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Richard Werner: A Whistle-Stop Tour Of Modern Banking

Published by Anonymous (not verified) on Fri, 27/08/2021 - 3:02pm in

Professor Werner discusses a whole a range of banking issues including the Weimar Republic, central bank digital currencies, credit creation, the war on cash, crypto, gold, the date of the next crash and personal sovereignty.

The post Richard Werner: A Whistle-Stop Tour Of Modern Banking appeared first on Renegade Inc.

Richard Werner: A Whistle-Stop Tour Of Modern Banking

Published by Anonymous (not verified) on Fri, 27/08/2021 - 3:02pm in

Professor Werner discusses a whole a range of banking issues including the Weimar Republic, central bank digital currencies, credit creation, the war on cash, crypto, gold, the date of the next crash and personal sovereignty.

The post Richard Werner: A Whistle-Stop Tour Of Modern Banking appeared first on Renegade Inc.

Hey, Economist! What’s the Case for Central Bank Digital Currencies?

Published by Anonymous (not verified) on Thu, 17/06/2021 - 12:35am in

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central banks

Michael Lee and Antoine Martin

Hey, Economist! What’s the Case for Central Bank Digital Currencies?

Since the launch of Bitcoin and other first-generation cryptocurrencies, there has been extensive experimentation in the digital currency space. So far, however, digital currencies have yet to gain much ground as a means of payment. Is there a vacuum in the landscape of digital money and payments that central banks are naturally positioned to fill? In this post, Michael Lee and Antoine Martin, economists in the New York Fed’s Money and Payment Studies function, answer some questions regarding the concept of central bank digital currencies (CBDCs).

Q: There’s a lot of buzz about central bank digital currencies these days. How has the pandemic accelerated these discussions?

In addition to being a major public health crisis, COVID led to major changes in the usage of payment methods, as noted in this Liberty Street Economics post. Given the benefits of contactless payments amidst the pandemic, a lot of people have adopted digital payment solutions. Another factor has been the difficulty of getting stimulus payments to all eligible recipients due to gaps in account data and contact information. Plus, stimulus payments were disbursed by check, which is not the most efficient form of payment available today. And there is still the issue of getting funds to the unbanked. Some have proposed that a CBDC could address some of these issues by providing expanded and direct access to funds instantaneously.

Q: In a previous Q&A, you discussed how Bitcoin resolves issues of trust. How would a CBDC differ from cryptocurrencies like Bitcoin? How would a CBDC be different from a stablecoin?

In a prior blog post, we highlighted two distinct features to keep in mind when considering various digital currencies. We differentiate between the “money” that is being exchanged, and the “exchange mechanism.”

A CBDC differs from Bitcoin on both dimensions. A CBDC differs from Bitcoin in terms of the type of money it represents. Bitcoin is not a claim on anything or anyone. By contrast, a CBDC would be a central bank liability. A CBDC would take central bank money and synthesize it into a digital form available for use by anyone. Offering a payment method that has a stable value is one of the reasons central banks were created in the first place.

The exchange mechanism is also very different. The central ethos of cryptocurrencies is the idea that transactions can take place without a trusted intermediary, whether public or private, that operates and governs payments. By contrast, a CBDC embraces the involvement of a trusted intermediary, namely a central bank, to facilitate transactions.

Stablecoins try to replicate central bank money by stabilizing the value of the digital currency. They do so by promising to back the coins with financial assets or cash. However, a CBDC differs on both dimensions from stablecoins as well, at least those that exist today. First, stablecoins are riskier, as the value of the assets backing the coin could fluctuate, or these assets may not be present, despite promises made. Second, some stablecoins still try to avoid a central intermediary. With the involvement of a central bank, a CBDC would be a quintessential form of stable money, a dollar bill in digital form.

Q: Would a CBDC be built using distributed ledger technology?

A CBDC can certainly involve the use of distributed ledger technology (DLT). However, that does not need to be the case. Some central banks have experimented with CBDCs for interbank payments using DLT (see projects by the Bank of Canada and Monetary Authority of Singapore, for example), but not all central banks appear to be going this route. A range of designs are being explored, as noted in this working paper from the Bank for International Settlements.

Q: What problems might a central bank digital currency solve?

CBDC proponents point to a variety of existing and emerging issues. At a basic level, CBDC could improve the efficiencies of payments, especially in high-friction areas, such as cross-border payments. From a technological perspective, a CBDC may prompt innovations in financial services, as it may enable the private sector to provide new and innovative services. Finally, from a consumer welfare perspective, a CBDC may have a role in safeguarding privacy and improving access to finance.

Q: These seem like broad issues. Is a CBDC the only solution?

Certainly not. All of these dimensions are active policy issues that are being tackled from multiple directions. There’s a lot of effort aimed at modernizing payments and, in particular, speeding the settlement process. An example is the FedNow ServiceSM. For major pain points, such as cross-border payments, there’s a lot of innovation, both private and public, to improve transactions. The Committee of Payments and Markets Infrastructure (CPMI) and other international organizations have been pushing to improve cross-border communication and coordination around such issues. These other approaches are evolutionary improvements on the existing system. A CBDC would be an attempt to solve some of these issues with much more revolutionary changes. Whether that happens remains to be seen.

Q: Okay, so it’s not clear that a CBDC is the obvious solution to any given problem. What considerations might make a CBDC the right approach?

Since CBDCs are part of several possible options, it is important to understand the costs and benefits of all the alternatives. To do so, we need to better understand the underlying frictions that cause the problems we face today.

How should the CBDC be designed? In a previous blog post, we note that while new technologies might enable us to do fundamentally new things (as Bitcoin allows us to make payments without a third party), those advances might not be very useful (Bitcoin is too clunky). We also need to also consider the best arrangement for private and public collaboration. What things are central banks good at? What things is the private sector good at? How can we manage the development of CBDCs in a safe and robust manner?

Ultimately, new technologies can only be part of the potential solutions to the policy goals outlined above. New technologies will need to be accompanied by an appropriate legal and regulatory structure. For example, let’s consider access to finance. Whether a CBDC can help achieve better access to finance may depend less on the technology on which it is built, than on how it might enable certain policies or influence the incentives and dynamics of the free market.

Q: What are the next steps for CBDC development?

There’s a vibrant discussion and research on addressing these questions, both inside the Federal Reserve System and externally. The need for collaboration on digital dollars has been emphasized by multiple Fed policymakers, including Chair Jerome Powell and Governor Lael Brainard. The Federal Reserve Bank of Boston has started Project Hamilton, a collaboration with the Digital Currency Initiative at the Massachusetts Institute of Technology to perform technical research related to a central bank digital currency. A CBDC in any jurisdiction would likely to be a joint endeavor with collaboration between the public and private sectors, to better understand if and how it should be implemented.

michael leeMichael Lee is an economist in the Federal Reserve Bank of New York’s Research and Statistics Group.

Antoine MartinAntoine Martin is a senior vice president in the Bank’s Research and Statistics Group.

How to cite this post:

Michael Lee and Antoine Martin, “What’s the Case for Central Bank Digital Currencies?,” Federal Reserve Bank of New York Liberty Street Economics, April 30, 2021, https://libertystreeteconomics.newyorkfed.org/2021/04/hey-economist-what....

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

David and Goliath

Published by Anonymous (not verified) on Fri, 07/05/2021 - 11:44pm in

Yesterday, someone who had been watching one of my (all too frequent) Twitter arguments about money made this comment: 

The "unknown person with few followers" was my protagonist. And the blue tick "classical expert" was me. I am Goliath. 

But ten years ago, I was David. Armed only with Blogger and Twitter, and my knowledge of banking and finance, I set out to slay the financial Philistines that rampaged across the internet in the aftermath of the 2008 financial crisis. I published my first Coppola Comment post on 20th February, 2011. It throws slingshots at a media pundit who had written an article about short selling, on which he was far from expert. You can still read it, if you like. 

My early posts were rough and ready, and my terminology is at times excruciatingly loose, but I was sure of my subject. I understood British banking and financial markets well, though I had left RBS nearly ten years before. It was evident to me that the 2008 financial crisis in the UK was one of retail banking, not investment banking. The banks that failed, with one notable exception, were retail banks that had over-extended themselves in property and commercial lending, and in some cases had also invested in toxic securities as part of their treasury function. The European banks that failed in the crisis were similarly over-leveraged and riddled with non-performing loans and toxic securities. I was critical of regulators, central banks, the banks themselves, and above all the self-appointed pundits promoting bank breakups and ring-fencing, neither of which I considered an appropriate response to the crisis. 

Now, re-reading what I said ten years ago, I wince at my writing style but nod my head at the message. Banks did have insufficient capital and inadequate liquidity, central banks were too slow and too limited in their response to the crisis, and regulators were asleep at the wheel. Now that banks have better capital and more liquidity, regulators have tighter control of their activities (perhaps even too tight), and central banks are more active in markets, ring-fencing has turned out to be pointless. Banks pretty much broke themselves up to meet tougher capital requirements. There's not much left of British and European investment banking now.  

But the financial crisis originated in the American mortgage market. The Philistines talked as if all mortgage markets were the same, but in fact the American market is unique in the world. And it is the unique structure of this market that enabled an American crisis to propagate itself across the world. 

I knew what adjustable-rate mortgages were - after all, the entire UK mortgage market consists of adjustable-rate mortgages - and I knew what a subprime mortgage was like, having had one myself (my first mortgage was 100% LTV). But I was amazed to discover that most American mortgages are fixed-rate for 25 or 30 years. Adjustable-rate mortgages were inevitably subprime, because people took out adjustable-rate mortgages if they weren't creditworthy enough to qualify for prime fixed-rate mortgages. These people were generally on lower incomes and therefore more sensitive to interest rate rises than the average borrower, and yet the average borrower was protected from interest rate rises while they were fully exposed to them. It was a mind-blowingly stupid market structure. 

Furthermore, the US was exporting its mortgage interest rate risk. Whereas in Britain and Europe mortgage lenders generally keep mortgages on their books, American mortgage lenders (known as "originators") sold on the loans: prime mortgages (and in the mid-2000s some subprime too) went to the Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac, while adjustable-rate subprime mortgages went to investment banks. GSEs and investment banks alike issued securities backed by these mortgages and sold them to international investors. "Tranching" and the use of structured instruments such as collateralized debt obligations (CDOs) made it possible for many securities to be sold as safe assets even if they were backed by subprime mortgages. And derivatives such as credit default swaps helped to distribute US mortgage default risk out to the far reaches of the capital markets universe. 

I understood securitisation and derivatives. My MBA dissertation is about derivatives, and I spent quite a bit of my banking career devising systems for managing derivative exposures and structured products. I didn't know the Gaussian copula equation used to price CDOs, but I was familiar with the related Black-Scholes equation for derivatives pricing. But I had never seen systematic securitisation before, and I didn't know how tranching worked, though I understood capital structures. So I had a steep learning curve in those early months. But I did the research, and I found out how it worked. And then I wrote about it. You can still read my "sausage factories" explanation of how securitisation and tranching spread an American subprime mortgage crisis to the whole world. 

I was not the only David taking aim at the Goliaths of conventional finance and economics at that time. Writers such as Cullen Roche and Edward Harrison, and heterodox economists such as Steve Keen and Ann Pettifor, were as determined as I was to correct the widespread misunderstanding of so-called "fractional reserve" banking that had resulted in central bankers failing to understand the risks posed by rising leverage in the banking system. 

It quickly became apparent that central bankers and economists not only didn't understand how banks could crash the world, they didn't understand their own tools either. They simply did not know how money is created in a modern economy. They thought quantitative easing (QE) must be used sparingly to avoid triggering runaway inflation, because banks would lend out all those new reserves at 10 times leverage, wouldn't they? 

But banks don't lend out reserves. And they don't "lend out 90% of deposits keeping 10% in reserve", either. They lend, creating new deposits in the process, then borrow reserves if they need them to settle the drawdown of those deposits. The new deposits add to the total amount of money in circulation - to be clear, because of the way we measure money, they do so before they are drawn, not as a result of being drawn. So bank lending creates new money. 

When bank lending is out of control, so too is money creation. And when there is a liquid interbank market, reserve availability does not constrain lending, because banks can always borrow what they need: central banks that are using the interbank lending rate as their principal inflation control tool will always ensure there are sufficient reserves for banks to borrow, since if they do not, they will lose control of inflation. 

Furthermore, when lending is mainly against property, it does not raise consumer price inflation: people are borrowing to buy property, not to spend on consumer goods. So while banks were lending more and more, driving up property prices to the skies, central banks that were only watching the consumer price index were unconcerned. 

Thus, prior to the crisis, bank lending was unconstrained by reserves or regulation. And although their loans were undercollateralized, their borrowers skint and their capital paper-thin, they thoujght they were safe, because the value of the collateral against which they were lending was constantly rising. Central bankers also thought they were safe, because inflation was low and stable. And governments thought they were safe, because the economy was growing strongly and tax receipts were rising. When the whole house of cards collapsed, everyone scratched their heads and muttered, "how did that happen?" 

After the crisis, banks didn't want to lend, to each other or anyone else. Their balance sheets were overleveraged and stuffed with non-performing loans. They were under pressure from regulators to reduce their risks and clean up their underwriting standards. So, far from banks increasing lending in response to QE, they actually reduced lending despite QE. The "second bailout for banks" headline that is famously etched on Bitcoin's genesis block is a reference to the desperate measures considered by the UK's then Chancellor of the Exchequer, Alistair Darling, to try to get damaged banks to start lending again. 

So when central banks provided banks with copious quantities of new reserves in the expectation that they would lend them out, banks simply ended up with far more reserves than they knew what to do with. They gratefully parked their excess reserves at central banks for a few basis points in interest, thus ensuring that the few banks that did need to borrow reserves had to do so at a positive interest rate. "Banks are being paid not to lend," muttered mainstream economists. But as many of us pointed out, had central banks not paid interest on excess reserves, the main policy rate would have fallen below zero. At that time, no-one wanted to experiment with negative rates. So it's not so much that banks were being paid not to lend, it's more that they were being paid to lend to each other to prevent the main policy rate from turning negative. 

The terrm "fractional reserve lending" is thus extremely misleading. Banks lend, creating money in the process: as a consequence of the lending and drawdown process, banks end up with fewer reserves than they have deposits. In this era of excess reserves and Basel liquidity regulations. reserve requirements intended to ensure that banks always have sufficient reserves to meet normal daily deposit withdrawal requests are redundant: in March 2020, the Fed abolished its iconic10% reserve requirement, the source of the "10% reserve" of the money multiplier model. 

It is capital, not reserves, that constrains lending. Reinforcing this message, and explaining how bank lending really works, has formed a large part of my writing over the last decade. 

But even now, the same old nonsense about fractional reserve banking and money multipliers is still circulating. Ordinary people repeat it to me because they've seen it on Facebook. Teenagers too young too remember the financial crisis pontificate about it with extraordinary assurance because they remember it from their high school economics classes or because some crypto bro on twitter told them about it. People tweet blogposts they've written using the failed money multiplier model to explain how banks work. Old economic models never die, they just hide in the dark corners of the internet and in economics textbooks.   

And it's not just nonsense about banks that is still being spread. Nonsense about money is, more widely. QE is still being called "money printing", including by mainstream media journalists and pundits who should know better. People are alleging that central banks are directly financing government deficits, even though this is illegal in most Western countries. And the goldbugs I spent so much of my time arguing with all those years ago are back in force, promoting their deflationary hard-money regimes and descriibing the fiat money creation that is currently keeping people alive as "immoral". To me, failing to give people the money they need to keep them alive is immoral. Better some inflation than poverty and starvation. 

Anyway, I've heard all this inflation scaremongering before. It was wrong ten years ago and it is equally wrong now. QE does not cause inflation, and nor do government deficits when the economy is in a slump. We are living through an era of "QE for the People" right now, and there is no significant inflation. There will probably be a short burst of inflation as the economy reopens, because the damaged supply side will take a while to catch up with resurgent demand, but neither the exceptional government spending during this time nor the monetary policy that supported it will cause runaway inflation. 

We are doing now what we should have done after the financial crisis. It is vital that the inflation hawks, bond vigilantes and goldbugs aren't allowed to derail this train as they did the last one. The consequences if they do are too ghastly to contemplate.

And so I find myself, once again, fighting against the spread of nonsense about banking and finance on the internet. But to the new kids on the block, I am part of the establishment that they blame for their troubles. They insist that central banks will cause inflation with all this "money printing", and when I say "it doesn't work like that", they tell me I don't understand how money works. They have never read my work, and they don't want to: they only know that I am a blue tick and a "classical expert". To them, I am a dinosaur, and when the cryptocurrency asteroid strikes, I will die. I have become Goliath, to be slain, not listened to. 

The price David paid for slaying Goliath is that he became the new Goliath. Did King David ever long to be back on that hillside tending his sheep? These days, I would rather be in the garden tending my plants than wielding a slingshot against a new tide of internet Philistines. 

Someone even suggested yesterday that if I wanted to talk sensibly about money I should write a blog. I laughed hollowly and pointed them to this blog. But there are a lot of posts on this site, and it's not very well organised. Blogposts, like Twitter, are ephemeral: once the occasion has passed, it can be hard to find them again. So maybe I need to organise my old posts into an indexed archive. Or maybe I should turn them into a few e-books. What do you think?

More importantly, Blogger is an old and tired platform, It's increasingly unpleasant to use: I have to manipulate the HTML to make the posts look half decent. I had to add code to comply with GDPR, but as a result my own domain, coppolacomment.com, can't be found on search engines now, though individual blogposts can. And Blogger is withdrawing the subscribe by email facility in July 2021. It's almost as if Google doesn't want to maintain a CMS for casual bloggers any more. So I am thinking of shutting down this site. Not to throw away what I have done in the last decade, but to draw a line under it and move on, at least to a better platform. 

The last ten years have been a blast. I have learned an immense amount, and achieved more than I ever imagined possible. I am no longer the singing teacher from Kent who knew a bit about banking and was surprised to find she could write. I'm a professional writer, a published author and an acknowledged expert on banking, finance and monetary economics. In a way, I really have become Goliath. I am proud of that, and immensely grateful to all the people who have helped me along the way. 

But I am also still David. I still scrape a living from freelance writing, singing and teaching: senior jobs in central banking, thinktanks and financial publications have entirely passed me by. And I still want to slay the resurgent Goliaths. Indeed, I'm currently writing a book called "The Absolute Essentials of Banking", because even now, more than a decade after the financial crisis, people still don't understand how banks work. And I continue to wield my slingshot on the internet, even though I really prefer being in the garden. Some things are too important to give up. 

Related reading:

David and Goliath, 1 Samuel 17 - Bible Gateway