China’s Monetary Tradition and the Origins of Money

Written by Joseph T. Salerno

In the introduction to this book, first published in English in 2010, I wrote: “The idea of sound money was present from the very beginning of modern monetary theory in the works of the sixteenth-century Spanish Scholastics….” Recent research has shown that the seeds of the theory of sound money were already present in Chinese writings centuries before the Scholastics.1

China was one of the first countries to develop a metallic money that was valued and exchanged by weight. Evidence suggests that this monetary regime originated during the Shang Dynasty (1766–1122 BC) or the Zhou Dynasty (1122–221 BC). China was also one of the first countries to use precious metals as money and may have invented coined money. The long experience with a purely metallic monetary system naturally stimulated Chinese state officials, royal advisers, and philosophers to investigate and debate the origins and functioning of such a system and the policies appropriate to its smooth operation. It is therefore not surprising that China developed a rich tradition of monetary thought, which extended over nineteen centuries (roughly 700 BC to 1200 AD). This literature on monetary theory and policy embodied ideas, insights, and controversies that would appear in European writings only centuries later. In particular, some contributors to this Chinese monetary tradition formulated the conceptual foundations of the theory of sound money, the topic of the present book.

While ideas about the development of money were expressed as early as the seventh century BC, the most prevalent view of money’s origin is attributable to a politician of the sixth century BC. Shan Qi (b. 585 BC) contended that money was invented by one of the ancient philosopher-kings to measure the value of goods. However, several Chinese writers later disputed this story and argued that money originated as a market phenomenon. Sima Qian (104~91 BC), Luo Mi (1165~1173 AD) and Ye Shi (1150~223 AD) basically argued that money grew out of the trading of commodities and could not have emerged in the absence of commodity exchange. Money was only later adopted by kings as an aid in ruling their countries. 

The first step in theorizing correctly about money is to understand that the value of money, like that of commodities, is never fixed and unchanging. Chinese philosophers who published the earlier Mohist Canons(468 BC~376 BC) grasped this crucial point. They recognized that metallic money, such as the “knife coins” then in wide circulation, was valued and exchanged by weight and argued that the real value of money, despite its fixed face value, was not stable but fluctuated inversely with the prices of commodities. When commodity prices were high, money was “light” or its purchasing power low; when prices were low, money was “heavy” or its purchasing power high. Thus, if monetary conditions were such that the nominal prices of commodities were abnormally high, the real prices of commodities were not high but rather money was “light” or depreciated.

In investigating the market conditions that determined the purchasing power of money, two eighth-century Chinese writers, Liu Zhi (734 AD) and Lu Zhi (794 AD), clearly formulated the quantity, or supply-and-demand, theory of money—eight centuries before the theory was introduced into European thought by Jean Bodin and the Spanish Scholastics. Liu Zhi argued that if population grew more rapidly than the money supply, the purchasing power of money would rise. Zhi reasoned that the growth of population would produce an increase in the labor force and, therefore, in the supply of commodities. As a result, the demand for money would grow in excess of supply and raise the purchasing power of money. He also deduced that high prices were a result of an “excess” of money and advocated a reduction in the quantity of money to increase its purchasing power. Liu Zhi’s contemporary Lu Zhi argued similarly that the quantity of money is a prime factor determining the prices of goods and the purchasing power of money. Thus, goods are cheap and money “heavy” when the quantity of money is relatively small, whereas goods are expensive and money “light” when the quantity of money is large. Lu Zhi inferred from his theory that government is therefore able to affect the height of prices by altering the quantity of money. 

Chinese monetary writers also focused on the proper institutional arrangements for coining money, because coinage affected the quantity and quality of money in the economy. At least four major debates on the coinage question occurred during the period 175 BC–734 AD. The main point at issue was whether the coining of money should be a private and decentralized business or a royal prerogative monopolized by the central government. Of great interest is the fact that in the third (457 AD) and fourth (734 AD) debates government ministers heroically proposed private coinage as a means of ridding the realm of a shortage of money.

My book is a small contribution to this great Sino-European tradition of sound monetary theory. I hope that its translation sparks interest among contemporary Chinese scholars in recovering and extending this tradition as first presented in the brilliant writings of their ancient predecessors. 

1.Zheng Xueyi, Yaguang Zhang, and John Whalley, “Monetary Theory from a Chinese Historical Perspective” (NBER Working Paper 16092, June 2010). The following discussion is drawn from this research paper.

Fed Drains $485 Billion in Liquidity from Market via Reverse Repos, Undoing 4 Months of QE, Even as QE Continues, Total Assets Near $8 Trillion

Article written by Wolf Richter of Wolf Street

May 27, 2021

This morning, the Fed sold a record $485 billion in Treasury securities via overnight “reverse repos” to 50 counterparties, beating the prior record set on December 31, 2015. These overnight reverse repos will mature and unwind tomorrow morning. Today, yesterday’s $450 billion in overnight reverse repos matured and unwound, and were more than replaced with this new batch of $485 billion in overnight reverse repos.

Reverse repos are liabilities on the Fed’s balance sheet. They’re the opposite of repos, which are assets. With these reverse repos, the Fed is sellingTreasury securities to counterparties and is taking their cash, thereby massively draining liquidity from the market – the opposite effect of QE.

In past years of large reserves following QE, banks shed reserves via reverse repos, reducing reserves on the balance sheet and increasing their Treasury holdings, to dress up their balance sheet at the end of the quarter, and particularly at the end of the year. Reverse repos declined after the Fed started reducing its assets during Quantitative Tightening in 2018 and 2019. But the current record spike is taking place in the middle of the quarter, a sign that the enormous amount of liquidity is going haywire:

This is a crazy situation that the Fed backed into.

Even as liquidity is going haywire, and as the Fed trying to deal with it via reverse repos, the Fed is still buying about $120 billion per month in Treasury securities and mortgage-backed securities, thereby adding liquidity.

But with its reverse repos of $485 billion, the Fed undid four months of QE!

The Fed could stop buying securities altogether and reduce its balance sheet, which would also drain liquidity from the market. But the Fed cannot do that because it said it would be slow and deliberate in announcing changes in its monetary policy, and that it might eventually talk about talking about tapering, so it can’t just suddenly do an about-face.

But this liquidity-haywire situation appears to be an emergency that needs to be addressed now, and so the Fed is addressing it through the backdoor via the overnight reverse repos.

At the same time, the Fed continues QE. Its total assets were of $7.90 trillion on its balance sheet as of May 26, released today, were down by $19 billion from the record last week, following the typical pattern. These assets include $5.09 trillion in Treasury securities and $2.24 trillion in mortgage-backed securities (MBS):

The Fed has discussed this liquidity issue during the last FOMC meeting and summarized some of the discussions in its meeting minutes. It noted that “a modest amount of trading” in the reverse repo market took place at negative yields, meaning that there is so much demand for Treasury securities, and so much liquidity chasing them, that the holders of liquidity were willing to lose money to obtain Treasury securities. This threatens to push related rates into the negative, such as SOFR (Secured Overnight Financing Rate) which is the Fed’s reference rate to replace LIBOR.

The Fed, sitting on $5.09 trillion in Treasury securities, has been stepping into the reverse repo market, selling Treasuries overnight to satisfy this demand for Treasuries and keep yields from meandering below zero.

The tsunami of liquidity.

Everyone has their own theory as to why there is so much demand for Treasury securities. But one thing we know: the banking system is creaking under a huge amount of liquidity.

Bank reserves on deposit at the Fed – a liability on the Fed’s balance sheet, money that the Fed owes the banks and that it pays the banks currently 0.1% interest on – ballooned to a record of $3.98 trillion on April 14 and have since then zigzagged down a smidgen. On the Fed’s balance sheet released today, they were at $3.81 trillion. This is a sign of just how much liquidity banks are swimming in:

The drawdown of the Treasury General Account.

The government sold a gigantic amount of debt last spring, adding $3 trillion to its debt in a few months and kept the unspent amounts in its checking account – the General Treasury Account or GTA at the Fed, which is a liability for the Fed, money that it owes the US Treasury. The balance in the GTA ballooned to $1.8 trillion by July 2020, compared to the pre-crisis range between $100 billion and $400 billion.

The Mnuchin Treasury started spending down the balance in the checking account by borrowing a little less. By early January, the GTA was down to $1.6 trillion.

The Yellen Treasury formalized the drawdown and in early February announced that it would bring the balance down to $500 billion by June. This turned out to be too much too fast, and it now looks like August will be the month when the drawdown reaches the $500 billion mark.

On the balance sheet the Fed released today, the balance as of May 26 was down to $779 billion. Down by $821 billion since February, $279 billion to go:

The drawdown of the GTA has some implications for the markets: this is money that the government will spend but doesn’t have to collect in taxes or borrow; it already borrowed it in March through June last year. And the Fed mopped up this debt with its $3 trillion in asset purchases. So the drawdown means that the government has been spending this money that the Fed had already monetized in the spring last year.

All of this has big implications for the markets. These are huge amounts, in terms of reserves on deposit at the Fed, the drawdown of GTA at the Fed, and now the reverse repos at the Fed, all of them liabilities at the Fed, all of them representing different aspects of the massive flows of liquidity that are now bouncing off the walls.

How Governments Killed the Gold Standard

Article by: Joseph Salerno

The historical embodiment of monetary freedom is the gold standard. The era of its greatest flourishing was not coincidentally the 19th century, the century in which classical liberal ideology reigned, a century of unprecedented material progress and peaceful relations between nations. Unfortunately, the monetary freedom represented by the gold standard, along with many other freedoms of the classical liberal era, was brought to a calamitous end by World War I.

Also, and not so coincidentally, this was the “War to Make the World Safe for Mass Democracy,” a political system which we have all learned by now is the great enemy of freedom in all its social and economic manifestations.

Now, it is true that the gold standard did not disappear overnight, but limped along in weakened form into the early 1930s. But this was not the pre-1914 classical gold standard, in which the actions of private citizens operating on free markets ultimately controlled the supply and value of money and governments had very little influence.

Under this monetary system, if people in one nation demanded more money to carry out more transactions or because they were more uncertain of the future, they would export more goods and financial assets to the rest of the world, while importing less. As a result, additional gold would flow in through a surplus in the balance of payments increasing the nation’s money supply.

Sometimes, private banks tried to inflate the money supply by issuing additional bank notes and deposits, called “fiduciary media,” promising to pay gold but unbacked by gold reserves. They lent these notes and deposits to either businesses or the government. However, as soon as the borrowers spent these additional fractional-reserve notes and deposits, domestic incomes and prices would begin to rise.

As a result, foreigners would reduce their purchases of the nation’s exports, and domestic residents would increase their spending on the relatively cheap foreign imports. Gold would flow out of the coffers of the nation’s banks to finance the resulting trade deficit, as the excess paper notes and checks were returned to their issuers for redemption in gold.

To check this outflow of gold reserves, which made their depositors very nervous, the banks would contract the supply of fiduciary media bringing about a monetary deflation and an ensuing depression.

Temporarily chastened by the experience, banks would refrain from again expanding credit for a while. If the Treasury tried to issue convertible notes only partially backed by gold, as it occasionally did, it too would face these consequences and be forced to restrain its note issue within narrow bounds.

Thus, governments and commercial banks under the gold standard did not have much influence over the money supply in the long run. The only sizable inflations that occurred during the 19th century did so during wartime when almost all belligerent nations would “go off the gold standard.” They did so in order to conceal the staggering costs of war from their citizens by printing money rather than raising taxes to pay for it.

For example, Great Britain experienced a substantial inflation at the beginning of the 19th century during the period of the Napoleonic Wars, when it had suspended the convertibility of the British pound into gold. Likewise, the United States and the Confederate States of America both suffered a devastating hyperinflation during the War for Southern Independence, because both sides issued inconvertible Treasury notes to finance budget deficits. It is because politicians and their privileged banks were unable to tamper with and inflate a gold money that prices in the United States and in Great Britain at the close of the 19th century were roughly the same as they were at the beginning of the century.

Within weeks of the outbreak of World War I, all belligerent nations departed from the gold standard. Needless to say by the war’s end the paper fiat currencies of all these nations were in the throes of inflations of varying degrees of severity, with the German hyperinflation that culminated in 1923 being the worst. To put their currencies back in order and to restore the public’s confidence in them, one country after another reinstituted the gold standard during the 1920s.

Unfortunately, the new gold standard of the 1920s was fundamentally different from the classical gold standard. For one thing, under this latter version, gold coin was not used in daily transactions. In Great Britain, for example, the Bank of England would only redeem pounds in large and expensive bars of gold bullion. But gold bullion was mainly useful for financing international trade transactions.

Other countries such as Germany and the smaller countries of Central and Eastern Europe used gold-convertible foreign currencies such as the US dollar or the pound sterling as reserves for their own domestic currencies. This was called the gold-exchange standard.

While the US dollar was technically redeemable in honest-to-goodness gold coin, banks no longer held reserves in gold coin but in Federal Reserve notes. All gold reserves were centralized, by law, in the hands of the Fed and banks were encouraged to use Fed notes to cash checks and pay for checking and savings deposit withdrawals. This meant that very little gold coin circulated among the public in the 1920s, and residents of all nations came increasingly to view the paper IOUs of their central banks as the ultimate embodiment of the dollar, franc, pound, etc.

This state of affairs gave governments and their central banks much greater leeway for manipulating their national money supplies. The Bank of England, for example, could expand the amount of paper claims to gold pounds through the banking system without fearing a run on its gold reserves for two reasons.

Foreign countries on the gold exchange standard would be willing to pile up the paper pounds that flowed out of Great Britain through its balance of payments deficit and not demand immediate conversion into gold. In fact by issuing their own currency to tourists and exporters in exchange for the increasing quantities of inflated paper pounds, foreign central banks were in effect inflating their own money supplies in lock-step with the Bank of England. This drove up prices in their own countries to the inflated level attained by British prices and put an end to the British deficits.

In effect, this system enabled countries such as Great Britain and the United States to export monetary inflation abroad and to run “a deficit without tears” — that is, a balance-of-payments deficit that does not involve a loss of gold.

But even if gold reserves were to drain out of the vaults of the Bank of England or the Fed to foreign nations, British and US citizens would be disinclined, either by law or by custom, to put further pressure on their respective central banks to stop inflating by threatening bank runs to rid themselves of their depreciating notes and retrieve their rightful property left with the banks for safekeeping.

Unfortunately, contemporary economists and economic historians do not grasp the fundamental difference between the hard-money classical gold standard of the 19th century and the inflationary phony gold standard of the 1920s.

Thus, many admit, if somewhat grudgingly, that the gold standard worked exceedingly well in the 19th century. However, at the same time, they maintain that the gold standard suddenly broke down in the 1920s and 1930s and that this breakdown triggered the Great Depression. Monetary freedom in their minds is forever discredited by the tragic events of the 1930s. The gold standard, whatever its merits in an earlier era, is seen by them as a quaint and outmoded monetary system that has proved it cannot survive the rigors and stresses of a modern economy.

Those who implicate the gold standard as the main culprit in precipitating the events of the 1930s generally fall into one of two groups. One group argues that it was an inherent flaw in the gold standard itself that led to a collapse of the financial system, which in turn dragged the real economy down into depression. Writers in the second group maintain that governments, for social and political reasons, stopped adhering to the so-called rules of the gold standard, and that this initiated the downward spiral into the abyss of the Great Depression.

From either perspective, however, it is clear that the gold standard can never again be trusted to serve as the basis of the world’s monetary system. On the one hand, if it is true that the gold standard is fundamentally flawed, that in itself is a crushing practical argument against the principle of monetary freedom. On the other hand, if the gold standard is in fact a creature of rules contrived by governments, and it is politically impossible for them to follow those rules, then monetary freedom is simply irrelevant from the outset.

The first argument is the Keynesian argument and the second the monetarist argument against the gold standard.

Two recent books have elaborated these arguments against the gold standard. The economic historian Barry Eichengreen published a book in 1992 entitled Golden Fetters: The Gold Standard and the Great Depression.Eichengreen summarized the argument of this book in the following words:

The gold standard of the 1920s set the stage for the Depression of the 1930s by heightening the fragility of the international financial system. The gold standard was the mechanism transmitting the destabilizing impulse from the United States to the rest of the world. The gold standard magnified that initial destabilizing shock. It was the principle obstacle to offsetting action. It was the binding constraint preventing policymakers from averting the failure of banks and containing the spread of financial panic. For all these reason the international gold standard was a central factor in the worldwide Depression. Recovery proved possible, for these same reasons, only after abandoning the gold standard.

According to Eichengreen, then, not only was the gold standard responsible for initiating and internationally propagating the Great Depression, it was also the primary reason why the recovery was delayed for so long.

It was only after governments one after another in the 1930s severed the link between their national currencies and gold that their national economies finally began to recover. This was because, unbound by the rules of the gold standard, governments were now able to bail out their banking systems and run budget deficits financed by bank credit inflation without the constraining fear of losing their gold reserves.

Thus, the phrase “golden fetters” in the title of Eichengreen’s book is a reference to Keynes’s statement in 1931, “There are few Englishman who do not rejoice at the breaking of our gold fetters.”

Of course, what Keynes and Eichengreen fail to understand is that the end of the classical liberal era in 1914 caused the removal from government central banks of the “golden handcuffs” of the genuine gold standard. Were these “golden handcuffs” still in place in the 1920s, central banks would have been rigidly constrained from inflating their money supplies in the first place and the business cycle that culminated in the Great Depression would not have taken place.

A second book that inculpates the gold standard as a leading cause of the Great Depression was published in 1998 and is entitled The Great Depression: An International Disaster of Perverse Economic Policies. According to the authors, Thomas E. Hall and J. David Ferguson, one of the most perverse and destabilizing economic policies of the 1920s involved the Fed violating the rules of the gold standard by allegedly “sterilizing” the inflow of gold from Great Britain.

This means that the Fed refused to pyramid inflated paper dollars on top of these newly acquired gold reserves in quantities sufficient to drive US prices up to the inflated level of British prices. This policy would have made US products more expensive relative to British products on world markets and would have helped mitigate Great Britain’s ongoing loss of gold reserves through its balance-of-payments deficits.

These deficits were the result of the fact that Great Britain had returned to the gold standard after its wartime inflation at the prewar gold parity, which, given the inflated level of domestic prices, significantly overvalued the British pound in terms of the dollar.

These deficits could have been avoided if the British government had either deflated its price level sufficiently or chosen to return to gold at a devalued exchange rate reflecting the true extent of its previous inflation.

Hall and Ferguson, however, ignore these considerations, arguing that when the United States sterilizes gold,

The impact on the system is that Britain bears the brunt of the adjustment. Since the money supply in the United States did not rise, neither did U.S. incomes and prices as they were supposed to, which would have helped Britain eliminate their payments deficit. Since Britain was not aided by rising exports to the United States, Britain must experience a more severe decline in incomes and prices than would have been the case if the U.S. money supply had gone up. In this way Britain would bear the brunt of the adjustment in the form of a more severe recession than would have occurred if the United States had been playing by the rules. Thus it was critical that each country play fair.

Thus, in Hall and Ferguson’s view, the rules of the gold standard dictate that when one central bank irresponsibly engages in monetary inflation and subsequently attempts to maintain an overvalued exchange rate, less inflationary central banks must rush to its aid and expand their own nations’ money supplies in order to prevent it from losing its gold reserves.

But if a nation losing gold due to inept or irresponsible monetary policy can always count on those gaining gold to share “the brunt of the adjustment” by expanding their own money supplies, this is surely a recipe for worldwide inflation.

Now, this line of argument indicates that Hall and Ferguson completely misunderstand the true purpose and function of the gold standard. To begin with, a gold standard functions much better without a central bank, because these institutions, as creatures of politics, are inherently inflationary and tend to promote rather than restrain the inflationary propensities of the fractional-reserve commercial banks.

But, second, under a genuine gold coin standard, the choices of private households and firms effectively control the money supply. As I explained above, if the residents of one nation demand to hold more money for whatever reason, they can obtain the precise quantity of gold coin they require through the balance of payments by temporarily selling more exports and buying fewer imports.

This implies that, if a central bank does exist and it wishes to act in accordance with a genuine gold standard, it should always “sterilize” gold inflows by issuing additional notes and deposits only on the basis of 100 percent gold reserves and insisting that the commercial banks do the same. It should not permit these gold reserves to be used as the basis of a multiple credit expansion by the banking system.

In this way, a nation’s money supply would be completely subject to market forces. By the way, this is precisely how the distribution of the supply of dollars between the different states of the United States is determined today. There is no government agency charged with monitoring and controlling New Jersey’s or Alabama’s money supply.

Hall and Ferguson reveal their uneasiness with and lack of insight into the operation of the money supply process under a genuine gold standard with the following example:

Suppose a fad had swept the nation in 1927 because Calvin Coolidge appeared in public wearing one gold earring. Then every teenager in America wanted to wear a gold earring “just like silent Cal”.… The result would be an [increase] in the commercial demand for gold. Since more gold would be used in earrings less would be available for money.… It would be beyond the power of government to do anything about this fact. What a scary thought, the teenagers of America would have caused the U.S. money supply to decline.

While it is true that the commercial demand for gold does play a role in determining the supply and value of money under a gold standard, it is hardly cause for alarm. Rather, it highlights the important fact that the gold standard evolved on the market from a useful commodity with a preexisting supply and demand and was not the product of a set of arbitrary rules promulgated by governments.

Now, Hall and Ferguson conclude that by breaking the rules of the game and persisting in sterilizing the gold inflows from 1929 to 1933, the Fed caused a monetary deflation in Great Britain and throughout Europe. The nations losing gold were forced to contract their money supplies and this contributed to a financial collapse and a precipitous decline in real economic activity that marked the onset of the Great Depression.

Thus while the authors blame the initiation of the Great Depression on Fed sterilization policies, they attribute its length and severity to the gold standard. According to the authors, as long as European countries remained on the gold standard and US sterilization continued, there could be no end of the Depression in sight. The US gold stock would become a huge pile of sterilized and useless gold. Starting with the British in 1931, our trading partners began to recognize this fact, and one by one they left the gold standard. The Germans and ironically the United States were among the last to leave gold and so were hurt the worst, experiencing the longest and deepest forms of the Depression.

So although Eichengreen emphasizes the gold standard as a restraint on government monetary policy and Hall and Ferguson the failure of governments to play by its rules, in effect, they reach the same conclusion: the gold standard, and with it monetary freedom, stands indicted as a primary cause of the greatest economic catastrophe in history.

In the face of the historical evidence they adduce, can any defense be mounted in favor of the gold standard? The answer is a resounding “yes,” and the defense is as simple as it is impregnable. As I have tried to indicate above, the case against the gold standard is from beginning to end a case of mistaken identity. The genuine gold standard did not fail in the 1920s, because it had already been destroyed by government policies after 1914.

The monetary system that sowed the seeds of the Great Depression in the 1920s was a central-bank-manipulated and inflationary pseudogold standard. It was central banking that failed in the 1920s and stands discredited to this day as the cause of the Great Depression.

A detailed case in support of this view can be found in the works of Murray N. Rothbard, particularly in his book America’s Great Depression and in A History of Money and Banking in the United States: The Colonial Era to World War II.

In these works you will read that the US money supply, properly defined, increased from 1921 to 1928 at the annual rate of 7 percent per year, a rate of monetary inflation that was unseen under the classical gold standard. You will also learn that during the 1920s the Fed, far from operating as the deflationary force on the money supply portrayed by some monetarists, increased the categories of bank reserves within its control at the annual rate of 18 percent per year.

Finally you will read that from 1929 to 1932, the Fed continued to exercise a highly inflationary impact on the money supply, as it feverishly pumped new reserves into the banking system in a vain attempt to ward off the cyclical downturn entailed by its own earlier inflation of the money supply. The Fed was defeated in this endeavor to pump up the money supply and “reflate” prices in the early 1930s by domestic and foreign depositors who reclaimed their rightful property from an inherently bankrupt US banking system. They had suddenly lost confidence in the Fed-controlled monetary system masquerading as a gold standard, when they perceived at last the dwindling prospect of ever redeeming the rapidly expanding mountain of inflated paper claims for their gold dollars.

Currency experts say cryptonotes are in our future

By Arthur L. Friedberg of Coinworld

A paper by Franklin Noll, president of Noll Historical Consulting and an expert on American monetary history, and Andrei Lipkin, a Belarussian consultant on bank notes and cryptocurrency, who originated the term “cryptobanknotes” in 2017, takes a close look at bank notes and how they relate to cryptocurrencies. 

Their conclusion is that the forms of currency are not mutually exclusive. “Smart Banknotes and Cryptobanknotes: Hybrid Banknotes for Central Bank Digital Currencies and Cryptocurrency Payments” is a paper that will be presented at the Seventh Joint Bank of Canada and Payments Canada Symposium on Sept. 16.

The premise is that cash as we know it will not be around forever, but neither will it go away quickly. Bank notes will be around for the foreseeable future, and what is needed is a transitional device to ease the transition from 19th century cash to the digital currency of the future.

The answer is a hybrid bank note — a physical note on paper or polymer that can transfer its value over an electronic network. It would have all the characteristics of a traditional note so it could be used in traditional cash transactions, but when needed, its owner can use the electronic network to transfer the face value off the note.

Two basic forms are envisioned, a smart bank note and a cryptobanknote. Smart notes are further explained here. (I will address cryptonotes next week).

The paper defines a smart bank note as being like a traditional bank note in that it bears intaglio and offset printing on paper or polymer, and like a traditional bank note it can work offline, hand to hand without a network or electricity. The difference from traditional bank notes is that there is the option of using it to transmit its value over an electronic network, letting it act as an electronic payment vehicle.

The smart note would communicate with a network via an embedded radio-frequency identification microchip. When desired, the note’s value can be transferred off the note, for example, by smart phone or point of sale device. Using the same devices, the value of the smart bank note can also be transferred back from a network onto an “empty” or valueless smart banknote. The status of the smart bank note, whether it contains its face value or is empty, is indicated by a tactile and visible icon made of electronic ink. 

This icon could involve an existing design feature or a new one integrated into an existing design. An example authors Noll and Lipkin give is a $10 U.S. smart bank note. The chip, or status icon could be the current Statue of Liberty torch on the bill’s face. If the user wants to make an electronic transaction — say, to their bank account, a relative, or at a place that does not accept cash, the note is touched to a phone and the value is transferred over the network. Since the note is now “empty” of value, the Statue of Liberty torch icon disappears, showing visually and by touch that the smart banknote no longer has value.

To put the value back onto the note, the user can turn it in to a bank or merchant that will recharge it and put it back into circulation. Or, the user can personally do the same thing. Either way, the Statue of Liberty torch would reappear, showing that the note has regained its value, and it can continue circulating hand-to-hand.

A future Federal Reserve note could feature an embedded radio-frequency identification microchip, appearing as a design element similar in appearance to the Liberty torch on the current $10 denomination.Images courtesy of United States Mint.

China Reiterates Cyrpto Bans from 2013 and 2017

Regulators cite the dangers of speculative trading

Article by: Muyao Shen

The National Internet Finance Association of China, the China Banking Association and the Payment and Clearing Association of China reiterated their stance on banning crypto services.

The three entities published a note Tuesday confirming bans originally implemented in 2013 and 2017 that bar financial and payment institutions from providing any services related to cryptocurrency transactions and saying that initial coin offerings remain illegal.

“Virtual currency’s prices have soared and plummeted recently, resulting [in] a rebound of speculative trading activities of virtual currency,” the report said. “It has seriously damaged the safety of the people’s investment and damaged the normal economic and financial orders.”

In 2013, China’s central bank barred financial institutions from handling bitcoin (BTC, +3.35%)transactions, according to a notice from China Securities Regulatory Commission.

And then again in 2017, the central bank in China declared initial coin offerings as illegal, which caused bitcoin’s price to fall.

Robert’s two cents: The last line of this article assumes that was the cause of the price fall. Yet, there is no proof supporting this claim. Its highly possible, in fact more probable, that the market correction with BTC has more to do with its volatility during its growth phase rather than simply one or two persons speaking out against it. This is a fallacious presumption.

Inflation Is Great If You’re Already Rich

Written by Doug French

he 4.2 percent Consumer Price Index (CPI) bounce for April sent a chill through some traders and financial commentators who had expected a tamer number like a 3.6 or 3.9 percent from last year’s covid price level air pocket. 

The MarketWatch headline screamed, “U.S. Inflation Soars in April to Thirteen-Year High, CPI Shows, and Reveals Fresh Stress on the Economy.” Barron’s was slightly more relaxed: “Surging Inflation Is Hammering the Stock Market. Why It Isn’t Time to Panic Just Yet.” Then there was Nobel laureate Paul Krugman, who tweeted, “So, the inflation report wasn’t a nothingburger, but it was sort of a White Castle slider—not a very big deal.”

Before the 4.2 percent print, John Authers posted a piece on Bloomberg, “Markets Give Powell a Break. It May Be Transitory.” “It” being CPI. “Transitory” being a term Powell uses often, a.k.a., “don’t worry, be happy, this too will pass.” 

With all of this teeth gnashing over CPI and money supply, Nobelist Krugman offered up what he calls “Krugman Wonks Out: Return of the Monetary Cockroaches,” where he says, “[C]ockroach ideas, false beliefs that sometimes go away for a while but always come back.” The false belief according to him is that increases in the supply of money lead to inflation, meaning price inflation.

We must remember what Ludwig von Mises wrote, “What people today call inflation is not inflation, i.e., the increase in the quantity of money and money substitutes, but the general rise in commodity prices and wage rates which is the inevitable consequence of inflation. This semantic innovation is by no means harmless.”

So while Chairman Powell claims to be adhering to the Fed’s mandate of stable prices, stable prices in a world with the division of labor and technology running step for step like Affirmed and Alydar in the 1978 Belmont Stakes, prices should be falling, making everyone, especially those at the bottom of the economic food chain better off.

Tragically, Powell sees it another way. Reuters reported the Fed chair as saying that “low inflation hurts American businesses and households and constrains the Fed’s ability to offset economic shocks with easy monetary policy.” Nothing could be further from the truth.

Professor Jörg Guido Hülsmann wrote in Deflation and Liberty,

In a word: the dangers of deflation are chimerical, but its charms are very real. There is absolutely no reason to be concerned about the economic effects of deflation—unless one equates the welfare of the nation with the welfare of its false elites. There are by contrast many reasons to be concerned about both the economic and political consequences of the only alternative to deflation, namely, re-inflation—which is of course nothing but inflation pure and simple.

Given the retirement of the Contra Krugman team of Tom Woods and Bob Murphy, I’m left to point out that what Krugman can’t see must not be. Where’s the hyperinflation, you zombies and monetary cockroaches? He said we cried wolf ten years ago and are doing it again.

Now, he fingers the crypto crowd for the money-printing panic. He claims to be patient, but those who seek escape from the government’s currency and are arguing “[f]iat money is doomed because the Fed won’t stop running the printing press” are wrong, he says, because “nothing like that has happened in the U.S.”

But it has happened and is happening. Murray Rothbard explained, “[A]n increase in the money supply can only dilute the effectiveness of each existing money unit, and therefore must be “inflationary” in the sense of raising prices beyond what they would have been otherwise.”

“What they would have been otherwise” being the key. Were the Weimar Republic or recently Zimbabwe or today’s Venezuela sophisticated economies ripe with technology and the division of labor, creating efficiencies and pushing down prices? No. Those governments printed money, and their people had nowhere to escape the falling currency but by buying up consumer goods, creating shortages, clearing shelves, and forcing up prices until their entire economies fell apart.

Everyone has seen pictures of empty shelves in Venezuela. Meantime, the one-year return on the Caracas stock exchange is 1,804.92 percent according to Bloomberg.

Venezuela’s well-to-do survive and possibly thrive, while the poor starve. And, for Nobel laureates and Fed chairmen that’s just fine.

The US has inflation. It benefits the rich, at the expense of the poor.

“Inflation is the true opium of the people and it is administered to them by anticapitalist governments and parties,” wrote Mises.

What Krugman can’t see is that people are escaping the Fed’s money creation by buying stocks, bonds, real estate, crypto, NFTs, and who knows what all. While it might not be hyper, yet, the Fed is providing an overdose of what Mises called true opium.

Let’s Level the Playing Field between the Dollar and Competing Currencies

Written by Michael Milano

To be a reliable and useful medium of exchange, money must be durable, portable, divisible, and recognizable, but also scarce. The privileged power of the state to manipulate the scarcity of money has had disastrous consequences for national currency systems throughout history. While money, like everything else, is subject to the subjective valuations of consumers—as noted by Mises—money’s exchange value is “the most important kind of value, because it governs the social and not merely the individual aspect of economic life.” Legal tender laws and other regulations imposed on currencies cause value discrepancies to arise.

Indeed, when states intervene to impose “official value” on money, true market preferences can be partly observed in the workings of Gresham’s law. Gresham’s law is conventionally described as “bad” money drives out “good” money, but a more accurate definition per Rothbard is that “money overvalued artificially by government will drive out of circulation artificially undervalued money.” Imagine a specie-based economy that issues a coin containing one ounce of gold. Facing mounting debts, the government substitutes copper for a more valuable metal in the minting process while maintaining the coin’s denominational value. According to Gresham’s law, once citizens recognize the inconsistencies in the precious metal content, they’ll opt to spend their artificially “overvalued” newer coins while hoarding their artificially “undervalued” older coins.

Whereas “overvalued” money was created in the past by physical debasement, “overvalued” money today is the result of reckless monetary and fiscal policy. Over the course of the pandemic, the money supply, M2 according to the Federal Reserve, increased 29.7 percent, from $15.405 trillion in February 2020 to $19.979 trillion in March 2021. Since the advent of the Federal Reserve, the purchasing power of the dollar has dropped by over 96 percent (i.e., $1 today is the equivalent of $26.14 in 1913). Unbridled quantitative easing has further amplified inflation worries and global doubts about the stability of the dollar.

Legal tender laws in the United States require the public to accept payment for debts and taxes at the dollar denomination shown on the bill. This form of coercive price control has established the dollar as the economy’s unit of account. Similarly, burdensome tax regulations bolster the “overvalued” dollar by constructing barriers of use for its rivals.

The Case of Cryptocurrency

We can see the effects of these regulations at work today in how cryptocurrency is used.

According to the IRS, bitcoin and other cryptocurrencies are considered property for taxation purposes. Thus, the act of buying goods and services with BTC is identified as a realization event that requires the purchaser to declare any gains recognized from their BTC cost basis. Disregarding scalability concerns, onerous requirements that force users to track gains and losses for all transactions ultimately prevents BTC from serving as an effective medium of exchange.

On the other hand, if there is real market demand for various cryptos, government regulations designed to discourage the use of anything other than the “official” money will cause the demanded “unofficial” monies to become “undervalued” currency.

Thus, in accordance with Gresham’s law, the in-demand cryptos would be hoarded, rather than circulated at large. In the bitcoin community, for example, this mentality is personified by the Hodl meme encouraging bitcoin users to simply hold, rather than spend, bitcoin. A feedback loop has been generated where greater levels of fiat inflation have led to wealth flooding into BTC, further strengthening the perception that BTC is a reliable store of value. This mentality has been embraced of late by numerous corporations, who have transferred portions of their cash reserves into BTC (e.g., Tesla, MicroStrategy, Square, and MassMutual).

Thanks to so many government restrictions on the use of potential monies that aren’t the dollar, we can only guess as to what the relationship between dollars and bitcoin would be in a functioning marketplace. To find out, it would be best to level the playing field by eliminating legal tender laws and onerous taxation requirements. This would allow individuals to actively assess true differences in purchasing power.

This is unlikely, however, because elected officials depend so much on inflating the supply of dollars for political gain. Whether Democrat or Republican, politicians within our current system overwhelmingly perpetuate the welfare-warfare state—and this would be much more difficult with market-based money not subject to easy inflation by central banks.

Perversely incentivized, these politicians promote expansionary monetary policies that benefit special interest groups while pandering to their electoral base. As noted by Hayek, “[W]ith the exception only of the 200-year period of the gold standard, practically all governments of history have used their exclusive power to issue money in order to defraud and plunder the people.” Depriving the state of this exclusive power would force accountability first and foremost. If the threat of violence and imprisonment were stripped away, the public could freely evaluate the quality of different currencies and act accordingly.

Financing Infrastructure Spending with Corporate Tax Increases Would Stunt Economic Growth

Written by: Alex Durante, Huaqun Li, and Garrett Wilson

Original Article link here:

The Biden administration’s American Jobs Plan (AJP) proposal to fund infrastructure spending relies on a bet that the benefits outweigh the costs of a higher corporate tax burden. Using the Tax Foundation model, we find that this trade-off is a bad one for the U.S. economy, resulting in reduced GDP, less capital investment, fewer jobs, and lower wages.

To show the combined effect of infrastructure spending and different financing options, consider a stylized example of $1 trillion in additional infrastructure spending evenly spread over five years. New infrastructure will accrue returns over time, raising economic output. We assume a 5 percent return for public investments, consistent with assumptions by the Congressional Budget Office. The infrastructure spending could be financed entirely through the issuance of new federal debt, or alternatively by increasing the corporate tax rate, or by imposing new private user fees or excise taxes (such as the federal gas tax).

We find that financing $1 trillion in new infrastructure through additional borrowing would raise long-run GDP by about 0.2 percent. New borrowing raises long-term interest costs for the federal government, both because of the immediate infrastructure spending and long-term maintenance costs, but it does not result in substantially higher interest rates or crowd-out of private investment. However, much of the borrowing would be financed internationally, so the returns to that financing would accrue to foreign investors, reducing American incomes (GNP) in the long run by 0.1 percent.

Economic and Revenue Impact of $1 Trillion in Additional Infrastructure Spending and Three Financing Options

Financing OptionsBorrowing (issuance of federal debt)Increase the Corporate Tax RateImpose User Fees or Excise Taxes
Long-Run Gross Domestic Product (GDP)+0.2%-0.3%+0.1%
Long-Run Gross National Product (GNP)-0.1%-0.2%+0.1%
Capital Stock+0.2%-0.7%+0.1%
Wage Rate+0.2%-0.2%+0.2%
Full-time Equivalent Jobs+36,000-48,000-50,000
Long-Run Annual Conventional Deficit, 2031 Dollars-$67$0$0
Long-Run Annual Dynamic Deficit, 2031 Dollars-$52-$39+$6
Source: Tax Foundation General Equilibrium Model, May 2021.

On the other hand, financing the new infrastructure with an increase in the corporate tax rate reduces long-run GDP by 0.3 percent, because it raises the cost of corporate investment. It also reduces GNP by 0.2 percent, lowers the capital stock by 0.7 percent, reduces employment by 48,000 full-time equivalent jobs, and reduces wages by 0.2 percent. While this option would be deficit neutral in the long run on a conventional basis (which holds GDP constant), on a dynamic basis annual revenue would drop by $39 billion in the long run due to a smaller economy.

A third financing option is to rely on private user fees, such as tolls, or excise taxes, such as a higher gas tax. We find that this financing option would raise long-run GDP and GNP by 0.1 percent, but would reduce employment by 50,000 full-time equivalent jobs. Financing infrastructure through user fees or the gas tax would create a better connection between the usage of the new infrastructure and tax collections. Taxes imposed on consumption (in this case, consuming infrastructure services) tend to be less damaging to GDP.

Our modeling illustrates that the financing method for infrastructure matters, and that corporate tax increases would be one of the most counterproductive ways to finance the infrastructure spending, ultimately shrinking the U.S. economy, incomes, and available jobs. It is also worth noting that public investment tends to deliver only half of the economic returns as private sector investments (5 percent for public investments, versus about 10 percent for the private sector), which is an additional opportunity cost worth considering.

Modeling notes: We assume the infrastructure requires an increase in depreciation-related outlays to maintain the assets over time. Roads and bridges are assumed to have more than a 50-year life, and require about 2 percent of their initial cost in annual maintenance. We target the amount of financing that would be required to cover the long-run costs of maintenance and interest payments.

Silver Price: Eyes on $28 as Demand Exceeds Supply

Silver price is higher as its industrial and safe-haven demand rises. Investors are now keen on FOMC meeting minutes on Wednesday.

silver price

Inflation concerns

On Friday, silver price was higher as a reaction to the stagnation of April’s retail sales. Analysts expected a reading of 1.0% compared to March’s 10.7%.  Besides, Fed officials like Governor Christopher Waller and Vice Chair Richard Clarida have downplayed inflation fears. In the ensuing sessions, investors will be keen on the FOMC meeting minutes scheduled for Wednesday. Fed maintained a dovish tone in its recent interest rate decision.    

Industrial demand

Unlike its lustrous cousin – gold, silver is more than a hedge against inflation. Due to its durability and electrical conductivity, it has various technological, electrical, and industrial applications. The reopening of economies and shift towards the green economy has heightened silver’s industrial demand. According to the Silver Institute, the metal’s industrial demand in the current year is significantly beyond its supply. On the supply side, it is risen by 8% in 2021 compared to the prior year’s -4%. In comparison, its demand has soared by 15%, which is significantly higher than 2020’s -10%. A continuation of this trend is likely to push silver price higher.

Silver Price Technical Outlook

Silver price has continued with its uptrend on Friday’s session. On a larger scale, the uptrend has continued since late March. On 30th March, the precious metal had its price drop to the lowest level since mid-December 2020. Subsequently, it been on a rebound journey characterised by several pullbacks and sideway trading moments. Over the past one-and-a-half months, it has risen by about 16.61%. At the time of writing, it was up by 0.74% at 27.60.  

On a daily chart, silver price is trading above the two and four-week exponential moving averages. Besides, it is within an ascending channel, which substantiates the bullish outlook. I expect the precious metal to rise further as bulls target 28 in the short-term and 30 towards the end of the second quarter.

In today’s session, the price is likely to rise to past the psychological 28 to 28.38. At that point, it will find resistance along the channel’s upper border. It may then pull back and trade sideways along 28 before moving higher. Notably, that has been an important resistance level since August 2020.  

Article originally featured here

What’s the Carbon Footprint for Fiat Currency?

Bigger than Bitcoin that is for sure.

Article by Peter St. Onge, Phd.
Peter St. Onge, Ph.D. is a former professor and Mises Institute Associated Scholar. He writes about Austrian economics and Bitcoin

Critics of Bitcoin like to compare its carbon footprint to a transaction on your Visa card, ignoring the environmental impact of the infrastructure that sustains fiat money and the enormous collateral damage that fiat brings. These secondary effects make fiat money orders of magnitude more energy-destructive than Bitcoin. 

You can appreciate fiat’s secondary footprint from any street corner on Earth: 80,000 bank branches and 470,000 ATMs in the U.S. alone, along with forests of skyscrapers that dominate every city on the planet. Then the part we don’t see: Finance and insurance are 8.4% of the gross domestic product in the U.S., only slightly behind manufacturing. That means millions taking the subway or driving to the office – or, the pandemic equivalent, firing up an army of laptops and call centers – to sling paper money under fiat’s harsh fluorescent glow. Visa transactions don’t even come close.

And that’s on the good days. Because, when it comes to fiat, there are a lot of bad days. Fiat money has caused a recession every 5.6 years, to be precise, in the U.S. since the Federal Reserve’s founding, by manipulating the pace of money creation that drives the boom-bust cycle. Beyond the human toll, each recession has brought trillions in wealth destruction, wealth that took an enormous amount of resources and, yes, an enormous amount of carbon to create.

To translate this recession cost into something that can be compared to Bitcoin, I relied on the most mainstream estimates of the carbon cost of a dollar of GDP – about 5,000 BTU (British thermal units), or 1.5 kWh (kilowatt hour), per dollar. Then, using the Federal Reserve’s own estimate of $11 trillion destroyed peak to trough in the 2008 crisis – the very crisis that inspired Satoshi to create Bitcoin – you simply multiply the two. That comes out to 16,500 TWh (terawatt hour) of carbon equivalence destroyed during that single recession. Accounting for the rest of the world, that might triple. Accounting for the other 16 recessions the Fed has given us – with more to come – makes it astronomical.

The modern recession and the boom-bust cycle that drives it is entirely a creation of fiat money. Governments intervene in the allocation of capital, randomly starting and stopping a fire hose of credit that whipsaws the real economy and destroys real lives. Just as the cost of a five-second delay in a footrace can be measured in distance lost, the cost of a recession can be measured by the resources it will take to rebuild lost wealth. Bitcoin, by taking purchasing power out of central banks’ manipulation space, can reduce or even eliminate their ability to cause boom-bust cycles.

Even Bitcoin’s worst critics allege the distributed network consumes no more than 86 TWh per year, of which perhaps 16 TWh might be Americans, with much of that green energy. It would take between 500 and 1,000 years for Bitcoin’s energy use to even approach the 2008 crisis alone. With another recession permanently on the way, over and over again. That 500 to 1,000 years’ worth of energy goes on top of the 8.4% of GDP, the 80,000 bank branches and 470,000 ATMs and those skyscrapers.

These ratios suggest that central banks are vastly more polluting than Bitcoin, indeed more polluting than the worst industrial offender you could imagine. Bitcoin, by implication, is among the most green technologies humanity has ever invented. Indeed, if Bitcoin even slightly reduces central banks’ ability to cause recessions, it could pay back every watt many times over. For example, if Bitcoin reduces the odds or magnitude of central bank recessions by just 2%, Bitcoin would actually save us far more energy than it uses – it would be net carbon negative. 

Of course, collateral damage from fiat doesn’t end at recessions. Inflation, business cycles and money printing lead to economic chaos and human misery, bailouts of politically connected industries and fiat-subsidized wars – with carbon footprints and human costs all their own. Fiat money perverts the natural symbiosis between taxpayer and tax collector, whereby governments do well when we do well, by allowing governments to magic up what they need via the printing press. 

Given we live in a world of irresponsible governments, bankers with senators on speed dial and still-immature altcoins, Bitcoin remains the safest bet for reducing the enormous energy waste and human cost of rebuilding our economy over and over again. 

Skipping the roof on your new house may be green in the moment, but not if you have to rebuild every 5.6 years. If you really do prioritize the environment, help Bitcoin shut down the most polluting industry on Earth: central banking.