDP level targeting can actually be shown to ensure Pareto optimality (yes, yes I know it is based on questionable theoretical assumptions…)

Even though I like Tyler’s explanations to his question I think there is one big problem with his comment and that is his premise that Market Monetarists are advocating “expansionary” monetary policy. We are not – at least I am not and I don’t think Scott Sumner is. I have again and again argued that NGDP level targeting is not about “stimulus” and it is certainly not discretionary. Rather NGDP level targeting is about ensuring that monetary policy is “neutral” and does not distort the price system.

As I have earlier argued that if the central bank is pursuing a policy of NGDP level targeting then (ideally) relatively prices would be unaffected by monetary policy and hence be equal to what they would have been in a pure barter economy.

This is what I have called Selgin’s Monetary Credo:

“The goal of monetary policy ought to be that of avoiding unnatural fluctuations in output…while refraining from interfering with fluctuations that are “natural.” That means having a single mandate only, where that mandate calls for the central bank to keep spending stable, and then tolerate as optimal, if it does not actually welcome, those changes in P and y that occur despite that stability“

Hence, what we line with George Selgin are arguing is the true Free Market alternative to the present monetary policy in for example the euro zone and the US. Contrary to for example the Taylor rule which anybody who has studied David Eagle or George Selgin would tell you is leading to distortions of relative prices. How can any conservative or libertarian advocate a monetary policy rule which distorts market prices?

Furthermore, Scott Sumner, Bill Woolsey and myself have suggested that not only should the central banks target the only non-distortionary policy rule (NGDP level targeting), but the central bank should also leave the implementation of this rule to the market through the use of predictions markets (e.g. NGDP futures). I have not seen conservative economists like John Taylor or Allan Meltzer showing such trust in the free market. (The gold bugs and Rothbard style Austrians do not even want to let the market decide on was level of reserves banks should hold…)

Of course there is a position which is even more Free Market and that is of course the Free Banking alternative. However, as I argued the Market Monetarist position and the Free Banking position are fundamentally not in conflict. In fact NGDP targeting could be seen as a privatisation strategy. Free Banking theorists like George Selgin of course understand this, but will John Taylor or Allan Meltzer go along with that idea? I think not…

But why do people get confused and think we want monetary stimulus? Well, it is probably partly our own fault because we argue that the present crisis particularly in the US and Europe is due to overly tight monetary policy and as a natural consequence we seem to be favouring “expansionary” monetary policy or “monetary stimulus”.  However, the point is that we argue that the ECB and Fed failed in 2008 and to a large extent have continued to fail ever since and that they need to undo their mistakes. But we mostly want the central bank to stop distorting relative prices and we would really just like to have a big nice “computer” called The Market to take care of the implementation of monetary policy. That is also what Milton Friedman favoured and what right-winger would be against that?

PS I assume that Tyler uses the term “right-winger” to mean somebody who is in favour of free markets. That is at least how I here use the term.

18 Comments
by Lars Christensen on February 22, 2012  •  Permalink
Posted in Bill Woolsey, ECB, Federal Reserve, Free Banking, George Selgin, Scott Sumner, Tyler Cowen
Tagged , , , ,

Posted by Lars Christensen on February 22, 2012

https://marketmonetarist.com/2012/02/22/ngdp-level-targeting-the-true-free-market-alternative/

Selgin on Quasi-Commodity Money (Part 1)

George Selgin just send me his new paper on what he has termed Quasi-Commodity Money. George spoke briefly on this topic in his recent presentation at the Italian Free Market think tank the Bruno Leoni Institute. See my comment here on the presentation and my review on a related paper – “L Street – Selgin’s prescription for Money Market reform”

Over at Freebanking.org George is complaining that he does not have enough time for blogging. Unfortunately I am in slightly the same situation. Greece is on the verge of default and so it is busy, busy times in the financial sector and I have promised to write a paper on monetary explanations for the Great Depression for the Danish libertarian journal the Libertas magazine and also need to write a preview for the republished version of the Danish translation of Milton Friedman’s “Free to Choose” (Remember uncle Milt would have turned 100 this year). And then I need to review a couple of books for another magazine. So yes I share George’s frustration about not having enough time for everything. Therefore, I will not write a review of George’s paper today. However, I do promise to do that very soon as I know that what George has to say always is interesting and important.

Until then here is the abstract of George’s paper:

“This paper considers reform possibilities posed by a type of base money that has heretofore been overlooked in the literature on monetary economics. I call this sort of money ‘quasi-commodity money’ because it shares features with both commodity money and fiat money, as these are usually defined, without fitting the conventional definition of either; examples of such money are Bitcoin and the ‘Swiss dinars’ that served as the currency of northern Iraq for over a decade. I argue that the attributes of quasi-commodity money are such as might supply the basis for a monetary regime that does not require oversight by any monetary authority, yet is capable of providing for all such changes in the money stock as may be needed to achieve a high degree of macroeconomic stability.”

As I will not be reviewing the paper this week but hopefully next week I would like to hear what my readers make of George’s paper – I know I will probably be convinced that George’s concept is correct once I have read the paper, but will my readers be as well?

9 Comments
by Lars Christensen on February 7, 2012  •  Permalink
Posted in Free Banking, George Selgin, Quasi-Commodity Money
Tagged , ,

Posted by Lars Christensen on February 7, 2012

https://marketmonetarist.com/2012/02/07/selgin-on-quasi-commodity-money-part-1/

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