September 22, 2017

Breakingviews: Crypto Currencies Presage New Monetary Era

by Breakingviews.

Sometimes a small number can be a sign of a big thing. Take the $1.5 billion of initial coin offerings (ICOs) that were launched in the first eight months of 2017, as calculated by promotional website That’s not even a ripple in the $75 trillion global economy. Still, the enthusiasm over the creation of useless electronic tokens is a clear indicator that too many people have more money than sense.

As a money-substitute, the new pseudo-currencies are a stunning failure. They are the opposite of stable, since they can be created at will and their supply is unlimited. For speculation, though, ICOs are working extremely well. Transaction costs are lower than for art and other collectibles. Sharply rising prices demonstrate that the mania of crowds is in ready supply.

A much larger crowd of enthusiasts is keeping the valuation of stocks at near-manic levels. Robert Shiller, the Nobel Prize-winning guru of stock market valuation, calculates that the cyclically adjusted price-earnings ratio for the S&P 500 is almost twice the long-term average. It would be higher still if he adjusted for the flattering effect of ultra-cheap debt on corporate earnings.

Still, for the $22 trillion dollars of stocks in that index, mere speculative fervour is not enough to push up prices. Money provides the fuel. After a decade of near-zero interest rates and extensive quantitative easing by central banks, financial markets are awash with cash and cheap debt.

The financial system has become dependent on this monetary abundance. Even the Bank for International Settlements, a financial institution that has called for higher policy interest rates for decades, is now highlighting “vulnerabilities” to rising borrowing costs. If the BIS’s fears prove justified, those vulnerabilities could easily turn a normalisation of policy into another financial crisis.

A crisis might not be all bad, though. It would offer an opportunity for profound monetary reform. It’s not too early to plan. Two ideas from the aftermath of the Great Depression are good places to start.

Abba Lerner proposed that the government take full charge of providing spending money whenever the real economy and the financial system were failing. In a world of what the left-wing economist called “functional finance”, the authorities would not be constrained by worries about government debt and deficits. They would simply print as much money as needed to keep up employment. The new funds could either be spent by the government or given to the people with a strong encouragement to spend.

The same basic idea was renamed helicopter money by Ben Bernanke before he ran the U.S. Federal Reserve, borrowing from the 1969 formulation of the economist Milton Friedman. Adair Turner, Chairman of the Institute for New Economic Thinking, promoted it as Monetary Finance as recently as 2016.

The difference with the current system is simple but significant. At the moment, central banks try to push extra money into the real economy by placing funds with banks or in financial markets. Speculative bubbles show that too much money is getting stuck there. With functional finance, there would be no financial intermediary.

The idea violates the traditional principles that government budgets should be balanced and that money-printing is inflationary. Lerner’s 1941 response was brief: “So much the worse for these principles.”

Government money-printing also conflicts with the newer theory that central banks should be independent of politicians. That principle looks increasingly out of date. The separation of monetary policy from fiscal decisions hasn’t clearly helped the economy. Besides, central bankers these days make many politically significant decisions, such as whether to rescue the euro, how long to condemn savers to negative real returns and how closely to supervise bank lending.

The other old revolutionary idea is about lending – it should no longer be used to create money. This was the proposal of Henry C. Simons, one of the fathers of the University of Chicago’s school of free market economics. His 1948 “Positive Program for Laissez Faire” aimed at “avoiding revolutionary changes in economic and political institutions”. He was worrying about Communists. Today populists pose a greater threat.

At the centre of Simons’ proposed financial revolution was an end of fractional reserve banking, in which depositors and borrowers both have access to the same funds. He thought the arrangement was impossibly volatile. “No real stability of production and employment is possible” if depositors can withdraw their funds without notice.

Simons wanted investments to be illiquid. Private money creation would be prohibited, with the “federal monetary authority” taking up its “direct and inescapable responsibility” to control the quantity of money. In effect, the government would work, Lerner-style, to provide enough liquidity to keep competitive markets humming along.

Variations on Simons’ ideas enjoyed a revival after the financial crisis, but that talk has faded away. Whether because economists were too timid or bankers too powerful, the last crisis was largely wasted when it comes to pushing through fundamental reforms to the financial system. The flourishing of ICOs suggests the world may soon get another chance.


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