Lawrence H. White on Monetary Constitutions
Mar 9 2015

Lawrence H. White of George Mason University talks with EconTalk host Russ Roberts about the possibility of a monetary constitution. Based on a new book, Renewing the Search for a Monetary Constitution, White explores different constitutional constraints that might be put on the government's role in money and monetary policy. Topics discussed include cryptocurrencies, the gold standard, the Taylor Rule, the performance of the Fed, free banking, and private currency.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Shayne Cook
Mar 9 2015 at 9:43am

This was interesting, but I’m afraid I have to expose a very old and seemingly un-killable myth that underpins nearly all of the conversation here. That myth is that somehow the U.S. Federal Reserve coupons (or “Dollars”, if you prefer) are not really valid because they can’t be exchanged at a bank for gold, silver, or some other shiny metal, or some other “commodity” (shiny or otherwise), or some “basket of commodities”.

I heard the term “un-backed“, in reference to U.S. Federal Reserve coupons, numerous times during this discussion, and nothing could be further from the truth! Ultimately, U.S. Federal Reserve coupons are backed by the entire productive capacity of the U.S. economy, as well as a non-trivial portion of the productive capacity of the entire global economy. And the proof happens each and every time you give your U.S. Federal Reserve coupons to nearly anyone on the planet, in exchange for their produced goods and services – to include gold, silver, other shiny metals and commodities.

And for those who think that “gold exchangeability” is the be-all/ends-all of currency validity, I would point out that you are free to exchange all (or part) of your U.S. Federal Reserve coupon collection for gold (or silver, or any other shiny metal or other commodity for that matter) right now, or at any time you please – just not at a bank.

The concept, or “rules” if you prefer, for properly managing a fiat currency are still being discovered and defined. I grant you that. Doing so is something historically fairly “new”. And I won’t even attempt to argue that central banks (including the U.S. Federal Reserve) have fully “broken the code”. It is evident, however, that they’ve made significant progress.

But I would argue that perhaps the most difficult “barrier to getting it right”, that central banks (or governments, if you prefer) face in managing fiat currencies is the seemingly un-killable notion that a currency has to be “backed” solely by some shiny metal or other “commodities”.

And I would argue that efforts by economists to “help” central bankers effectively/efficiently manage fiat currencies is to begin with the premise that such currencies ARE “backed” – by the entire productive capacity of entire economies, not just their shiny metals and “commodity” holdings or productions.

Mar 9 2015 at 12:37pm

@Shayne, if you believe centrally government issued fiat currency is the best, then why not remove the barriers (such as capital gains on gold) that make a metal backed or digital currency workable? Remove the artificial barriers and see what works best.

Michael Byrnes
Mar 9 2015 at 7:07pm

It is always a good day when there is a new monetary policy Econtalk…

I have to admit, the idea of a “monetary constitution” makes me a little nervous, because it seems like a bad monetary constitution could be disastrous.

White mentioned that one idea for a monetary constitution would be that money should have a positive return. I think this would be a big mistake. To me, the major purpose of money should be this: to facilitate the voluntary exchange of real resources. At times, money that serves this purpose effectively might be associated with a positive return… but at other times (ie recessions), requiring money to have a positive return may hinder its capacity to facilitate exchange – which is a far more important objective. There are other assets one might own to earn a positive return; there is nothing else (beyond various other types of money) that can facilitate the types of exchange we all engage in.

That said, there is a lot of appeal in the idea of a good monetary constitution. A few things I would like to see:

1. We should have a “monetary policy committee” whose sole responsibility is monetary policy. This committee should have nothing whatsoever to do with credit policy or fiscal policy. Clearly, the Fed did a lot of credit policy in 2008-09, which the justified on the rationale that they had to save the banks in order to save the economy. They might have performed better if they were limited to monetary policy tools.

2. Target nominal income, level targeting. Level targeting is part of the means for holding them accountable. No trying to estimate inflation and then conduct policy based on that estimate.

Russ Roberts made very a key point about the benefits of nominal income targeting – a seller who sees a spike in sales doesn’t know (and will never know) exactly what is driving those sales. Could be the quality/scacity of his product… or it could be an economic boom that raises real living standards… or it could be loose money and inflation that (temporarily) lowers the real cost of his product. Under nominal income targeting, prices will be less distorted than under other systems.

3. Some kind of effective constraint on the Fed’s monetary policy objectives. That’s hard to even think about.

Lastly, I thought White’s idea of a cryptocurrency with a nominal spending target rather than a strict quantity target was a brilliant idea. But how would that work? I can see how it would adjust to a fall in spending (raise quantity), but it is harder to imagine how it would contract the quantity when it became necessary to reign in spending. I suppose transaction fees (paid in the currency, which is then destroyed) are one option. Maybe another is paying out interest? That would increase the quantity but would also increase the demand to hold it, which could have a negative affect on spending.

Juan C. de Cardenas
Mar 9 2015 at 7:43pm

Shayne, rather than expose the myth that free-floating fiat currencies have to be backed by something you just endorse another variant of the same, namely that they are backed by the entire productive economy of the countries that emit them.
In fact they are only “backed” by the faith that those governments/central banks will manage the currency more or less prudently and will not let the “printing presses” run wild way outstripping that productive capacity and by implication the ability to collect taxes. That faith have been found wanting in a number of countries, we just hope it won’t happen in the U.S., the E.C. and other major economies.
For a very wise discussion on this matter check this post from George Selgin

Shayne Cook
Mar 10 2015 at 6:40am

Hi MichaelT:

Actually I don’t think that a government or a central bank chartered by a government is, of critical necessity, the only type of entity to issue and manage a currency. (Although I do think such governmental entities are probably the most naturally appropriate to serve such tasks.) Nor do I advocate governmental “barriers” to alternative non-government issued/managed currencies. And I also have no objection whatsoever to the concept of a “Monetary Constitution” or other institutionalized rules for the U.S. Federal Reserve and/or other central banks for creation and management of the currency, as is discussed here.

What I (vociferously) object to is anyone – especially economists – referring to the U.S. Federal Reserve Note as an “un-backed” currency. In every possible sense, both real and theoretical (medium of exchange, store of value and unit of account), the U.S. Federal Reserve Note is fully “backed” by the entire productive capacity of the entire U.S. economy, AND a non-trivial portion of the entire global economy. Any “Monetary Constitution”, central bank rules/guidelines/policies, or even suggestions affecting monetary policy has to begin from that premise, and not from the premise that it is an “unbacked” currency. (More below)

Hi Juan C. de Cardenas:

I agree with you completely. First, free-floating fiat currencies, or any currency for that matter, has to be “backed” by something or it is truly irrelevant. That was exactly my point – the U.S. Federal Reserve Note is a fully “backed” currency. And it’s “backed” by something far more extensive and far more valuable than shiny metals or “baskets of commodities”. U.S. Federal Reserve Notes are redeemable for ALL commodities (including gold) both held and produced in the U.S. (and many other) economies, MULTIPLIED BY ALL the value-added of the entire U.S. (and other economies) labor force and its entire capital structure.

(Yet there are still folks out there who want to convince me that I’d be better off if my U.S. Federal Reserve coupons were legally redeemable only for pieces of shiny metal. Sheesh.)

I also agree with you that fiat currencies are and can be susceptible to mismanagement, not the least of which is “over-printing”. That is why I have no conceptual objection to “Monetary Constitutions”, rules/guidelines/policies. But I would quickly point out that “hard metal backed” currencies are and have historically been just as susceptible to debasement and devaluation as fiat currencies. Russ and Lawrence gave some examples of that in the discussion.

Thank you for the reference to the George Selgin article. For the most part, I agree. But Selgin asserts the U.S. Federal Reserve Note is “backed” by the “full faith and credit of the U.S. Government”. Frankly, I’m almost as unimpressed with the “full faith and credit of the U.S. Government” as I am with “shiny metals”. Now, had Selgin said that the U.S. Federal Reserve Note was “Backed by the full faith and credit of the U.S. economy“, I’d be in full agreement.

Greg G
Mar 10 2015 at 2:59pm

One of my favorite things about EconTalk is that, when there are ideas I disagree with in the podcast, I can count on seeing them vigorously challenged in the comments in ways that get a fair hearing here.

So thanks to Shayne Cook for starting off the festivities by making a number of points that I think are right on the money. I would add that the thing that “backs” effective money is simply the confidence that the sellers of goods and services have in it. As Milton Friedman showed in “The Island of Stone Money” it’s confidence all the way down.

Now of course it is true that one of several possible ways to undermine that confidence is to debase the currency in some hyper-inflation. I think we are pretty good at this point at knowing how to avoid a hyper-inflation.

The best way to build confidence in a currency is to establish a tradition of prosperity and steady and predictable money growth. As Shayne points out, there is no better backing than the confidence you can exchange your dollars for almost any goods or services almost anywhere in the world.

Kevin Leonard
Mar 10 2015 at 10:43pm

As always, a very interesting discussion.

Larry White is one of my favorite guests, owing to the fact that while I was at the University of Georgia his Econ classes were tops in my book.

Thank you, Russ.

Chris T
Mar 11 2015 at 12:09am

On the Swiss Franc’s stability: Dumb luck? Banking culture? Maybe, however it was the last currency to be backed by gold, a minimum of 40% backed by gold reserves until May 1, 2000. The golden constant prevails and I would refer readers to Roy Jastram’s Golden Constant for nearly 450 years of evidence–1560 -1977, and recently updated through 2007.

Shayne Cook
Mar 11 2015 at 12:35pm

Russ, Lawrence, (Ron Paul and real or potential ‘Rothbardians’ everywhere):

Just to clarify a bit, lest I leave readers here the impression that my comments are just more “anti-Gold Bug” rant, I’ll make a Suggestion and a Promise.

My Suggestion (or challenge if you prefer) …
Use your own capital* and start your own bank. And issue competing gold-backed, or silver-backed or whatever-backed currency you wish – completely on your own terms and under whatever rules or “Monetary Constitutions” you specify.

(Contrary to some claims here, I don’t really think the legal barriers to doing that are nearly as high as stated. After all Bitcoin made it to legal legitimacy. But the question of the possibility of legal barriers is real, which leads to my Promise, explained below.)

* If there truly is “more interest in a gold (or other commodity-backed) standard than ever before”, as was stated at the end of this podcast, AND there is so little faith/belief in the U.S. Fed’s expertise in properly managing a fiat currency that you believe, you should have no trouble at all finding investors to capitalize your new bank/currency. And I would urgently recommend you do just that. It is perfectly and legally legitimate for anyone who so thoroughly believes in the merits of a commodity-backed currency to be able to convert their own Federal Reserve coupons in order to create one.
(As and aside, I won’t be investing any of my Federal Reserve coupons to your ends, but that’s just me.)

My Promise …
I give you my solemn promise to support you in your efforts to create a competing** banking and currency system of your specification. I’ll lobby, I’ll write, I’ll cajole, I’ll influence, and I’ll do anything else in my power (though I’m not terribly powerful or influential) to get you the legal right to create and use your competing bank/currency system.

And just to explain why I would make such a solemn promise, given my previous comments, it is just this: I thoroughly and completely believe in the benefits of competition, because I’ve always found that the presence of competition benefits ME – one way or the other.
Oh, and there’s the other thing – I’m perfectly willing to admit I might be wrong about the merits of a shiny metal, or other commodity-backed currency. I merely require proof (not based on myth.)

So, to paraphrase ‘Larry the Cable Guy’, stop talking about it, and “git ‘er done!” And I promise to help you gain the legal right to create your competing currency regime any way I can – except with the use of my U.S. Federal Reserve coupons of course.

** One thing though: If your intent is to replace rather than compete with the current Fed/fiat currency regime, by way of government edict … well, let’s just say you won’t get any support from me and I’m going to busy myself by continuing to identify “myths”.

Mar 11 2015 at 5:46pm

Shayne Cook argues that the USD is not “unbacked”, because it is backed by the “entire productive capacity of the U.S.” While that claim is superficially plausible, in substance it is demonstrably wrong.

If the Fed prints up new USD, does that increase the productive capacity of the U.S.? Not by one iota! The fact is that there is absolutely no relationship between the amount of money in circulation and the country’s productive capacity. The former comes about through some government bureaucrats willing it to be so, the latter through private sector entrepreneurial activity.

If money is useful at all, it is as a means to purchase real goods. Yet each time the government expands the amount of money, since there is no new production to back that expansion, it simply reduces the value of money in terms of real goods, thereby leading to a reduction in the purchasing power of money.

To imply that “all the money can buy all the goods” is a meaningless concept, since society is not a single entity but rather composed of individuals, and everyone does not have an equal share of the old or the new money. As new money gets printed it enters the economy at different points, usually favoring the government’s best friends first. They reap the benefit of gaining a larger percentage of the total money stock, thus getting a larger claim of the stock of real goods, compared with the average Joe who doesn’t, who thereby loses purchasing power.

Indeed the principal purpose of preferring a commodity money (it matters not what commodity) to a fiat currency is that it prevents the central planners in government from producing more money when they want, since they do not control the commodity. Moreover, there is a real cost to producing a commodity, compared with zero production cost to produce more fiat currency. which is why the volume of commodity money would grow very slowly.

With a commodity money the value of money held would not decline, and in fact if real production continued to grow and the money stock remained relatively stable, the value of money would increase in terms of real goods. This would mean increased living standards (your existing money could purchase more goods) and real value to holding money as a form of long-term savings for retirement.

That’s what happened before the Fed came into existence and has not happened since.

The argument to eliminate fiat currency is not a fixation on gold or any other metal, but a rejection of central planning. I would have thought that arguing against central planning was not really necessary any longer, but evidently some folks still believe in it.

Mar 11 2015 at 7:51pm

Shayne Cook’s other main comment is a challenge to those who are against fiat currencies to start their own commodity-backed currency to compete with the USD.

I am aware of at least three state measures which would put any person who tries this at a distinct disadvantage.

First, the state prohibits payment of taxes in anything except USD. So the state forcibly claims a material portion of your income, and then says it will only accept its own currency in satisfaction thereof. Thus anyone who created a business as Shayne is suggesting would still have to generate and use fiat currency for at least their taxes, and their customers would have to take a similar view. Moreover, since one can never be sure of one’s tax bill, one would need to keep an additional cushion in fiat currency too.

There may be other instances where the state also requires payments to occur only in USD; for instance, I’m sure all state payments — on government contracts, welfare payments, etc. — would necessarily be in USD.

At some point the amount of payments required to be in USD becomes so large that it creates an ongoing difficulty for an alternative currency (assuming the alternative currency were first able to surmount the start up challenges).

Second, the state views commodities as taxable assets, which means there could be leakage to the state each time someone sold the commodity (exchanged it for a real good or USD).

Third, the state would bail out any fiat currency-issuing bank that ran into trouble, and the resources to do this would be forcibly extracted from taxpayers, including the competing currency bank. Having the state guard your back with its coercive taxing power is quite a weapon to have in your corner as a market participant (and for the competing currency bank, being forced to subsidize one’s competition doesn’t strike me as entirely fair).

Not exactly a level playing field.

I think it’s backwards logic to suggest that someone start a competing currency within these constraints to prove their idea can be successful, when these constraints are imposed coercively by the key competitor (the state). As someone else mentioned, if the state is so confident of the long-term attraction of its fiat currency, why doesn’t it remove these constraints and let the chips fall where they may?

Bob Anderson
Mar 12 2015 at 5:43am

Very interesting thesis but impervious to conflicting data. Dr. White has been sounding false debasement alarms for many years. Here, in March 2009, is the beginning of an editorial demanding that the Fed stop its cheap money policies:

“Inflation is reigniting. The U.S. Bureau of Labor Statistics announced last week that consumer prices, which had declined from November and December, rose 0.4% between December and January, an inflation rate of 4.9% on an annualized basis. The bureau announced earlier that producer prices rose 0.8% in the same period, a 10% annual rate of inflation.”

I sincerely wish Russ would challenge his guests when previous predictions have turned out so completely wrong. The answer would be interesting. Aren’t we interested in the truth rather than simply opinions that may be consistent with our biases?

[End-quotation mark added. Quote is from Please provide sources when quoting. –Econlib Ed.]

Mar 12 2015 at 5:43am

Thank you, Russ, for bringing up a few legitimate criticisms of “nominal growth targeting” during the discussion.

Thank you also for making the point that the actual contents of any document, including a Monetary Constitution, are probably going to be ignored in the long run. Good intentions and intelligent design is no defense against personal interest.

During the Podcast, Lawrence White stated that it is, “impossible for the Fed to be independent of Congress.” In the short term, I think his assertion is a simple statement of fact and a nice summary of the entire problem with the current FED structure. The idea that Congress, or any other government body, is capable of intelligently overseeing the operations of any bank—much less a central bank—is a guaranteed-to-fail proposition. The incentives are just all wrong for Congress to be a reliable overseer of any institution outside of national security and maintenance of Justice. The Congress is GOING to debase the currency. The entire attraction of a gold standard, or any standard really, is that the “standard” is outside the control of any and all government employees. In my humble opinion, the true potential benefit of a “Monetary Constitution” is that it could allow, in theory, for a central bank to operate under a directive from the entire population INDEPENDENT of the president, or congress, or any other government employees. In that circumstance, the incentives would be aligned appropriately for intelligent monetary management over an indefinite period of time—at least from the perspective of the voting population.

Michael Byrnes
Mar 12 2015 at 7:07am

Simon wrote:

“With a commodity money the value of money held would not decline, and in fact if real production continued to grow and the money stock remained relatively stable, the value of money would increase in terms of real goods. This would mean increased living standards (your existing money could purchase more goods) and real value to holding money as a form of long-term savings for retirement.”

No, it would not mean increased living standards, at least not in the simple manner that you outline. Living standards are based on real productive capacity, not on the real value of the dollar. For example, there’s a relationship between your salary in dollars and your real value to your employer. If the value of the dollar rises but all else remains equal then you will be paid fewer dollars and your living standard will be roughly the same.

There are other ways in which an unstable dollar would hurt living standards, but changel in value, in and of itself, is not one of them. The key reason to want monetary stability is that instability would harm 1) the productive capacity of the economy in various ways and 2) the ability of consumers to buy what they want with their money. But I think this sort of instability would be better addressed by a nominal income rule.

Shayne Cook
Mar 12 2015 at 8:27am

Hi Simon:

The concern, if I understand correctly, is that, generically, a pure fiat currency is subject to abuse/mis-management/over-printing/etc., resulting in artificially skewed price levels (at best), and hyperinflation/complete currency debasement at worst. I get it.

It is a completely valid concern and I share that concern – even fear.

I also understand that an explicit commodity-backed (such as gold or silver) ostensibly removes that “over-printing” risk, because the absolute quantity of those commodities is finite and can’t just be created with a printer. I get it.

While I don’t advocate a “commodity-backed” currency, I also don’t advocate a pure fiat currency either. I am NOT a “Modern Monetary Theory” (MMT) type*.

If you read what I’ve said here, you’ll see that I don’t consider the U.S. dollar (if you prefer) an un-backed currency. And I absolutely object to anyone considering or calling it, or treating it as an un-backed currency – as the MMT types want.

If it helps to clarify, think “economy-backed”. That may not be as satisfying as “gold-backed” to some, but it is vastly less scary than the “government edict-backed” concept the MMT types advocate.

Inasmuch as the U.S. currency isn’t a commodity-backed currency, with the associated natural quantity limits, I absolutely concur that artificial rules/policies/guidelines, even “Monetary Constitutions” have to be in place to help avoid gross currency mis-management. As a matter of fact, I strongly advocate that. But I’m insisting the premise for developing such rules/guidelines/policies/”Constitutions” must be and must always be that the U.S. currency IS backed – by the full productive capacity of not only the U.S. economy, but of any and all economic product (globally) that the U.S. currency serves.

* A couple of years ago I stumbled onto a YouTube video clip of Stephanie Kelton giving a speech to some group (don’t know who) about current and future U.S. Government debt and obligations. At the time, I had no clue who Stephanie Kelton was, only that she had been introduced as an economist. In any event, she proceeded to state that concerns about U.S. Government debt levels (current and future), as well as the actuarial insolvency of Social Security and Medicare should be dismissed. As she put it, “It’s the Government’s money, we’re just users of it, and the Government can print however much it needs to cover its obligations.”

At the time, I thought it was a joke. YouTube after all is not widely considered an authoritative source. The “joke” is evidently on me. In looking up some information on fiat currencies versus commodity-backed currencies yesterday (to refer to here), I stumbled across this gem: “On December 26, 2014 [Stephanie] Kelton announced via her Twitter account that she had “accepted a position as Chief Economist on the Senate Budget Committee”. It definitely isn’t a joking matter any more.

If those MMT folks, enamored of the “government edict” concept, have their way, even a gold standard isn’t going to save the U.S. currency or the U.S. economy.

Mar 12 2015 at 8:35pm

Michael Byrnes, I’m not sure I follow your comment about living standards. If I have $100 of savings and there are 50 widgets available to buy at $4 each, I can buy 25 of the widgets. If production of widgets doubles to 100 but there is no additional money in the economy, one would expect the price of widgets to halve to $2 each. That means I could afford to buy 50 of the widgets. Is that not an increase in living standards?

I wasn’t commenting on the employment relationship but on what one’s savings (existing money) could buy.

Mar 12 2015 at 8:55pm

Shayne Cook, I think we may be talking at cross purposes when it comes to the meaning of “unbacked”.

You seem to be saying that a currency is “backed” if there is stuff to buy with it; in your example, all of the goods produced in the U.S. By that definition every medium of exchanges is “backed”, since the whole purpose of a medium of exchange is is to buy stuff. It seems to decimate the usefulness of the phrase “backed”.

I think economists use “unbacked” in a different sense, namely, to illustrate the differences between a substantive currency and a fiat currency, as illustrated below.

Originally people held gold as money, but it was inconvenient to carry around. So they deposited it with banks for safekeeping (and paid a small fee for this), and the bank would issue a receipt saying something to the effect of “The bearer hereof has 10 oz of gold on deposit with us”. When the individual holding that receipt (and thus the owner of that gold) went to buy something for 10 oz, he would hand the receipt over to the seller, who would now be entitled to that gold in safekeeping. In that sense, gold receipts came to be treated as “money” because they evidenced ownership of the actual commodity that was being exchanged for goods. Thus the receipt was “backed” by the gold held at the bank.

Once the state took over the production of these receipts, and severed the link between receipts and the gold they originally represented — “severed” in the sense of proclaiming that there was no gold behind the receipt — this money became “unbacked”. If you took the “backed” receipts into the bank, you could retrieve your gold. Now, if you take the “unbacked” receipts into the bank, all you can retrieve is substitute pieces of paper, which are inherently worth no more than the receipts themselves (and look remarkably like them!).

Michael Byrnes
Mar 13 2015 at 7:02am

Simon wrote:

“Michael Byrnes, I’m not sure I follow your comment about living standards. If I have $100 of savings and there are 50 widgets available to buy at $4 each, I can buy 25 of the widgets. If production of widgets doubles to 100 but there is no additional money in the economy, one would expect the price of widgets to halve to $2 each. That means I could afford to buy 50 of the widgets. Is that not an increase in living standards?

I wasn’t commenting on the employment relationship but on what one’s savings (existing money) could buy.”

That’s “cost of living”. “Standard of living” depends on production. Most people’s most valuable asset is their future labor. If not that it is the real return on capital they own. For standard of living, both of those sources of wealth matter more than cash savings. Doubling the purchasing power of my salary, or of my retirement accounts, would have a far greater impact on my stanard of living than doubling the purchasing power of the cash I have in the bank.

Shayne Cook
Mar 13 2015 at 5:56pm

Hi again Simon:

I think we might be getting somewhere – a common understanding – after all.

You said …

“[Shayne,] You seem to be saying that a currency is “backed” if there is stuff to buy with it; in your example, all of the goods produced in the U.S.”

Sort of. I’m actually saying that Federal Reserve Notes ARE a backed currency, specifically because they can be exchanged for all goods/services produced in the U.S. economy, and a non-trivial product of the global economy as well.
(And I think I may have mentioned that before somewhere.)

You said …

“I think economists use “unbacked” in a different sense, namely, to illustrate the differences between a substantive currency and a fiat currency, as illustrated below.”

If “economists”, or anyone else for that matter, who attach that “unbacked” adjective to U.S. Federal Reserve Notes, they are absolutely and unequivocally wrong – in every possible sense.

IF, however, someone/anyone is describing U.S. Treasury Notes (or U.S. Treasury Dollars) as an “un-backed” currency, they are at least partially correct. U.S. Treasury issued paper is “backed” by the “full faith and credit of the U.S. Government”, for whatever that’s worth.

I think you, and others, may be inadvertently conflating Federal Reserve Notes with Treasury Notes/paper. It’s a very common misunderstanding. (I’ve had to explain this to some of my grad students – grad students who should have already known.)

What makes me cranky is when people – especially “economists” – intentionally and insidiously conflate Federal Reserve Notes with Treasury Notes/paper. They are NOT the same thing, either in fact, in theory or in law. And understanding the difference is critically important for everyone, especially “economists”.

Federal Reserve Notes – the pieces of paper/cotton/whatever with pictures of dead presidents (and Ben Franklin) on them that you carry in your wallet and use to buy things – are CURRENCY, which sole legal AND theoretical purpose is to facilitate commerce. Federal Reserve Notes ARE NOT DEBT OBLIGATIONS. The Federal Reserve is precluded by law from issuing debt.

Treasury Notes, on the other hand, ARE DEBT OBLIGATIONS. And as such fit exactly the definitions and flaws of a pure fiat currency. They are just pieces of paper, that may have some value in exchange, but are basically debt, “backed” only by the “Full Faith and Credit of the U.S. Government”.

The U.S. Government has the constitutional authority to issue debt. Just now, the U.S. Government issues debt specifically as debt, in the form of T-Bonds, savings bonds, T-Bills, T-Notes, etc. But it has also the constitutional authority to issue debt intended to be used in a currency role, labeled “Dollars” that are pure fiat currency. And it has done that in the past, most prominently during the 1860’s to finance the Civil War – while a silver/gold standard, was already in place, and before the Federal Reserve system was even conceived.

Here is where things get interesting.

Most recently, beginning in 2008, the U.S. Government started issuing debt obligations, and I mean writ large. Where some folks – including me – started to get really nervous is when the U.S. Federal Reserve simultaneously (and later during the QE3) cranked up the proverbial “printing presses” (writ large) and created new Federal Reserve Notes – ostensibly to be used to buy all that new U.S. Government/Treasury debt but primarily so that the U.S. Government’s exorbitant borrowing didn’t suck all the pre-existing Federal Reserve Notes out of the nominal economy .

So to a lot of folks, that marvelous difference between Federal Reserve Notes and Treasury Notes, that I labored to explain to you above, started to look suspiciously like a mere distinction without a difference. I get that. At the very least, the outsized Federal Reserve currency “printing” may well have facilitated and enabled the U.S. Government’s outsized spending proclivities. It was certainly intended to.

(As a quick aside here, I have absolutely no problem with Federal Reserve policies acting directly in concert with, and in direct support of U.S. Government fiscal policies from time to time – even if I vehemently disagree with those U.S. Government fiscal policies.)

But here is where the difference I described above remains not only a difference, but a difference with distinction …

Federal Reserve Notes obviously can be used to purchase U.S. Treasury (Government) issued debt. And it’s perfectly legal and legitimate for the Federal Reserve to “print” those Federal Reserve Notes specifically to buy U.S. Treasury debt. BUT, the Federal Reserve is precluded by law from purchasing U.S. Treasury debt directly from the U.S. Treasury. The Federal Reserve is required by law to only purchase U.S. Treasury debt from “private” owners of that debt, who are allowed by law to purchase directly from the U.S. Treasury.

Sounds kinda dopey, doesn’t it?

The reason that the Federal Reserve can only buy U.S. Treasury debt from “private” owners, and not directly from the U.S. Treasury, is so that only private market forces have the opportunity to price (set the interest rate of) that U.S. Treasury debt. The Federal Reserve has the legal right (and obligation) to set various market interest rates. But it is precluded by law by practice from setting U.S. Treasury/Government debt obligation interest rates.

There is one more thing, Simon.

I don’t have even the tiniest particle of interest in arguing the overall merits/failings of a “gold-backed” currency versus the current U.S. Federal Reserve “economy-backed” currency versus a pure fiat currency with you or with anyone else. That argument has been going on for a couple of hundred years. It isn’t settled, and neither you or I or Russ or anyone else is going to settle it, for all time and for all circumstances.

You seem to favor a commodity(gold)-backed currency standard. I’m okay with that. Commodity-backed currencies have merit, in some circumstances.

Suffice to say, my opinion as to what type of currency best fits and serves the U.S. and global economy is different from your opinion.

I suspect we agree that any kind of pure fiat currency is merely a disaster-waiting-to-happen.
(And MMT types wouldn’t agree with either of us.)

Mar 14 2015 at 7:51am

Firstly, a great discussion. I don’t have the answer but I know it isn’t Bitcoin and that the Fed (and ECB and BoJ and BoC) are screwing up the fiats.

That being said, let’s do a little math:

M1 is $3T, M2 is $12T. US gold reserves are 262M toz. At today’s price, that is $304B.

(BTW, the Fed printed the equivalent of our entire gold reserves every 3-4 months during QE3.)

So if the dollar were to be gold backed, the price of gold would have to go from $1,160/toz to either $11,500 (M1) or $45,800 (M2).

(BTW, M1 and M2 have doubled in 10 years, while official inflation averaged 2-3%/yr. Hmmm…)

Lastly, few people realize that the Treasury prints far more $100 bills than $1 bills (more than 2x $1 and 50x $50). When was the last time you used, or a store even accepted, a $100 bill?

Maybe then a cocaine standard?

Mar 14 2015 at 7:57am

Shayne Cook above notes that the Fed has to buy notes from private investors, which is true. Today, that means that the Treasury sells Goldman (or other primaries) a note then a nanosecond later the Fed buys that same note from Goldman at a small profit (which adds up to billions of risk free profits for the primaries over a year).

It is merely a technicality (and a farce).

Like Japan, when your central bank is buying your debt, you are in the end game.

Mar 14 2015 at 8:43am

Last one today (I promise).

Central bankers are politicians, not economists. There are many good economists, but only good politicians get to be central bankers.

If you get a below interest loan from your uncle, for the entire term of that loan, you have to declare the difference to the IRS as imputed income. The government claims that the market rate is the true rate no matter what your agreement might be.

When Uncle Alan, Uncle Ben or Aunt Janet create a similar situation for the US, it is declared a novel economic theory (“Just set all interest rates to zero! Why hasn’t anyone tried that before? Brilliant!)

So let’s do a little math:

In FY14, the US paid out $230B in interest on $17,800B of debt, or a rate of 1.3% (do not confuse this with the average interest rate on the national debt, the Fed tries to keep the higher rates always in the future, just anther game they like to play called “Twist”). At a pre-QE free market rate of maybe 3.5%, the interest paid would have been $623B.

So QE is saving the government $400B/yr. As always, there are costs, primarily lost returns on savings to seniors and investors, so QE is, like inflation, a hidden tax ($400B in this case).

All federal tax revenue in FY14 was $3,022B. So at a free market rate, without the Fed, without QE, the US would be paying out 20% of income in just interest.

(Anyone remember the 80’s when we paid out 7% in interest, or twice the scenario above? Nah, couldn’t happen again. That would mean QE failed and we would be paying 40% of all tax income in interest. Inconceivable!…)

Back on point:

All of this is impossible without a fiat currency.

Fiat currencies exist to enable politicians to make impossible promises that they are unable to make with hard currencies. Their central bankers rarely, if ever, disappoint their masters.

Mar 14 2015 at 9:16am

jw is right on his last point that “Fiat currencies exist to enable politicians to make impossible promises that they are unable to make with hard currencies.”

Inflation of the money supply, which is only really possible with a fiat currency, is just one of three taxation tools.

The first is direct taxation. This is highly visible, so it’s the least popular alternative among the political class.

The second is government borrowing. This simply transfers the tax burden to future generations, since they will have to pay the taxes to repay the principal. However, this is a useful tool of medium attractiveness to politicians since it doesn’t require an immediate increase in taxes and future generations aren’t today’s voters.

The third is inflation. This is the politician’s favorite tool, since the vast majority of the population who are on the wrong end of this doesn’t realize it is being taxed. What a sweet tool. It’s also necessary now because tool #2, borrowings, is running out of steam: the U.S. government debt is so high that even the pro-state crowd is getting worried.

Mar 16 2015 at 8:11am

Michael Byrnes wrote “That’s “cost of living”. “Standard of living” depends on production. Most people’s most valuable asset is their future labor. If not that it is the real return on capital they own. For standard of living, both of those sources of wealth matter more than cash savings. Doubling the purchasing power of my salary, or of my retirement accounts, would have a far greater impact on my stanard of living than doubling the purchasing power of the cash I have in the bank.”

I think distinguishing between “cost of living” and “standard of living” is semantics. How well one lives is a function of both the amount of stuff there is to buy and how much of it one can buy. Thus both production and purchasing power are relevant.

If, as you implied in an earlier post, the purchasing power of your ongoing income is more likely to be stable (if nominal wages fluctuate with price levels), then the real issue is whether the historic savings you have accumulated will gain or losing purchasing power over time. And by “savings” I mean all deferred consumption, so it would include “retirement accounts” as well as cash at the bank. (Indeed, the reason people have retirement accounts invested in equities is because inflation of fiat currencies makes it uneconomic to hold cash for retirement. In a commodity-backed currency world, you could safely just hold cash, as it would increase its purchasing power over time as production outstripped money supply growth every year. Fiat currencies push people to take more risk with their savings, one of the big cultural hazards Guido Hulsmann has talked about.)

Also, it’s not always true that one’s labor is the largest source of future income. As one moves closer to retirement, one’s savings are more important than a few more years of income.

Michael Byrnes
Mar 16 2015 at 3:18pm


I disagree that it is a semantic distinction. How well one lives (standard of living) is a function of real wealth. Cost of living is not a function of real wealth (and it is a very nebulous concept anyway, as it will be different for everyone and even in the general case can only be estimated, not measured precisely).

If cost of living and standard of living are the same thing, then it follows logically that Americans were far wealthier in 1915 than we are today, 100 years later. After all, the price level has doubled several times over during the past 100 years. Yet, this claim is obviously false – we are far wealthier today despite 100 years of inflation.

Mar 17 2015 at 7:30pm

If “economists”, or anyone else for that matter, who attach that “unbacked” adjective to U.S. Federal Reserve Notes, they are absolutely and unequivocally wrong – in every possible sense.”

This is where Shayne Cook betrays his whole ‘argument’ as a semantical one. He is arguing over the definition of a word and then building a strawman where some very serious people with very serious educations cannot tell the difference between Federal Reserve Notes and T-bills.

This was not a very productive discussion, which is sad because Dr White is one of my favorite guests and the whole Modern Free Banking School is an utter fascination to me.

Ron Crossland
Mar 18 2015 at 4:50pm

There may be a good theoretical case for changing the way any current government, modeled closely on the US system, handles a central bank. White surely believes he has some good suggestions for this.

Using a historic Scottish banking system as perhaps the only instance of a modern or pre-modern example is pretty problematic. Checkland’s (love that surname associated with a Scottish banking scholar) expertise on the subject can also be used to show the Scottish system White refers to was a de facto central bank. The three primary banking institutions in Scotland at that time relied upon London for their backing essentially. A Lord couldn’t stroll into one of those banks and ask for a wagonful (or pocketful) of gold in any real sense.

I’d be for some rule changes, but it’s hard to see in an electronic banking world that printing or stamping any kind of 3D money is especially interesting. Bitcoin or it’s ilk may have more promise in the future, especially given the security that systems like this offer.

Claiming the only spiker’s of the punch bowl were bad housing policy and bad monetary policy without mentioning shadow banking, greed, and fraud seems disingenuous. Nearly everyone, including I daresay Mr. Greenspan, drank from the bowl.

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Podcast Episode Highlights
0:33Intro. [Recording date: February 25, 2015.] Russ: Our topic today is whether we should have a monetary constitution, a set of rules governing government's role in supplying money, along with what those rules might be. We're recording this episode in front of a live audience at the Cato Institute and in honor of a new book that Larry has co-edited with Viktor J. Vanberg, Ekkehard A. Köhler, Renewing the Search for a Monetary Constitution. Larry, welcome back to EconTalk. Guest: Thanks, Russ. Good to be here. Russ: Now, this book is the result of a symposium organized by Liberty Fund in honor of a book written 50 years ago, In Search of a Monetary Constitution, which was edited by Leland Yeager. So a lot of what we are going to be talking about today is what we've learned in the last 50 years about money and government's role in money. But I want to start with the basics. What do you mean by a 'monetary constitution'? Guest: Well, that's one of the issues we debate in the volume. But you can think of a monetary constitution as a set of rules that govern the creation of money. In particular by the government. So, you can either think of it as a set of prescriptions that say what the government may not do to interfere with the monetary system. Or you can think of it as empowering the government. And then of course you can combine the two: the government is empowered to do such and such but not go beyond that. So, there are provisions about money in the U.S. Constitution. So, that's one of the topics we discuss in the book. But there continues to be debate about what they mean. And most of our discussion in the volume is about whether they are adequate: whether we've ended up with the kind of monetary system that the Framers wanted or that we should want. And we're not limited to the United States. Many of the contributors are from Europe, so we discuss the Constitution of the European Central Bank as well. Russ: Well, you mention that the Constitution deals with money. It deals with other things, too, by the way. Most of which we banish and neglect. So it wouldn't be unusual that there'd be something similar with money. But let me start with a basic question which a lot of economists in seeing such a volume would ask--not me, but others would: What would we want a monetary constitution for? The Fed's doing a great job. Saved us from the Great Recession. We had the Great Moderation, this wonderful period of success that was stewarded by these geniuses as the great steering wheel of the ship of the economy. Guest: Well, I think we found out in the financial crisis that the Great Moderation was hollower than we realized at the time. In a way, the timing of this volume is similar to the timing of the 1962 volume in that, it's true it's being published in a period of low inflation. Inflation has been between 1 and 2% in the last few years; and in the early 1960s it was between 1 and 2%. But as we've seen in the intervening 50 years, it didn't stay there. And we had all kinds of monetary troubles in the last 50 years. And the idea that the Fed had finally figured it out and we don't need to tell them what to do any more because they've got it completely figured out, I think was revealed to be much too optimistic. Russ: I'm sympathetic to that view but let's--I want to push back a little bit. So, clearly the period from 1962-1982 was not so good, toward the last part, very high inflation-- Guest: Double-digit inflation. Russ: Double-digit nominal interest rates as a result. Then there came this alleged golden era where they "figured it out". And couldn't you argue that, okay, things went bad in 2007-2008, but that wasn't the Fed's fault. That was the fault of an aggressive housing policy, exuberant animal spirits. And the Fed actually intervened and did a great job once they were called on to save things? Unlike the Great Depression, say, where Milton Friedman, Anna Schwartz, others have said that they failed their mission at that time. But now, Ben Bernanke, being a student of Milton, he knew what to do and look how well it turned out. Broad brush enough for you? Guest: Yeah, well, where do I begin? Russ: We've got an hour. Guest: Okay. Well, I think the Fed did a little better than it did in the early 1930s, in the sense that we didn't have so drastic a collapse in the economy. Of course, a lot of things have changed that make the economy better diversified. But, we did have the sort of careening from 4.5% inflation down to -2% inflation and then back up. And then of course we had all the financial troubles. It's true that housing policy had a lot to do--has a lot to do--with explaining why it was a housing bubble and not some other kind of bubble. But if you see people behaving exuberantly, and not just a few people but you see that it's widespread, you have to ask yourself: What's the common signal to which they are referring? To which they are reacting? If you see everybody at the party beginning to act a little crazy, you have to ask: Who spiked the punch bowl? And my view is that the Fed had a lot to do with it. They made the funds available that went into the housing investment, well, the housing purchases, driving up the prices of houses, making mortgages cheaper than they otherwise would have been, making mortgages available in greater quantity to people who were less creditworthy than in previous experience. So, I think it's the interaction of the bad housing policy and the bad monetary policy that spiked the punch bowl, that made this overinvestment boom in housing possible. If you just look at the price level, you wouldn't have seen anything going on. But I think that's part of the problem with the way that the Fed has been running policy. They take moderate inflation as a license to do whatever they like with interest rates and with financial policy. Russ: So I also add to the mix the bailing out of creditors in the preceding decades to this, which I think emboldened the drinkers at the punch bowl to spend a lot of other people's money and in irresponsible and imprudent ways. But let's put that to the side for the moment. Let's just look at the last 5 years. So, let's be agnostic on whether the Fed is the cause of the drop in output, the high unemployment rate that we dealt with. What kind of marks do you give the Fed for its behavior in the last 6 years when the economy slowly recovered, and many would say--again, I'm not one of them, but many economists would give them very high marks for averting a crisis, injecting liquidity into the system and making sure that the economy recovered? Do you agree with that? Guest: I actually have more complaints about the Fed's credit policies than I do about its monetary policies in the last few years. So, they've kept monetary policy on a kind of even keel. I think interest rates probably should be higher. I think they are continuing to keep us in this ultra-low interest-rate regime much longer than is justified. And that may come back to bite us. Russ: I think that's an excellent point. I think one view is, it's too early to tell. Guest: Yeah. Russ: It's like when they said we'd get a lot of our money back from the bailout of the TARP (Troubled Asset Relief Program) and I'm thinking, 'Yeah, what about the long-run cost that you've ignored?' But, go ahead. Guest: Yeah. So, the real problem in the last few years, and during the financial crisis and thereafter has been the sort of lack of constraint, a lack of limitation on the Fed to the rule of law. I mean, they've sort of been making stuff up as they go along, bailing people out, continuing that kind of policy. And creating a very uncertain environment as to who is going to be saved and who isn't. And whether we can count on the market--we can no longer count on the market to discipline banks that pursue imprudent policies. Especially the systematically important banks. Russ: Yeah. I think that's a disastrous thing for democracy. And capitalism.
9:45Russ: Let's put the Fed aside now and let's look at some alternatives that are discussed in the book. Let's start with a broad question: What's special about money? And you raised this question in your introduction to the book, a very nice essay that explores many of the issues we're talking about today. And I recommend it to our readers, as well as the rest of the volume. But you start off with a very basic question, which is: What's the government--I mean, the government's really involved with money. Guest: Has been for a long time. Russ: Has been for a long time. We understand why sovereigns like sovereigns. They're into that. So, what's the theoretical case, if any, for why government should be involved in the supply of money? Guest: It's actually hard to pin down what is the case, because most economists who even see this as a question--why does government provide money?--tend to sort of zip by it in a couple of paragraphs. Russ: Like, why is the sky blue? It's just a reality; we move on. Guest: Well, so it's obviously: everybody uses the same money, therefore it's something the government has to provide. But if you sort of dig down into the technical question of whether money has the characteristics of a public good--the characteristics of being my consumption of it doesn't diminish your consumption of it, like when I tune in the radio it doesn't diminish the amount of radio you can tune it--that doesn't apply to money. The money in my pocket is not in your pocket. Russ: You're using the 'public good' here as a technical term that economists use for special--it doesn't mean just 'a good thing.' Guest: No. It doesn't mean 'a good thing for the public.' It means a good that the market has trouble providing because you can't sort out who is getting the benefits in what degree, and you can't exclude people from enjoying it even if they don't pay. So, the market does well with goods where you can make the user pay, otherwise you don't get it. And then you have an incentive to supply it because you get paid for supplying it. So the claim is that money is different from that. But it's hard to see it. I mean, as I said, the money in my pocket is not in yours. So banking has been private for a long time. Russ: It could be, though. Guest: Well. Before that, coins. Same story. The coins in my pocket are not in your pocket. If you ask, Why did government get onto this track of monopolizing the production of money, you have to go back to the early monarchs and kings who monopolized the mints. But it wasn't always so. As far as we know, the earliest mints were private merchants who were sort of certifying the weight and the purity of the pieces of metal they were trading with. And if you ask, why would government take that business over--and we've got lots of historical examples of private mints, even in the 19th century before they were outlawed. In the California Gold Rush there were a dozen private mints. Why would government take that over? It's like asking why does government run buses? There are sort of two possible explanations. One is there is a market failure to produce efficiently the good in question. And the other is that it's somehow in the government's interest, most likely there's a fiscal motive. And if you look into the question of whether governments have improved the quality of coins when they've been in charge of issuing silver and gold coins, the answer is, 'No.' They've notoriously debased the coins. Whereas the private mints actually had a pretty good track record. Because their business depended on the coins being regarded as reliable. Whereas if you have a monopoly and you have a law that says people have to bring their silver to you for coinage and are not allowed to take it anywhere else, you can debase it without losing all your customers. So, just on the evidence it seems like the fiscal motive was at work, and-- Russ: 'Fiscal motive' makes it sound pretty high falutin'. Guest: Phrasing relatively[?]. Yeah. Russ: It means exploiting the opportunity to control the currency to make more profit than they otherwise would. Guest: Make a profit. That's right. And in the Middle Ages and during the wartimes sometimes two-thirds of the sovereign's revenue came from the Mint. So, if you want to be less high-falutin', they asked Willie Sutton why he robbed banks, and he said, 'That's where the money is.' Russ: Yeah. Guest: Why do you control the Mint? Because that's where you can make a lot of money doing that. You can call in the old coins, take half the silver out, issue new coins, and now you've got half the money supply; replace everybody's coin with half as much silver. Now you've got half the silver to spend. If you move on to more modern money, it was banks that introduced checking accounts, that introduced paper money in the form of bank notes that were redeemable for gold or silver. And governments eventually monopolized the issue of paper currency. They haven't monopolized, at least in the United States, the issue of checking accounts. In some developing countries the only checking account you can get is in a government-owned bank. So--and they use that as a source of revenue. Russ: I have to mention a couple of things. I find it amusing when people say, 'Well, there is private issuing of money--they just exploited and make a profit.' Of course, the government has done that for centuries. Guest: Yeah. Russ: You might like to think it was confined to monarchs. But of course in democracies, that tendency has apparently been a problem as well.
15:24Russ: We've done better recently relative to the historical record. And we'll come back to that. I just want to make one other point about public goods, though, because I think it's so important: this temptation to say, 'Well, we know from theory that x can't exist.' Famous example is: Lighthouses can't be provided because it's a public good. And Ronald Coase pointed out that communities of sailors got together and found a way to provide a lighthouse anyway. And I remember, oh, maybe 20 years ago, papers being written that said we had to have government control of taxis because it would be inefficient; too many cabs would come in; all the cab drivers would be driven out of the market; they wouldn't make enough to stay in business. Yet somehow Uber, Lyft, and others are thriving. Not in the way that the theorists imagined, of course. But in a different way. That we weren't as economists clever enough to imagine. So, I think we should always be careful when we say, 'Government has to do x'. Having said that, James Buchanan argues that it's efficient for government to provide money. So, what is his argument and what are your thoughts on that? Guest: I want to react to something you said a minute ago, which is, when private people produce money they also exploit the profit opportunity. Well, but as long as they are under competition, it's not that they earn monopoly profits. It's that the public gets a better product. So, Buchanan--I don't know if this is going to be one of his last publications. Of course, he died shortly after our conference. Well, 9 months after our conference. This may be one of his last papers. Buchanan makes the case the monetary constitution should empower the government to produce money, and direct it to stabilize the purchasing power of money. So when he says 'inefficient' what he seems to mean is, you're not going to get the kind of money you want unless you write down the set of rules saying this is the kind of money we want, and direct the Central Bank to produce money that has that characteristic. So, he draws a distinction between money and other goods--which we were talking about a minute ago--and says, money is different in that, with other goods we just provide a legal framework and let the market sort out what the qualities of goods are going to be and who produces them and what the prices are. But in the case of money, we want to specify the characteristics in terms of the behavior, the purchasing power of money, because the most important thing is predictability. And predictability means either 0 inflation or an easily predictable rate of inflation. I think he's kind of jumping the gun, here. There are theoretical arguments that the public may prefer money that actually pays a positive rate of return. Milton Friedman's famous Optimum Quantity of Money argument is that if you had the government acting and issuing un-backed paper money, if you had it acting like a competitive firm, they would have to pay a competitive rate or return on this IOU they are issuing. So, it should appreciate. Or, in terms of the price level, the price level should be gradually falling. That's sort of looking at it from the point of view of a monetary consumer. So, it depends on what kind of money consumers want. And I think Buchanan's preference makes sense but it may not be everybody's preference. And we shouldn't short-circuit the market process of discovering exactly what kind of features people want in their money. Given a choice between paper money that's manipulated in a certain way or that is supposed to be manipulated in a certain way, and a commodity money, people may prefer a commodity money even though gold does not have a perfectly constant purchasing power. Under the classical gold standard, there were years of +2% inflation and years of -2% inflation. Although on average it had pretty close to a 0% rate of inflation.
19:42Russ: So, let me bring it back to his constitutional idea. You could argue--it would be foolish, but you could argue--wouldn't it be better if Americans only had one religion? We could all be together, in one big community. And yet we've decided, Constitutionally, that that's a bad thing for the government to try to create. And so, in that case it's very clear that there's a bunch of people who want no religion. There's a bunch of people who want a religion other than what the central religion would be. So, going back to your version of Buchanan's argument: Okay, maybe Buchanan's wrong; maybe people want lots of money--different kinds of money. But I want to think about the constitutional issue in a slightly different way. Which is, we basically say to the government with respect to religion, 'Hands off. Don't get involved.' What's the argument for that in the monetary constitution? What's the monetary analogy? We see its virtues with respect to the press, with religion. One of the challenges I think you have of convincing people I think who are skeptical about the virtues of a hands-off policy, is that, 'Well, we've never had that, and that scares me. So I think I'll stick with the devil I'm used to.' But make the case for why that particular proscribed role for a constitution would be a good idea. Guest: So, I don't want to make the argument that, if we left it to the market everybody could have their own kind of money. Well, they could, but everybody would have their own kind of money and you'd have, you know, hundreds of different competing monetary standards in the same economy. I don't expect that. All the historical evidence says there are reasons of convenience to converge on a common monetary standard. But the question is: Which monetary standard should it be? What that would mean for a monetary constitution, a sort of hands-off policy, would be, have the usual rule-of-law, property rights, contract enforcement--have those kind of things apply to monetary contracts; have the ordinary rules of business law apply to banks; but don't have special discriminatory laws that hamper banks or that favor certain banks. You know, for a long time we weakened the U.S. banking system by restricting banks, say, from branching across state lines. In recent years we've switched-- Russ: We've fixed that. [?] of them, really. Guest: We've switched to weakening the banking system by giving them privileges. Russ: Yeah. Guest: So that they have less incentive to behave prudently. So, if the government had never interfered--and I have evidence on this in the chapter where I contributed to the volume because my chapter is on the history of free banking and the theory of free banking--we can look at systems that had the most minimal government intervention. There's no case of zero. But the systems where the intervention was the least were the most stable. And had the most success. Had the most innovation in banking. Had the most competition, of course, in banking. Provided the best services at the best prices to their customers. Russ: Why did they end, if they were so good? Guest: I think largely for fiscal reasons. So, the system I've written the most about is in Scotland, roughly from 1720-1845. But in 1845, the British government, because Scotland was part of the United Kingdom now, decided to sort of amalgamate all the banking rules between the rest of the United Kingdom and Scotland, which up till then had had a sort of separate set of banking rules. Basically for the benefit of the Bank of England, which was the monopolist in London, that was lending money to the British government. So, the wider the circulation of Bank of England Notes, the more it can lend to the government. And there seems to have been some concern about Scotland being a kind of embarrassing example of how the government doesn't need to intervene in the banking system. But anyway, if you look at that case, if you look at other cases, I think the pattern is pretty clear that the least restricted systems are the ones that performed best from the point of view of the average user of money. And those were systems that were on gold or silver standards. And there doesn't seem to have been any great dissatisfaction with that. There were proposals by some economists to try to have a system that was even more stable in purchasing power. But in retrospect, the variations in the purchasing power of the dollar under the classical gold standard were trivial compared to what it's been under the post-gold-standard period, the fiat dollar standard. And Buchanan talks about predictability as an important feature of money; and I agree more predictability is desirable. But if you look at the--one practical fall-out from the shift to a fiat dollar is that the predictability of the purchasing power of the dollar has gone down. It's true that in the last few years, inflation has been fairly low and steady. But nobody can count on that continuing. And so nobody's willing to buy 50-year bonds under today's monetary standard, the way they were under the gold standard, because they can't predict what the dollar is going to be worth 20, 30, 50 years from now. Russ: Explain what 'fiat money' is. Guest: So, fiat money is money that is not backed by gold or silver or any commodity. It's just issued by the decree--'fiat' is a technical term meaning a decree--by the decree of the government. So the government says, 'This is money.' And if you read the fine print on your dollar bill, it says, 'This is legal tender for all debts, public and private.' Which means, this will pay any debt denominated in dollars. If you've been paid with these pieces of paper, you can't go to court and say, 'I haven't been paid because when I made the contract I was expecting to get gold.' Too bad. Russ: If I make a contract that says I want gold, I can enforce that, right? Or no? Guest: That remains-- Russ: Or bitcoin? Guest: That remains to be determined. It's actually a little bit up in the air. Availability of gold for ownership by U.S. citizens, which was illegal for several decades, has been restored. So you can own gold. You can write contracts denominated in gold. The question is if the other party wants to pay them off in dollars, what the court will decide. I don't think we've had a clear ruling on that.
26:57Russ: So, your example was, if we started from scratch, with, say, free banking, we have some evidence that it might turn out okay. We're not at scratch. We're in the middle. Guest: That's right. Russ: So, give me a possible route by which we could either reduce or eliminate the government's role in the issuing of currency. One, right now, if I want to issue currency that competes with the government, I guess it's iffy. Bitcoin is out there. Guest: Yes. I did a paper for the Cato Monetary Conference a few years ago, which is in The Cato Journal, on two cases of people who tried to compete with the Federal Reserve in issuing money and were shut down by the Federal Government. The case of the Liberty Dollar, which was a silver coin and silver-backed bank note. They didn't shut down the bank notes but they came and raided the operation and confiscated all the coins they could find. This was a project by an entrepreneur--well, it was a non-profit project--but an entrepreneur named Bernard von NotHaus. He was convicted of-- Russ: What was the crime? Guest: The crime was, there is a provision in the Federal Law dating back to the Civil War that makes it a crime to issue pieces of metal, well, or anything, that are intended to circulate as currency. He was also convicted of counterfeiting, as though his coins were identical to the U.S. coins--which was ridiculous. He was recently sentenced, after many years of delay. And his sentence is limited to probation and monitoring. So that was a relief. Russ: You've got to keep an eye on a guy in case he starts printing up coins. Guest: But his business was shut down, and people who are owed money from that business-- Russ: [?]-- Guest: have yet to be resolved. Russ: So the-- [?] Guest: So, the [?]. And the other business was EGold. So, EGold was-- Russ: E-dash-gold? Guest: E-Gold. E-dash-gold. Well, actually there wasn't a dash in the trademarked name of it. Russ: Sorry. Guest: So it was an online system for transferring ownership of gold, where your account balances were in gold ounces, and you could transfer them to other people in the system, just like you can, you know, go online and transfer dollars in our current system. And that was shut down for violating money laundering laws. So, one way to come back to, to re-open the possibility of owning sound money for people is to illuminate these kind of legal barriers that prevent private entrepreneurs from trying to introduce some other kind of money. Now I, a minute ago, talked about the convenience of being on the same monetary standard with everybody else. So I don't expect these kind of projects, or Bitcoin, to take off in a big way, until the dollar starts to show much greater instability than it has at the moment. Because you see that--you've seen that in Latin American countries: high inflation, people dollarize themselves. So, they use an external money. And in the extreme cases, the government tosses in the towel. So, in Ecuador, they said, 'Okay, nobody wants our currency any more. Let's just stop issuing it and just have the dollar be our official money.' Russ: The U.S. dollar. Guest: The U.S. dollar. So, that's one way to get a sounder money, but we don't really want to go through that. 3035 Russ: So we should be rooting for inflation. Guest: No. Russ: To encourage-- Guest: we don't want to do that. Russ: Okay. But my question is, for example, I'm trying to think of analogies that would give people comfort. So, FedEx came along. And FedEx found a little loophole--the U.S. government has a monopoly on the delivery of letters and first-class mail. Whatever that means. Of course it's open to interpretation, I assume. But FedEx created a product that was considered legal. Which, I'm sure took some creativity. Guest: It was express delivery. Russ: Express delivery. Overnight, quick. Which certainly was in contrast to its government competitor. Russ: And it turned out pretty well. The government could have shut them down. They could have changed the law. Legislators could have responded, changed the legislation to have prevented it. Guest: The Courts could have ruled in favor of the Post Office. Russ: Correct. In which case there would be no competitor. Or, the government also could have said, 'Hey, this is great! We need to get out of this business. We'll do something else.' They didn't. They've moved along in parallel; other places have come along, DHL, UPS, etc. And UPS was already delivering packages, but express delivery became more diverse. What would be your ideal for how we would allow a thousand flowers to bloom--would you like to see the government just say, 'Anything goes? We're open to competition?' Or would you prefer to have the government out of the business entirely? Guest: Well, the first step would be to say it's open to anybody who wants to come along with a new idea. And so, we repeal the law that makes it a crime to produce pieces of metal of whatever shape and design that are intended to circulate as money. We revise the money-laundering laws and the know-your-customer restrictions so that there's a level playing field. Russ: What are 'know your customer' restrictions? Guest: So, 'know your customer' is, nobody is allowed to open an account or transfer money, basically, without revealing their identity to the institution that's doing the money transferring. Russ: Can't have Swiss banks in the United States. Guest: You can't have numbered accounts. You can't have anonymity. That's right. Russ: That's to prevent criminals from--? Guest: So, if we were serious about that, we would want to withdraw $100-dollar bills, because that's actually the preferred medium of payment for criminals. Russ: And there's been some serious talk about that, actually. Because that would raise the cost, presumably, of transacting--you'd have to give out 5 $20s. Exhausting. Guest: But getting the government out of the business is actually a thorny question. Because as I said, there's actually a great convenience in being on the same monetary standard. So it seems to me we can't just advocate for liberty of competition in money, but we also need to do something to write a constitution that constrains the existing monetary system. Or provides a path for winding it down. One way to wind it down would be to go back to a commodity standard. We used to have a monetary system in the United States without a Central Bank. We could go back to that. Russ: It's pre-1913. Guest: Pre-1913. Russ: How is that possible, [?] happened didn't it? Guest: Well, we'd have to put a different monetary standard in the place of Federal Reserve dollar. So, a commodity standard is one option. People in the volume talk about other options. Instead of a single commodity like gold or silver, a multi-commodity basket is one possibility. Just freezing the supply of Federal Reserve liabilities so the Fed no longer has discretion to run a monetary policy is another possibility. But then there are sort of more status-quo oriented or more moderate ideas discussed in the volume, like Scott Sumner's idea to give the Fed a set of instructions about monetary policy that eliminates its discretion. And that of course is an idea that goes back to Milton Friedman and before, that we would want the monetary rules rather than the discretion of monetary authorities.
35:13Russ: I want to come back to that, but I want to--since you brought up a commodity standard such as gold or silver or a basket of commodities, I want to talk about that. And I want again to bring it back to what modern macroeconomics, the way I was taught--I don't know if you were taught that way, too. But there's a certain mythology. Perhaps some of it's true, perhaps none of it. You tell me. But there's a certain idea that, well, before 1913, before there was a Central Bank to conduct monetary policy, the economy was struck now and then by the whims and winds of gold supply, animal spirits, etc., and there was no way to counter those with monetary policy because there was no Central Bank. And the virtue of the Central Bank in this story is that it's a steering wheel that allows us to offset the swerves and spills that would otherwise take place if no one were in charge. So, if we had--and help me out here. What's the difference between, say, the free issuance of currency, private, and, say, a gold standard? Or a better way to say it, pre-1913? What world were we in, pre-Federal Reserve? It wasn't free banking. Guest: No. Russ: So, what was it? Guest: It was a system in which-- Russ: And what was good and bad about it? Guest: We had a gold standard-- Russ: And why might we want to go back there? Or stay away? Guest: We had a gold standard. Paper currency was issued by private commercial banks--in the United States, the national banks. So, banks had Federal charters, had the authority. Now, they were restricted in various ways. In particular, they had to buy Federal government bonds to back their currency, to serve as a kind of liquidation fund in the event a bank failed. And there you see the fiscal motive pretty clearly at work. This was a Civil War measure: 'How do we get someone to lend us money?' the Union Government said. 'We'll have the banks have to buy our bonds if they want to issue bank notes. So that was the arrangement. A sort of better model would be a freer banking system, like Canada at the same period. So you've got nationwide branching of banks, banks issuing their own bank notes. But they are interchangeable. They all circulate at par value in terms of the gold that they are redeemable for. So, that's a system in which the quantity of money in the economy as a whole is ultimately governed by the international gold standard. The famous price-specie-flow mechanism, which says that if your price level gets higher than the world price level, your citizens will start buying imports; that will make money flow out; that will make your money supply shrink; that will make your price level come back down to the world level. And then it will stop. You'll reach an equilibrium. So, it was a kind of self-regulating system. Russ: So, in that world-- Guest: Now, recreating that in a world without an international gold standard, that's a real problem. Russ: But in that world--there were a lot of recessions. Just like now: there are recessions. The government just kind of twiddled its thumbs. I guess. Right? Guest: Right. Russ: Which would be disturbing to a lot of people. Not just economists. There would be a political clamor for doing something. Guest: There is this widespread view, or myth, I should say, that business cycles were much more terrible in that period. Russ: Bank runs, crises, panics. Guest: There were those things every so often, because the United States had a weak banking system. But even given that weak banking system, if you look at aggregate data on recessions; if you look at variation in the real output of the economy, if you look at the length of recessions and the frequency of recessions, that system was no worse than a system under the Fed. And George Selgin and Bill Lastrapes and I have an article setting forth that evidence, mostly drawn from the work of other people who are not, you know, talking about free banking, like-- Russ: Not crazy people-- Guest: Christina Romer. That's right. Guest: Exactly. I mean, that's what the system looks like. So the Fed has not in fact delivered on the promise of stabilizing the business cycle. Now maybe it could. But it hasn't. Russ: Yeah. We need to look more. Learn more. You could argue that the world as we know it is more complicated. More prone to business cycles. Globalization. Who knows? There could be other arguments beside just the monetary framework that we are talking about. Guest: Being more diversified actually works against business cycles. Russ: I understand. You'd think. Guest: I mean, we had agricultural shocks in the 19th century. Locusts could cause a recession. Russ: Yeah. I guess that's true.
40:07Russ: So, let's talk about, then--it would be hard to recreate that world, because we don't have an international gold standard. We're in America. I assume that's--or any individual country. What constitutional constraints can we put on the current system that might improve matters? So, let's not be crazy. We're stuck with the Fed. We're stuck with monetary policy. What should the Fed do--not what should the Fed do: What restraints should be on the Fed to keep it from getting us into trouble? What are some of the choices? Guest: I should say that the volume, the book we're talking about has a variety of proposals in it, so it's not all free banking by any means. Russ: You only get a chapter, right? Guest: I only get a chapter. Russ: Yeah, that's an oversight, there. Guest: There are a couple of other people who are favorable. Well, it's a good question. My view is that any constraint is better than no constraint--well, that's a little strange. Russ: I know what you meant. Guest: Many constraints are better than no constraint. And so, a popular constraint which a lot of central banks have adopted in the last 30 years is an inflation target. And it seems to me that that's better than no constraint. And the Fed has adopted an inflation target now, explicitly; except that the Fed adopted it, rather than Congress imposing it on the Fed. So the Fed could abandon it at any time. It's not a constraint in the same way as a legislatively- or Constitutionally even better-imposed constraint. But I'm persuaded by arguments in the volume and elsewhere that as far as fastening a rule on the Fed, a nominal income rule would be better, one that says-- Russ: Explain how that would work. Guest: Yeah. So, what the Fed should be concerned about is the total amount of spending in the economy, not just the stock of money and not just the price level. Guest: And not the interest rate or the overnight Federal Funds rate. Guest: Certainly not interest rates, that's right. But what that would mean is if there isn't any additional hoarding going on, or any dishoarding going on, then the Fed just pursues even money growth. But if people want to, for whatever reason, want to hold money--they want to hold more money balances relative to their spending, then the Fed should supply the additional money that people want to hold, because the alternative is that spending drops off; and that has real repercussions that we're better off avoiding. It's true that if the price level adjusted instantly, the market would clear-- Russ: It would be irrelevant-- Guest: and we'd be fine. But prices are sticky, I think is a fact about the world we are living in. Russ: Well, and information is imperfect. A bunch of people show up at your store; you don't know if they are there because they have more money in their pocket or less desire to hoard money, keep money, or whether your product is really great. So you could make a lot of real mistakes in the short run-- Guest: That's right-- Russ: trying to figure out what's going on. You can't ever figure out what's going on. So you will inevitably make mistakes. So, the argument I think is it would be better if what I saw coming into my store was real rather than nominal--that would be one way to put it, right? Guest: That's right. And actually stabilizing nominal income is a better way of reducing that signaling problem that people have, that sellers of goods have, than stabilizing the price level. So, some people who want to stabilize the price level acknowledge this in the case of an adverse supply shock. So, there's an oil price rise, let's say, and the United States is an oil-importing country. The price of oil goes up; the price of gasoline goes up; the price of things made with oil go up. If you want to stabilize the price level, you have to push other prices down so that the average level of prices doesn't rise. But the rise in the price of things made with oil is providing information. It's not clear why you want to cloud that information by pushing other prices down, because that means a tight monetary policy, tighter than people expected. Russ: At least in the short run. Guest: So you're hitting the economy with a double whammy. It's got a real shock and now it's got a monetary shock on top of that. Both of them negative. And some people who favor a stable price level will say, 'Okay, yeah, we grant it in that case.' But then they should also grant it in the other case. If you have an increase in the productivity of the economy, either a positive supply shock or improvements in technology, improvements in labor productivity or total factor productivity, you should let the prices of those particular goods that are now being produced more cheaply, let those prices fall. Don't try to offset that by raising other prices. Russ: Is that going to happen naturally? An oil price shock doesn't cause inflation; the Fed wouldn't have to do anything. Or are you talking about in the short run, when the signals are confused, right? Guest: Yeah. Russ: Those prices are going to have to fall--the Fed doesn't have to drive down the other prices. They are going to go down anyway, on their own, right? Guest: Oh. Eventually they'll go down on their own if people are spending more on oil. Russ: Yeah. Guest: Depends on the elasticity of demand for oil. But if they are spending more on oil, right--they'll be spending less on other things. Russ: So the Fed wouldn't intervene there. To me, the issue is just measuring price indices accurately in a time where we are blessed to live, where quality is changing every day. Every day, almost, the world is getting better and the products are getting better. And so assessing what's actually happening, the overall price level, seems to be much more difficult than it was 25, 50 years ago, when the economy was much more static. So to me the question is, given that uncertainty, that measurement uncertainty, is nominal GDP (Gross Domestic Product) targeting--are they going to be better? I'm not sure. I'm not sure it makes any difference. I'm not sure that really gets around that. Guest: Yeah, it actually is easier on that score, because you don't need to know the right price index to do it. Russ: You don't need to, but the question is are you still--are you doing the right thing? Guest: Yeah. I think for the reasons we talked about earlier. It is a problem if you want to stabilize the price level that you have to take account of quality changes, and that's difficult. There are all kinds of, as you've been saying, quality changes that goods experience. So, if it's a simple thing like your tire lasts 60,000 miles instead of 40,000 miles, you can make an adjustment. But what if it gives you a better ride? How do you adjust for that? Russ: What if it has a microwave oven in it? While you're driving along? How do you weight that? Guest: So, some people are under the misapprehension that it's harder to stabilize or to target nominal income because it's the product of real income and the price level. But that's actually not how it works. First the statistical authorities gather information on nominal income and then they derive real income by dividing by a price level. Russ: Which they also have to derive. Guest: Which they have to construct by going out with clipboards and writing down prices and then trying to make adjustments for quality changes. So you save yourself that trouble if you are just looking at total spending.
47:50Russ: Before we go on talking about this, I just want to make sure we get this question in, which is: The independence of the Fed is a popular conversational topic in Washington, D.C. these days. And I always find it moderately amusing--there's this fear that, oh my gosh, the Fed is going to have these kinds of constraints; it will be politicized, perhaps. It seems to me it's perhaps the most important political and politicized institutional in America. You want to say something about that. Guest: Yes. Well, I recall Ben Bernanke making joint press conference appearances with the Secretary of the Treasury, Hank Paulson, so I think that ship has kind of sailed, where the Fed says, 'Oh, no: we're pure and chaste on this political influence question.' Mark Calabria from the Cato Institutional wrote a piece recently saying, Look, independence of the Central Bank means independence from the executive branch. They are not supposed to take instructions from the President or the Secretary of the Treasury--which is what we've seen a gross violation of in recent years. It's impossible for the Fed to be independent of Congress. Congress wrote their statute. They can revise it. They revised it most recently in the Dodd-Frank Act. So, it's true we don't want Congress back-seat driving monetary policy on a week-by-week basis. But calling for the Fed to account for its actions to Congress is not a violation of the kind of independence that matters for monetary policy. Russ: Yeah. It seems one of the strangest things you could possibly imagine, this idea that--I mean, it's a nice fantasy for economists: We're so brilliant and have such high integrity that you can just put us over here in this black box and we'll work on the levers and turn all the dials to make sure the economy does great. And we never go to cocktail parties; we never get called down to Pennsylvania Average., etc., etc., etc. It's all just a bunch of devoted technocrats working on their craft. And that seems to me to be a-- Guest: And when we have a press conference to describe what we've done, we'll describe it in the most neutral, uncolored terms. Russ: Yes. Guest: We'll be completely frank and honest about our success record. Russ: That whole thing, to me, it strikes me that it would be better to be open and transparent about the political nature of the Fed, where accountability, usually even democracy is a good idea. Even if it's accountable to something as strange as Congress. But accountable to something would seem to be a good idea. Guest: Yes. So, the most shocking thing to me--we had a partial audit of the Fed coming out of the Dodd-Frank Act. But even then we didn't learn until there was a Freedom of Information Act suit against the Fed from Bloomberg News that we learned that during the financial crisis the Federal Reserve Bank of New York had a line of credit ready for Bank of America, and another one ready for Citibank, in the event they should need it. Right? Something that no other bank got. This should be public knowledge. I mean, this should not be the Fed's call. We're sort of beyond monetary policy here--this is a credit policy. When the Fed claims independence, it's ridiculous to claim it for things that aren't even monetary policy--that are credit-allocation policies. Russ: Well, they have a lot of responsibilities. They have a lot to take care of.
51:35Russ: Let's talk about another possible way we might restrain the Fed that gets talked about, which is the Taylor Rule. So, the Taylor Rule evolved as a description of what the Fed did during a time when the economy was doing well. And since people believe that those two are related, they concluded that maybe this would be a good rule. What are your thoughts on the Taylor Rule as a possible constitutional constraint on the Fed? I don't know if you have anything in the volume on it, so we might be going off. Guest: People allude to it, but there isn't a very deep discussion of the Taylor Rule, it's true. Because it's hard to think of it in constitutional terms. Russ: Hard to think of an equation in the-- Guest: Yeah. And it has some variables in it that it's up to the Central Bank to construct. Like, the Taylor Rule says the Central Bank is supposed to minimize a loss function which has to do with the difference between the inflation rate and the desired inflation rate. That one's easy enough to measure. But the other is the difference between the output of the economy and the potential output of the economy. And potential output is completely-- Russ: It's a will-o'-the-wisp. Guest: It's an extrapolation--there are different ways of doing it. There isn't any one clear way of doing it. And since the financial crisis, real output has been consistently below its potential output; and you have to ask: how many years can that go on before they realize that the potential ain't what it used to be? And the potential output has started to droop a little bit toward the path we're actually on. Russ: But, I joked earlier about the fact that the political constitution, the U.S. Constitution itself--not the monetary part or the kind we're speculating about today--that the political Constitution is more of a suggestion. It's not exactly a commandment. We've been flexible. One of my favorite things here in Washington is the Jefferson Memorial. If you go in the Jefferson Memorial you'll see quotes from Jefferson. They've somehow managed--it was built during the Roosevelt Administration--they found a--I don't remember it verbatim; I'll look it up and put a link to it--they found a quote from Jefferson that talks about the importance of flexibility. And not being stuck with rules. At a time when of course Roosevelt was trying to push the envelope on what the U.S. Government was allowed to do. So, one view says this whole constitution idea, although it's an interesting intellectual exercise, it's not really the issue because the real issue is: what does the body politic really want from its monetary policy? And if the body politic wants inflation, or if a particular part of the body politic, the financial sector, has a lot of power and they get what they want, it's unlikely that a constitution will constrain what the Fed might do or what the world might do. So, I just want to propose an alternative. Which would be--and I hate to say it, because I'm against this--but I think it's worth thinking about, which is: we should pick the right person. George Stigler called this the 'Ralph Nader school of regulation', when I took his class. Ralph Nader says, 'We have the wrong people running the regulations. The ones we have now, they're bad. They are corrupt; they've been influenced by political pressure. And they're just the wrong ones. We need the right ones and then everything will turn out okay.' It's imaginable that if you put, say, John Taylor as head of the Fed--which is a possibility. It's not like suggesting that I would be the head of the Fed, Larry. 'If we had John Taylor as head of the Fed, then we'd be pretty comfortable. It's true there'd be some slippage in the Taylor Rule and definitions.' But it's imaginable that he would be constrained by his past statements and personal philosophy to stick with it. Similarly, earlier, if we'd picked Milton Friedman to be the head of the Fed, that he might have followed an optimal quantity of money rule, or the equivalent of computer generated constant increase in M2, say. What do you think of that as a possible solution? Like you? You'd be a good one. Guest: Hmmm. Russ: The enthusiasm's boundless. Guest: It's unfortunately true that under our current system it does matter who is in charge. When G. William Miller was head of the Fed--that was under the Carter Administration--it didn't go so well. They eventually kicked him upstairs and brought in Paul Volker to replace him. So, it does matter, who is in charge. But the cautionary tale here is when Arthur Burns was appointed to head the Fed, Milton Friedman in his Newsweek column said, 'This is great; this is somebody who understands monetary economics; he'll do the right thing; he'll keep monetary growth moderate.' And not a couple of months in office had gone by when Burns started talking about how, 'Well, the economy is not behaving the way it's supposed to because inflation and unemployment are not staying on the Phillips Curve.' And Friedman had to write to him and say, 'Stop talking nonsense, Arthur.' And eventually they stopped being friends, eventually, because Friedman was determined to speak the truth even if the hurt burns his feelings. So, Burns did not live up to his advance billing. Yeah, I think I would feel more comfortable with John Taylor than with Janet Yellen. But even then, it's the wrong kind of system, if the outcome depends really crucially on who gets appointed. That's too much risk. And the whole logic of a monetary constitution is like the rest of the logic of the Constitution of the United States, that you want to tie your own hands as to what sort of wacky adventures the government can go off on. And the sort of classical analogy, of course, is Ulysses tied to the mast so that he doesn't steer the boat over to the island of the Sirens and smash it on the rocks. Russ: That's an important point. Guest: So, maybe what the public wants in its far-sighted self is to tie its own hands. They want the monetary system which can't be manipulated by the experts who are currently in charge. Russ: In a recent EconTalk episode with Mike Munger we talked about how when we choose in groups we sometimes are willing to tie our hands, willing to give up some of our freedom. Voluntarily, we give up our freedom. And it's under certain situations. The obvious one being if I don't comply with the contract, you put me in jail. You can take my money, against my will. But that, I signed the contract willingly, and if I didn't comply with the terms, I face the consequences. Because I understand that's a better world to live in. It's very hard for people to accept hand-tying arguments, because the temptation is always to say, 'Well, it would be better to have freedom to choose.' Guest: I go to meetings where I agree I'm not going to talk unless I raise my hand and I'm called on. And everybody else agrees to it, too. And the meeting goes more smoothly because of that. Russ: Absolutely. You mention getting the right person--I always wonder if you or I were Secretary of the Treasury in 2008 or 2009, would we have had the courage to say No. There have been. Guest: Well, we could have stayed in office if we had had that courage? Russ: That would be a different, that would be another question, right? Obviously there's tremendous political pressure, regardless of one's principles, to bail folks out. And I think, again, that's the virtue of the constraints. And there are constraints other than legal constraints, other than legislative constraints, other than constitution, etc. I just wanted to put that in, because I think it's important.
59:41Russ: I want to make sure we mention this: If we did have some rules for the monetary system, there is an issue of an emergency--which I can't say with a straight face. But you do talk about it. So, how would we deal with emergencies, where we might want to break the constitution? Which we do, by the way, in wartime, with respect to the political Constitution. We say, it's an emergency. And we lock people up, in ways that we would never do in non-wartime. Guest: So, it would be better if we assume that there's going to be emergency actions taken to constrain them. You might say, in an emergency as defined by the following characteristics, so that 'emergency' can't just be declared at any time. The following exceptions can be made but only the following exceptions. So, the Dodd-Frank Act actually has a section that deals with that. Russ: Have you read the Dodd-Frank Act? Guest: This section of it. Russ: Just checking. Guest: Not the other 2000 pages. But I always like to point out: the margins of the Dodd-Frank Act and other government bills--they are very large, the margins. So when you say, 2000 pages, it's not really 2000. Guest: Well, it's still being written as we speak. Russ: Of course! Well, it's a living document! That's the kind of quote that if I remember correctly FDR (Franklin Delano Roosevelt) used of Jefferson, about 'living documents.' Yeah, go ahead. Guest: So, a lot of people were understandably upset that special bailout arrangements were made for a few identifiable firms--Bear Stearns, AIG. So the Dodd-Frank Act says that there can't be that can't be that kind of bailout for a single firm. There can only be a broad-based lending program to which general criteria for inclusion apply. Now, it remains to be seen whether when push comes to shove that will be honored. We also had--one reason to be pessimistic is that in 1991 Congress wrote the Financial Institutions Reform Act-- Russ: I was just thinking about that. Guest: Which said that there's supposed to be structured early intervention for banks with low capital; they are supposed to be wound up and-- Russ: and management should be taken out of office and replaced. Guest: Completely ignored. When the time came, it was completely ignored. Russ: Ignored. Literally. Right? So, welp, there was a crisis. Was it an emergency? It's a dangerous word. Just want to mention that.
1:02:19Russ: You write--this is a quote:
Central bank histories around the world are equally or even more regrettable than the Fed's, with the exception of the Swiss national banks.
What is special about the Swiss? One argument would be--this is the argument I always like, where people say, 'Well, our school systems are awful and Finland's are good.' Although lately they haven't been doing so well in the international tests. But put that to the side. Guest: Yeah. Russ: Ours are awful; Finland's are good. We'll just use Finland's. Hey, they've got a track record. So, whatever Switzerland is doing, let's have more of that. Guest: So, it's just an observation that the Swiss franc has had lower inflation than any other currency in the post-War period-- Russ: Is that true? Guest: Yeah. As for explaining it, I'm not sure. Of course, Switzerland has an interesting constitutional setup, a very decentralized government. Russ: We need cantons instead of states. Whatever those are. Guest: With the exception of the Swiss National Bank, which is a national institution. But exactly why they've been more responsible? I suspect it's the good luck of having a history of monetary economists who were concerned about avoiding inflation. And of course a banking system which does banking for many more people than Swiss citizens. And bankers don't like their currency to be debauched. It's not a good way to attract customers. So I suspect that has something to do with it. Russ: Or it could be just that when you have--how many Central Banks are there in the world? 150? 120? 80? Do you know? Guest: Fewer than there are nations. Russ: There's about 200 countries, right? Guest: Yeah. Russ: So, let's say there are 100 Central Banks. You expect one of them to get righteous by chance. I guess. I don't know. Maybe that's a little pessimistic. Too cruel.
1:04:16Russ: Let's talk about Bitcoin for a minute. We mentioned it earlier in passing. Explain to folks what Bitcoin is and what it's potential. Those who remember the interview I did with Marc Andreessen will remember that--which was extremely eye-opening for me, which was bitcoin's real potential as a competing currency: it's as a reliable payment system that would evolve, would remove some of the transactions costs of transacting now in small amounts. And the uncertainty about whether, when I make a transaction, I've actually transferred the money. That's really fascinating. But other people are excited about it as a potential currency or a monetary solution. So, talk about it. Guest: When I spoke on this stage in November at the Cato Monetary Conference, my paper was on the "Market for Cryptocurrencies." And somebody in the audience asked that question: Can somebody tell me what is a bitcoin? Russ: It's a bit tricky. Guest: Yeah. A bit tricky. So, I thought about it afterward and this is the best I could come up with-- Russ: You can't bite it. You can't check it for reliability[?] Guest: So, gold was the original bitcoin, because you used [?]. So, we had commodity money, gold and silver coins. Then we had bank notes that were claims to gold and silver. It was an IOU (I Owe You)--you could go to the bank and they would give you coins that you had coming. Then we introduced paper money that you couldn't redeem. So that's an IOU-nothing. Russ: Right. Guest: That can serve as money if people accept it. Bitcoin is an electronic IOU-nothing. But it's not issued by the government. It's produced by a computer program. And there's a system of people whose computers are involved in the payment processing network. But that's a kind of metaphysical definition of what a bitcoin is. Russ: Well, what's special about it--there are a few things that are special about it. One of them is, how many exist and how many come into existence. Guest: Right. So the really interesting thing about it from the point of view of a monetary constitution is that there is literally a program written down that governs the quantity of bitcoins, the quantity of bitcoins. The path is pre-determined. And there is nobody in a position to change that. There isn't any Central Bitcoin Authority that has the power to introduce more bitcoins. The whole system of production is according to this program. So that has, sort of, interesting implications or sort of makes us think about other ways we might write a program to produce a money that instead of having a predetermined quantity path, might have a predetermined or stable purchasing power. Or might be defined to have stable nominal spending in terms of that currency. So that's it's interest from the point of view of a constitution. But you are right: the value of bitcoin is it's part of this payment system. Russ: Well that's its value now. Guest: Right. Russ: Potentially. Guest: Right. The blockchain could be used for other purposes, too. Russ: And I guess, to me the fascinating thing is, when you tell noneconomists about it, who are not cyber-sophisticated, they say, 'Well, why would anybody take it?' And the answer of course is because they can spend it somewhere. 'But then why would that person take it?' And the answer is, I think fundamentally: There are people in the world who would like there to be an alternative to the dollar, or a government-run currency, and they are willing to take the risk. They are not taking a risk of inflation, because of if this program is correct. What they are taking a risk of is that they may accumulate the equivalent of the Russian ruble after 1917, when the Czarist ruble was--we have friends who said, 'Well, we used them as wallpaper.' Because they were not legal tender any more. So there's a risk if you-- Guest: You know, if you hung onto your Confederate currency after 1860, it's actually performed better in purchasing power than the Federal Reserve Note. Russ: Is that true? Guest: Yes. Russ: As a collector's item now, you are saying? Guest: Yes. Because the quantity is-- Russ: Not too many people use them as wallpaper. That's the problem. Those people who have held them got lucky. So, I think there is, among renegade folks, there is a desire to have an alternative. And they are therefore willing to take a chance. They might not put their life savings into it. But eventually if enough people started to feel that way, we could get to a world of an alternative currency. Is there any chance of that? Guest: I was going to agree with you, that I think the bedrock of the demand for bitcoins is from people who are enthusiastic about the project of a non-government currency. It does have a problem, which is in getting more widely accepted as a medium of exchange, for people to want to hold their checking account balances in bitcoin. Which is that the value is, right now, rather unstable. Russ: Yes, it is. Despite the claim that there's this smooth path of expansion. Guest: That's the quantity. That's not the purchasing power. So, if demand goes down there's no place for it to be felt other than the price. Because it's not going to be felt in the quantity. So that's a problem. Maybe if somebody introduces a cryptocurrency that has a more stable purchasing power, they can get that more widely accepted. As long as bitcoin's purchasing power was appreciating, it wasn't a problem that it was bouncing around the path. But now that it's down, I think that it's been a blow to trying to get it more widely accepted. Because there are a lot of entrepreneurs who are trying to introduce payment systems or consumer front ends to make it easy for merchants to take payments by bitcoin. Russ: So you write,
Bitcoin is something else again, a transferable private unit with a positive value, unbacked by redeemability. Unlike Hayek's proposed unbacked private currencies, bitcoin is guaranteed by private programming to expand in nominal quantity only gradually along a known path. It is produced by decentralized mining rather than by any central issuer who could issue more at will
--and here's the key part I want you to talk about
because its volume cannot be unexpectedly expanded.
I want to read that again, because I butchered it.
... because its volume cannot be unexpectedly expanded. Bitcoin is free of the time-consistency problem that haunts Hayek's proposal--the temptation of a profit-maximizing issuer, when nominal expansion has no cost, to take the one shot seignorage profit from hyperinflationary overissue.
Explain that briefly. Guest: So, one of the most interesting proposals in monetary regimes over the last 50 years was Friedrich Hayek's "Denationalization of Money," where Hayek started by saying, well, we shouldn't put any legal barriers in the way of people using a currency from another country. Or gold or silver if they want to. So, don't try to stop people from fleeing a bad currency into a good currency, and maybe that will discipline the issuers of bad currency to stop being so bad. And then he revised it to say, Why not let private firms enter this competition? And if we think about it, maybe the reason we've never seen private firms issuing an unbacked money is that it's been illegal. Now, I'm a little skeptical of that part. I think there's a reason why people would prefer a commodity money to an unbacked private money. And that's what I referred to in that last sentence. Which is, if you can, as a private issuer, get people to accept the money which you have no obligation to buy back, in terms of any underlying commodity or bundle of goods, you have no contractual commitment to keep its purchasing power stable. You are just promising that that is what you are going to do. Once people start to accept that, you make a profit with every additional unit you can issue, whether it's in note form or bank balance form. And so there's a temptation to hyperinflate. Russ: Your brand name-- Guest: Yeah, it's true, it's a one-shot profit. Russ: Right. Guest: And you destroy your brand name. But if that profit is big enough-- Russ: Right-- Guest: and if you write down a model of it, it looks like the profit is basically infinite. Until people react and stop accepting it. So I think maybe that's why we've never seen unbacked private money. Not the absence of legal restrictions against it. I'm all in favor of letting people issue an unbacked private money. But there is this problem of how the users of it are going to trust you not to hyperinflate it. That's the problem that Bitcoin has solved by making the quantity written down into a program that's publicly observable. Russ: At least we think that's true. It's hard to-- Guest: That's true. Russ: I trust that. Right. It seems true. But we don't 100% know.
1:13:50Russ: I want to close with a couple of political questions. Which is perhaps a bit unfair: you are not a Political Scientist. But I have to ask. And I think it's appropriate when you write a book called Renewing the Search for a Monetary Constitution, when you edit a book like that-- Guest: Some of the people in the volume are Political Scientists. Russ: Yeah, exactly. So, you could draw on their knowledge. Does the range of somewhat attractive alternatives--meaning, marginal improvements to the Fed's behavior--reduce the political feasibility of creating a viable alternative to the current discretionary regime? So, the current regime is discretionary. It's a lot of power to the Federal Reserve's Chair, the Board. There's a lot of political pressure involved. And everybody understands it could be better. But a lot of [?] it's okay. And so, push around the edges. You and I would probably like to see something a little more radical. Is there any chance of that? Given that it's always--[?] no, no, no, that's crazy, this will be good enough. Guest: Well, if you want to count the number of votes in Congress that would vote for something radical tomorrow, it's not going to be enough. So, it's going to take either a crisis--which we hope we don't get-- Russ: We had something like that. Guest: We had a crisis, which the Fed seems to have dodged most of the blame for. Although they did get some slap on the wrist from Dodd-Frank and they did get the partial audit. But we haven't changed the regime. We haven't constrained the Fed's discretion in the least. So,-- Russ: Having said that, though, there are more people in favor of a gold standard, and more people in favor of radical alternatives to the Fed than any time in my lifetime. Still a small number. Right, but, -- Guest: Yeah, no, I never thought I would live to see a day when a book entitled on the Fed was on the Best Seller List. Russ: Shocking. Let me close with this question: What's the purpose of imagining a policy change like we've been discussing, that seemed to have virtually a minimal chance of passing? So, there's more support now than before, but not very much. Is it just an academic exercise? Guest: Not entirely. I hope. I mean, I hope. I mean, I think there is a practical value. And this is a point Milton Friedman made for many years: in studying alternative institutions and developing proposals for them so that you have somewhere to turn when the institutions you've got are breaking down--so, when the fixed exchange rate regime of Bretton Woods broke down, it was nice to have the reassurance that, look, we've studied the countries that have had floating exchange rates and it worked okay--and so, people felt a little better about switching and not trying to hold on to the bitter end of preserving the fixed exchange rate. So, I think that's the kind of excersize we are engaged in here, keeping the ideas alive, keeping them under discussion. We are not making the last word here. The title is "Renewing the Search" because we hope to attract other people to get into to this discussion. There's too much discussion in the economics profession about either not conceding any change in the Fed's operating procedure. Or, sort of marginal adjustments in how the Fed might avoid some of the mistakes it's made. But we think it's time to--just like after the Panic of 1907 they formed the National Monetary Commission to consider alternatives to the system they had, after the panic of 2007, it's high time to reconsider the fundamental alternatives and have them ready for when we need them.