Sunday, July 10, 2011

Why is there a $20 bill sitting on the sidewalk?

Economists like to say that there's no such thing as $20 bills lying on sidewalks. They just don't exist, because people pick them up. Put it this way - if you see a $20 bill lying on the sidewalk of a pretty busy street you at least stop and puzzle over its existence.

I feel like I muddied the waters in this post by mentioning free banking at all, which people got defensive about - so let's forget free banking. Forget I even mentioned the term. I really want to try to get the point out again and get an answer.

As far as I know, you're not allowed to counterfeit American currency, but there's no law preventing people from circulating competing currencies. In the current situation, where a wide swath of people agree there is considerable excess demand for a medium of exchange, why don't market forces introduce a competing currency? Like the $20 bill sitting on the sidewalk, explaining why this is not happening should interest us.

Bitcoin demonstrates there's some market recognition of money demand. But Bitcoin is like a person walking by, picking up the $20 bill, and then leaving $19.50 in change back on the sidewalk.

Forget free banking - what is going on here?

I have a good sense of Gary's answer - what do others think?

10 comments:

  1. Well, forgetting all the legal murkiness of alternative currencies ...

    What you ought to ask is why we have what we have. I can think of plenty of stuff I would like to see invented, etc. (personal jetpacks, all kinds of cyberpunk devices, etc.), but they are either slow to develop or they don't come along at all. Human beings are often prone to status bias in other words, and the factors involved in that seem like a decent (if not complete) explanation.

    Plus a centralized, uniform currency is something that has not been around for very long (a little over a hundred years at best?) - even if governments have been manipulating the money supply for far longer. So if something hasn't been developed yet to compete with that notion my suggestion is to give it time.

    Is that the sort of answer you expected?

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  2. "In the current situation, where a wide swath of people agree there is considerable excess demand for a medium of exchange, why don't market forces introduce a competing currency?"

    I'm clearly not reading the same people you are, but I must point out (based on what I've been reading) that a demand for money is not necessarily a demand for a "medium of exchange." If the demand for money is for a store of value (commodity bubble anyone?) then Ithaca dollars ain't gonna satisfy it.

    Put it another way: all of my credit cards are offering me 12-15 months of 0% interest. That can be thought of as a competing currency (in that it's not M0). Do I take the offers? No, because my demand for money isn't to buy things at this point. Now, I've been thinking about taking these offers and buying CDs with the money, but at the amounts of my credit limits, it hardly seems worth it.

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  3. re: "a demand for money is not necessarily a demand for a "medium of exchange." If the demand for money is for a store of value (commodity bubble anyone?) then Ithaca dollars ain't gonna satisfy it."

    Of course it's not necessarily a demand for a medium of exchange, but I would think if a competing currency could only supply a medium of exchange function and not a store of value function, the whole point is it's not a very successful competing currency. So why aren't we seeing the emergence of competing currencies that can supply all three functions? What's preventing this, and what ought we to infer from it?

    I'm not sure I understand your credit card point... it's a debt instrument, but it's still in existing currencies.

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  4. It might just not be profitable to go through the trouble of creating a new medium of exchange for a bank. The bank either has to tie the value of the medium of exchange to the value of some commodity, which means that this currency has to develop naturally on the market over time. Or, the bank can tie the value to the dollar. But, then the bank might just prefer to operate in dollars, since for the bank in the short-run trading in either currency is effectively the same (except that the value of their new currency will be volatile early on, as the demand for it picks up).

    It's also worth considering that most banks have some type of connection to the central banking system, and so the perks of operating within that cartel might be greater than the perks of operating independently.

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  5. Network effects. (maybe i'm misusing the term).

    Anyway, in order to adopt a new currency, I'd first want to know that there was something that I wanted that could be purchased with the currency, or, next best, something that lots of my neighbors want to buy.

    Company scrip has an advantage this way, as long as the company produces something widely desirable, like food, heating fuel, or maybe jewelry, tobacco, or coffee.

    Foodstamps have some characteristics of currency for this reason.

    MMT people say that US dollars derive their value from their acceptance as payment of federal taxes.

    Anyway, it's a tough obstacle to overcome, if you don't already produce some desireable commodity.

    But why doesn't ford motor come out with "ford bucks" is the question.

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  6. Efficient markets is a good reason to think twice about bitcoin, that and common sense. There's also a theory by schumpeter that entrepreneurship comes to be more internalized over time. I'd like to see how competing currencies facilitate new productions before I would think it was a good idea.

    --successfulbuid

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  7. There is a law preventing people from circulating competing coins. Some guy in Kentucky, I think, last year was sent to jail for minting and circulating cilver coins. The US attorney called him a domestic terrorist.

    The desire for competition in currency is aimed at spreading value around so one party can't gain a monopoly over the monetary system. We've become accustomed to thinking the government should control our money, but many people (probably none at this blog) don't realize this is a strategic goal for governments in general. Today I think we would say it's a libertarian goal to separate the government from the money production business.

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  8. Daniel,

    I'm going to post something on this, I expect it will fall into your spam filter. I've got myself a google account, which I hope should prevent that happening so often.

    If you're interested in debating it I've a post on ABCT in the thread on that in your filter.

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  9. I agree that at least during the earlier part of the recession, though perhaps not now, there was an excess demand for money.

    To begin with we have to consider what money is. When economists and ordinary people talk about money they mean the medium-of-exchange, today that means notes and coins for small transactions and transfers of bank balances for large transactions. Things like "Bitcoins" are not really money, they are at the most an attempt to create a new form of money and not so far a successful one.

    Notes and coins are relatively unimportant in todays economy. In many countries the state has monopoly privileges on issuing them. This isn't always true, in some places types of local money have been created by private groups such as charities and federations of local businesses. Banks are generally not able to issue notes as they once did, as far as I know this applies to the US, UK and Europe. As Toby Baxendale often points out normal companies must "keep their short-term creditors whole". They can only produce a banknote if they hold a matching short-term liabilities, so they have little or no incentive to create money. In Scotland which is one of the last places where banks can still issue notes the quantity of those notes is controlled by the Bank of England.

    The local currency movement seems to be growing, though it's difficult to get good figures. The question may be asked: why didn't local currency issuers create more money? I think the answer lies in the dominant network effects of state currency. Now state issued notes and coins are accepted everywhere and most customers use them there is little incentive for either normal people or businesses to support alternative currencies. There isn't just one "stable equilibrium" here, as Scotland shows, if other types of banknote are important enough and safe enough then vendors will support them. Past historical examples show that when banks and other businesses are allowed to compete in the currency market then privately issued note and coins are likely to arise.

    All this said, notes and coins are not as important today as they were, our principle form of money today is the bank balance. Bank balances are created by fractional reserve banks which are private institutions. Normal businesses can create accounts for their customers and often do. The accounting law mentioned above means that normal companies have no more incentive to create balanced for general use than they do to create notes or coins. This leads to the question: why didn't these banks create more money? In my opinion this is the interesting question.

    In many countries banks must be part of the central banking system. I don't know if it's still possible in the US to run a commercial bank that isn't a member of the Federal Reserve system, but even if it is there are great disadvantages to doing that. The central banks limit the amount of money that the commercial banks can create through regulatory requirements, such as the reserve requirement and capital requirements. But, this doesn't give an explanation, at present and throughout the crisis the banks have held much greater reserves than necessary. The banks are not limited by the reserve requirement, in fact as many commentators have pointed out, if they were to loan more then the money supply would quickly explode.

    The reason the banks did not expand the money supply in 2008-2010 and are not doing so greatly now is that they're finances are very fragile. Before the crisis many of them, in the US, UK and Europe, invested in CDOs and CLOs that went bad. There were losses on conventional property loans such as those in Ireland and on loans to other banks involved in these investments. Since banks need assets to back current account balances this is a major problem.

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  10. continued...

    I'm an advocate of the Austrian Business Cycle Theory and I think it provides the best explanation of the last boom and bust. The toxic assets on the balance sheets of banks are the result of misallocation of capital. Some is be due to the secondary effects of the ensuing recession too. In my opinion too ask for the commercial banking system to deal with this is too much. Commercial banks can't know for certain when monetary expansion is going to cause a bust. The market interest rate doesn't easily provide information about the stance of monetary policy. The inflation brought about by an creation of money supply beyond demand doesn't immediately manifest itself in price inflation. As a result banks can't protect themselves from ABCT busts.

    I don't want to rely too much on ABCT though. Existing commercial banks suffer from a lack of assets which prevents them from creating money. Why then don't other businesses that own safe assets start up commercial banks? The problem here is that the regulatory obstacles are large. In the US there are many regulatory bodies that must approve the creation of a bank. A Federal Reserve bank must obey Federal reserve regulations, there are state banking regulations, FDIC regulations and regulations issued by the comptroller of the currency. There are also market issues, such as obtaining membership of clearinghouse networks and creating a structure of branches. The problem any company faces is that they must fulfil their regulatory obligations before the recession is over and the opportunity disappears. Despite this issue some have tried, Wal-Mart have tried several times to acquire a US banking license, but they have failed. The most plausible explanation for this is that incumbent banks have leaned on the regulators to prevent Wal-Mart from entering the market. This is interesting because of what it shows about US monetary policy. Many have argued that the Federal Reserve can't expand because the commercial banks won't expand lending. To the extent that this is true it concentrates too much on existing commericial banks. If new entrants were allowed into the market they would not be in the dire financial situation that the existing banks are and would be in a much better position to lend. If it were not for the bailouts starting a new commercial bank would be simpler, a business wishing to start a new bank could buy a bankrupt bank and use it's branch network and access to clearinghouses.

    The bailouts have caused a strange situation to develop. The existing commercial banks are perhaps not Zombie banks in the technical sense - banks with less than zero net worth. But, they are in such a precarious situation that they can't make many new loans. What preoccupies them is the performance of existing loans. Had they not being bailed out so extensively at the beginning of the crisis this wouldn't have happened.

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