Konig-Krugman fiat fundamentalism and Bitcoin

JP Konig writes as engagingly as ever about whether Bitcoin and central bank fiat currency differ in possessing inherent value, and what underpins their value.  He takes Paul Krugman’s side.

Krugman points out, correctly, that governments accept, in fact demand payment of taxes using the currency of its own central bank.  The same of course does not apply to Bitcoin or any of the other crypto-currencies.  At least not yet.  This, he says, is what underpins the value of fiat currency.

In the same vein one might similarly add that the government enacts a law of legal tender.  This law provides that a debt settled in fiat currency is settled.  If you contract in advance to sell something for £10, you cannot later complain that the debt is not settled if you are given £10, a complaint that you may take to the civil courts to obtain redress if you were to object to receiving instead £10 worth of bananas.  As well as demanding £ itself, the government seems to demand we also accept £.

However, I want to take a different position.

I would like to assert that the government’s demand that debts to it [ie taxes owed] be settled in fiat currency are an equilibrium response to the prevailing fact that that fiat currency has value, in the sense that it can be reliably be exchanged for things that the government wants.  Or rather, be exchanged for things that the government’s creditors [like civil servants owed salaries] might want [namely goods and services] after the government has tried to settle its debts by palming off the fiat currency it took in in lieu of taxes.  It is not an unconditional promise or demand that would prevail in all possible circumstances.  In so far as it is presented as one, it has to be considered a bluff.  Observationally, a deft policy to help select a monetary equilibrium and a rather prosaic one to help raise a convenient source of finance for government business look the same.

The authorities don’t explain the conditionality of tax demands openly.  Tax demands are not accompanied with riders that say ‘if the monetary framework and therefore the value of money were to implode between now and when your tax payments fall due, we may ask for payment in something else’.  This is because – I assert – if those riders were inserted, they fear it might unsettle confidence in money and make the highly unlikely implosion of the monetary equilibrium somewhat more likely.

Why is the tax demand/promise not unconditional?

If society turned against money for some reason, right or wrong, the government’s own best interests, whether those coincide with its citizens or not, would ultimately be served by taking what was useful to it in executing its business;  it will have civil servants, teachers, doctors and nurses and soldiers to pay.  If they want – or rather need – something other than fiat currency, in extremis, to manage their own affairs, they will get it, because if they do not the government will not be able to fulfil its basic obligations to maintain public services and law and order.  The analyst piping up about defending the old monetary order will be drowned out by the overwhelming need to pay and feed people.

Indeed, it’s possible to conceive that society turns away from fiat money and towards one of the crypto currencies.  Not very likely, given the protocols used to manage their supply, which induce high price volatility, and many other reasons right now.  But for the sake of our argument here, if society did turn to crypto currencies to do its record keeping, the government would, eventually, have to give in and accept crypto in lieu of taxes.

Thus, government behaviour here is codetermined with, and not the ultimate determinant of the value of the fiat money it issues.  Money is not treated as an asset solely because the government treats it as a liability.  It is at the same time true that governments treat money as a liability because others treat it as an asset.  Both behaviours emerge from successful management of the fiat supply protocol and the magic of equilibrium selection!

This same debate crops up in discussions of the merits and dangers of helicopter money.

I wrote about this before, but to recap:  helicopter money proponents have railed against their adversaries for asserting that since money is a ‘liability’, dropping loads of it on the private sector cannot have a wealth effect, and stores up trouble for the authorities.  [Echoing those that argue that helicopter drops of bonds would not be net wealth for those who catch them]. The assertion that money is a liability is sometimes linked to the fact that currently it is accepted as such in lieu of taxes [money deducts from its assets, tax claims, and hence is treated as a liability].

Repeating the argument I made above, I would argue that money may be treated as a liability currently, but only because the authorities know that its creditors will treat it as an asset subsequently.  And this is a behaviour that emerges in response to the current monetary framework and how it is operated.  Not one that would be expected to obtain regardless, unconditionally.  Money may seem like a liability now, but perhaps not in the future, and relevantly perhaps not after several large and unusual doses of helicopter money.



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Bloomberg View column on BoE fan charts

Latest column with Richard Barwell, once again arguing that the BoE should publish interest rate and QE fan charts based on its estimate of what it would do given how it sees the world developing.

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1p/2p/…/£50 = a/b/…/c as a nominal anchor that does not require measuring the price level

Here is a new post on FT’s Alphaville blog on this topic. It is somewhat crackpot. If anyone knows whether this has already been formalised please let me know.  Asking for a friend.

One thing that did not make the editor’s cut there is this….

Recapping, the basic idea is to get the central bank to target the voluntarily held denomination ratio, which I think is equivalent to it targeting the price level.

Why do this?  I don’t know.  Maybe the whole monetary framework is just not believable for some reason and we are hunting around for a reason to keep the 1p.

Bonkers though this idea is, it has one thing commending it, that denomination ratio targeting doesn’t require measuring the price level.  All it requires is being able to measure the exact number of each denominations that have been issued, which is standard business management for a Mint or Note Issue department.  This is intriguing because in modern economies we worry about our ability to measure prices when the product mix or quality of goods is changing a lot.  The advent of smartphones, apps and all the rest of it has posed just that question about our statistics. [Is the productivity puzzle a fact or an artefact?]

Having the BoE target both the denomination mix and conduct the note issue might not look good, however, as it would have an incentive to force the note mix on the private sector if outcomes were not looking good.

So that suggests delegating the note issue to a fully independent Mint [ie a Mint that would have to be as separate from the Treasury and the BoE as the current BoE is from the Treasury].  This opens up a Pandora’s Box of consequential institutional technicalities to make sure that only the BoE can do monetary policy and LOLR.  Probably something for another post.

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Here is my New Statesman post on the idea of abolishing the 1p.

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Alphaville post on the Venezuelan Petro

ICYMI:  guest post on the Petro and the Assignat.

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MPC not as split over £ as they made themselves out to be

Wednesday’s Treasury Committee hearing with the Bank of England’s Monetary Policy Committee featured an apparent squabble over whether exchange rate depreciations ‘worked’ or not.  It reads like something we could set students.  ‘OK who is wrong here, if anyone, and why?’

Andrew Haldane said, uncontroversially:  “A combination of the weaker pound, and a stronger global economy, has worked its magic…..  Depreciations work.  And that’s how they work.”

Prompted by MP Alistair Jack, Sylvana Tenreyro commented:   “[in Argentina [Jack’s words]] depreciations make people poorer.”

Mark Carney seemed to take Tenreyro’s side:   “Depreciations don’t work. They have an economic effect, but they’re not a good economic strategy.  They may be an outcome of various things… but it’s how you make yourself poorer.”

Students of open economy macro would probably find this fight confusing.  Everyone is right.  We might reasonably suppose – just as the Bank itself has – that the fall in Sterling after the EU Referendum result in June 2016 was prompted by i) a rise in the risk premium, on account of increased uncertainty about the near and long-term outlook, ii) a revision down to expected long term income per head in the UK [thus the real exchange rate] and expectations of looser monetary policy.

The combination of underlying causes that led to the depreciation [Brexit, basically] will make us poorer;  and the depreciation won’t alter that.  But the monetary policy response which in part prompted the depreciation will mean higher income per head along the transition.  So to that end Andy Haldane was right – they do work, which is why the MPC consciously engineered one. They don’t leave us better off than in the counter-factual situation in which the UK had voted Remain.  But they leave us better of than if MPC had attempted to fight to maintain the old level of Sterling.  In that case, we would be poorer along the necessary, unavoidable transition;  if they continued to try to do this, we might be very much poorer, and we would quite likely see a large recession and associated undershoot of the inflation target.

I doubt that Haldane, Carney and Tenreyro disagree about this at all.  But in the heat of the moment, Carney in particular seemed to turn the exchange into a fight.

All this has to be taken with a pinch of salt, of course, since DSGE macro has had questions asked of it of late;  and open economy macro was anyway more famous than most sub-fields for its long list of ‘puzzles’.  But this is how the BoE thinks about it, and is what is buried in the workings of the BoE’s forecasting platform COMPASS.

If I was still a staffer, I’d be urging one of the senior MPC members to rehearse a clear up of this mess, and refresh the commentariat’s understanding of how they think the exchange rate bears on monetary policy under inflation targeting.  It’s quite an important part of the framework, and it is necessary on occasion to deflect opposition to it from those with long enough memories to wish we still did target Sterling, and others with a tendency to view Sterling’s level as a matter of national pride, and anything that undermines it – eg nasty Remoaner monetary policy makers – as part of the problem.

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New Statesman blogs on 2nd Referendum and the inevitable bad politics of Brexit

In case you missed these posts on New Statesman’s The Staggers blog:

On the chances of Remain winning a 2nd Brexit referendum.

And on why the ‘could have done better’ theory of Theresa May’s government, a theory beloved of those like David Allen Green, misses the inevitability of the impasse embedded in the Leave vote.


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