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Showing posts from January, 2012

Why Does Fiat Money Have Value?

Money issued by modern-day governments and central banks is not convertible into a commodity (e.g., gold or silver).Notes and coins have minimal intrinsic value (see picture below for one suggestion), but they are made legal tender by ‘fiat’ or order of the government.But why do we accept worthless pieces of paper or deposits convertible into worthless pieces of paper?
According to Larry White, people accept fiat money because when the convertibility of government money into gold was abolished, the fiat money retained the old specie unit of account (e.g., pound sterling).In effect, nothing had changed and the practice of accepting them was self-reinforcing.
Others argue that fiat money has value (and is therefore demanded) because of its usefulness as a medium of exchange.In others words, fiat money has value because others will accept it as a medium of exchange (there is a network effect in operation here).However, the late Earl Thompson saw that there was a backwards induction probl…

Kodak's Final Moment

As someone who is interested in the long run, the bankruptcy of Kodak raises some interesting questions.  Kodak, in its prime, was a very profitable business, with one of the most recognizable brands in the world.  Its main product during its 138-year history was film for handheld cameras, a market which it dominated and which had large margins.  However, the development of the digital camera and mobile phones with in-built cameras has resulted in a huge decline in demand for film.  Although Kodak was instrumental in developing digital camera technology, this industry was very competitive and had low margins.  Could Kodak have avoided bankruptcy by moving into different product markets?  Can old-technology firms transform themselves into new-technology firms? Should Kodak's shareholders and managers have wound their business up voluntarily a decade ago?
As someone who has studied companies in the nineteenth century, I have a unique perspective on company longevity.  Few of the top …

Mitt Romney's Income

Slate has a neat widget which allows you to calculate how long it takes Mitt Romney to earn your income.  Wealthy individuals have run for the Presidency before, but Romney could be the first mega-wealthy person from the financial elite to run for President.  BTW, last week's Economist has an interesting article on how the rise of the 1% is closely associated with the rise of the new financial elite - click here.    


Do We Still Need Central Banks?

In the previous post, we discussed the Thompsonian view on central banks.  In this view, central banks are needed to raise emergency war finance.  However, with the emergence of the US nuclear umbrella and nuclear technology, nations have less need for emergency war finance.  So do we still need central banks?
According to David Glasner, given this decline in the need for emergency war finance, policy-makers should consider introducing a competitive currency or free banking system.  Click here for Glasner's book.
According to Thompson and Hickson, we may still need central banks due to internal threats (including natural disasters) and nuclear threats from rogue nations.However, central banks are no longer on the gold standard, with the result that their ability to raise emergency war finance is highly constrained.According to Thompson, writing 20 years ago, this ultimately means that “the increasing emergency usefulness of wealthy individuals relative to ordinary civilians will ine…

Free Banking and the Rationale for Central Banks

If free banking is so great and has worked in the past, why then did central banks develop?  Free bankers answer this question by arguing that central banks generate seignorage revenue for governments, thus central banks exist for a fiscal reason.  Although this may be the case for some developing economies, central banks generate relatively little income in economies with sophisticated tax-raising bureaucracies.
The mainstream and dominant view is that central banks exist to stabilise the financial system, which is prone to episodic crises.  Central banks are believed to stabilise the economy by providing liquidity to individual institutions as well as the system as a whole.  As central banks can essentially print money, they are able to create such liquidity almost ex nihilo.  The problem with this view is that historical banking systems were relatively stable even without a central bank.  In addition, the ongoing financial crisis occurred despite (and maybe because of) the existence…

Financial Crises as Art

My colleague, Ronan Gallagher, has forwarded me a link to a company which is selling a graphic entitled Cycles of Financial Crises 1810 to 2010.  This graphic is based on Reinhart and Rogoff's This Time is Different: Eight Centuries of Financial Folly.  Various frames and mounting options are available!

Will US Default on its Debt?

I have just received the current issue of Econ Journal Watch, which is a Symposium on the US Sovereign Debt Crisis.  Click here to see this issue of EJW.  Tyler Cowen, in his introductory remarks, suggests that the US will experience a debt crisis within the next one or two decades.  The US federal government is currently borrowing 40 cents of every dollar its spends - is this really sustainable in the long run?  I don't think we will see a total default by the US, but a partial one, with the Fed attempting to raise the inflation rate.


The Overclass

Charles Murray, the libertarian sociologist, is well-known (notorious in some quarters) for his work on the underclass.  Coming Apart, his new book, out at the end of this month, focuses on the troubling phenomenon of the overclass in the United States.  Here is an excerpt from a Daily Telegraph article on Murray's new book:
Murray exposes how the new United States upper class, which he labels a “cognitive elite”, has developed an hereditary stranglehold over the top professions and management positions. The brightest people tend to marry each other, then ensure that their offspring get to the best schools and universities, with the result that, to quote Murray: “The parents of the upper-middle class now produce a disproportionate number of the smartest children.”
These gilded families then inter-marry and socialise together, living in the same areas, creating a phenomenon which Murray labels “super zips” – the 800-plus richest and most desirable postal codes in the United States,…

Ron Paul at Cato

Here is a 20-minute video of Ron Paul's recent speech on monetary policy at the Cato Institute.


I have also included a short clip of Ron Paul berating John McCain and Mitt Romney back in 2008 on the Iraq War.  I can see why he is so popular with many voters!

Free Banking Experiments

Free banking may be a neat theory, but is there any evidence that it would work in practice?Are there historical examples of successful free banking systems?
Before we answer these questions, we need to define what we mean by success.We could use some or all of the following criteria: the absence of banking instability, a stable purchasing power of money, and efficient channelling of funds from savers to borrowers.As the third criteria is difficult to evaluate, scholars typically focus on the first two.
We also have to define what we mean by free banking as there are some Austrians, such as Murray Rothbard, who argue that free banking means privately-issued bank currency should be backed 100% by gold, whereas others, such as Larry White, argue that banks in a free banking system can have a fractional reserve i.e., bank deposits do not have to hold £1 of gold in reserve for every £1 of deposits.As historical examples of the former are extremely rare and belong to primitive financial syst…

Romney and the 99%

With Romney leading the pack for the Republican nomination, it is germane to ask what is his take on the inequality in American society?  Romney is part of the 1% - he sees a $360,000 income as peanuts (click here).  But more telling is his view that concern about inequality is simply down to envy!  This reveals how out of touch he actually is.  The United States fought the War of Independence to rid itself of an aristocratic elite.  From across the Atlantic, it looks like aristocracy is coming back into vogue.  

Free Banking and Gold

The type of free banking espoused by Ron Paul and Larry White has bank money convertible into gold.  In other words, gold is the base money.   Chris Colvin (a future colleague and reader of this blog) emailed me to ask whether a gold standard is essential for free banking.  Chris, like many other economic historians, has problems with the costs of the classical gold standard, particularly in the inter-war period.  The classical gold standard is often criticised for driving the business cycle and generating real income instability.  The economic decline suffered by economies after they came back unto gold after periods of conflict was particularly severe.
How would a free banker reply to this criticism?  Larry White argues that banking systems were "regulated in ways that almost surely contributed to monetary instability.  It would be necessary to disentangle these regulatory effects from any instability due to the gold standard itself" (Theory of Monetary Institutions, pp.4…

Books on the Financial Crisis

Andrew Lo (MIT) has written a book review for a forthcoming issue of the Journal of Economic Literature.  His review takes in 21 book written about the ongoing financial crisis.  You can obtain his article here.


Free Banking vs Central Banking

Why do free bankers believe that central banks should be abolished and that banks should be free to issue competitive currency? 
1. According to Carl Menger and free bankers, money has evolved organically over time.  Gradually, human societies adopted precious commodities such as gold and silver as their medium of exchange or money.  In this Mengerian story of the evolution of money, there is no role for government - “money is not an invention of the state.  It is not the product of a legislative act” (Carl Menger, “On the Origin of Money”)
2. Free bankers argue that the reason governments establish central banks is financial self-interest.  The early central banks (Bank of England and Banque de France) were clearly set up for fiscal reasons as they had to invest most of their capital in government bonds and provide cheap finance whenever required.  According to free bankers, this is the only rationale for central banks.  The mainstream view on central banks is that they exist to stab…

Ron Paul and Austrian Economics

Ron Paul came second in New Hampshire last night.   Matthew Yglesias over at Slate has an interesting piece on Paul's adherence to Austrian economics - click here.  There is a suggestion that Paul is simply using the primaries as a platform to advance his libertarian views.  It seems to be working because Austrian economics is now getting a worldwide audience thanks to Paul.

Free Banking: An Introduction

Over the next number of posts, I will be discussing the subject of 'free banking', the idea espoused by Ron Paul.  I had the privilege to be taught a graduate course on money and banking by Lawrence H. White (George Mason University), the leading exponent of free banking.  You can get Larry’s books on monetary theory and free banking here and here.
Free bankers are Austrian economists.  That doesn't mean that they are from Vienna, but it refers to the fact that the founding fathers of Austrian economics (Carl Menger, Eugen Böhm-Bawerk, Ludwig von Mises, Frederick Hayek etc.) all came from Austria.  The Austrian School emphasises methodological individualism, laissez-faire policy, the primacy of the price mechanism and economic liberty.  You can learn more about Austrian economics by clicking here.  See also a previous post on Keynes vs Hayek.

Free bankers believe that governments play no role in the money supply; rather money should be supplied by banks operating in competit…

Ronald Coase on China's Economic Transformation

As a graduate student, I was introduced to the influential work of Ronald Coase, the Nobel-prize-winning economist.  Coase was 101 at the end of December and, incredibly, is still active.  Here is a video of him giving a speech, just before his 101st birthday, on China's amazing transformation over the past three decades (hat tip to my colleague Graham Brownlow).

Ron Paul and the Wizard of Oz

The most viewed post on my blog in 2011 was "The Wizard of Oz".  I wonder what this says about the blog's followers?  Are they monetary cranks who would like to see a bimetallic monetary standard introduced or are they simply amused by the allegorical nature of one of their favourite movies?
Talking about monetary cranks, Ron Paul, who is campaigning for the Republican Presidential nomination, favours abolishing the Fed and bringing back the Gold Standard (i.e., the system where gold backs the currency and money issued by banks) - see the short video clip below for an interview with Ron Paul on this issue.   You can read Simon Johnson's critique of Paul's proposals here
Over the next few weeks, I will be blogging about Paul's "free banking" proposal and the economics which underlies its.