Friday, May 15, 2009

Madness from the London School of Economics

London School of Economics Professor Willem Buiter has written a truly bizarre column for FT.

There are more basic errors in Buiter's column than I have ever seen in one column before. Joe Weisenthal couldn't make this many errors in a column. Clearly, things have gone down hill since the Hayek years at LSE.

I'm just going to hit the highlights since to cover in detail the cluster of Buiter errors would take a book.

Let's first start off with the basics of basics. Buiter calls currency a bond:

Currency is an example of a bearer instrument. It is a negotiable bearer bond - it is transferable to another party by delivery.
It is a bearer instrument, since title to it generally belongs to the person in possession of it. And, it is an instrument (though this is an awkward use of the word instrument), an instrument of exchange, I prefer, as does most of the speaking world, medium of exchange. But, how does one jump from bearer instrument to bearer bond?

According to the business dictionary a bond is a:

Written and signed promise to pay a certain sum of money on a certain date, or on fulfillment of a specified condition.
How does currency fit into this definition? Not so well. There is no promise to pay anything. Further, there are no interest payments. I hasten to add that at one time dollars and pounds were warehouse receipts, but no longer. They are the currency. They are used as a medium of exchange, and no one ever expects them to be "redeemed"--which is the essence of a bond.

Buiter attempts this bizarre definition of currency because he wants to support the drunken proposal by Harvard Prof. Greg Mankiw (And obviously Harvard has gone down hill since the Schumpeter days) for a negative interest rate.

Writes Buiter:

There is no theoretical or practical reason for not having the Federal Funds target rate and market rates at, say, minus five percent...
Actually,there is a big problem. You can have a government negative rate, if banks are forced to keep deposits at the Fed, but it is the nature of coercive government that accounts for this possibility. On the free market, outside of a transactional fee for caretaking and custody of money, why would anyone put their money in a bank that is going to give you back less than you put in?

It's not going to happen, never ever.

Buiter even seems to get this momentarily:

Stricly [sic] speaking this story must be qualified in minor ways. If currency is the most liquid security, no other risk-free nominal instrument can earn less than it, net of carry costs (costs of storage, safekeeping and insurance). Carry costs for currency are higher than for Treasury bills or reserves with the central bank. The zero lower bound is therefore, strictly speaking a lower bound somewhat below zero. But not enough to achieve a minus five percent Federal Funds target rate.
But, not for long:

Fortunately, it turns out to be extremely simple to remove the zero lower bound on short, risk-free nominal interest rates.
He then calls for, hang on to your hat, the abolishment of currency. And, this, of course, is:

easy and would have many other benefits.
Benefits? Like greater government surveillance of every transaction conducted on the planet?

Buiter, does see one drawback, and I just checked to make sure he didn't write this column on April 1:

The main drawbacks would be the loss of seigniorage income to the central bank.
Although he is wrong on this point, he thinks the government wouldn't be able to inflate at will. And that is the drawback!

And, he has basically branded anyone who cherishes privacy a criminal:

The only domestic beneficiaries from the existence of anonymity-providing currency are the criminal fraternity: those engaged in tax evasion and money laundering, and those wishing to store the proceeds from crime and the means to commit further crimes.
He doesn't stop there:

Large denomination bank notes are an especially scandalous subsidy to criminal activity and to the grey and black economies. There is no economic justification for $50 and $100 bank note..
He is really nuts:

Instead of abolishing currency altogether, we could only issue low denominations, say nothing larger than $5 or €5...
Alternatively, he wants a tax currency stamp:

When the interest rate on currency is positive, the currency must be marked (by stamping or clipping coupons) to make sure the (anonymous) bearer does not present it repeatedly for the payment of interest. When the interest rate is negative, the (anonymous) bearer must (a) be induced to come forward to receive his negative interest (i.e. pay interest to the central bank) and (b) must be able to demonstrate that the negative interest has been received. To ensure (b), the currency must again be stamped or marked (electronically tagged). To get the bearer to come forward to pay the negative interest we can either rely on honesty and a sense of patriotic duty, or we can impose sanctions for non-compliance. I am afraid penalties for non-compliance (fines, a day in the stocks) would be required to make negative interest on currency work.
What the hell positive interest on currency is he talking about? Who is going to pay interest on currency that they don't have use of. And, of course, a "negative interest" on currency is just a tax that is also being promoted by Mankiw.

He then proposes a nutty new currency option, the rallod. And, he somehow twists the dollar as not being a currency, BUT securities will be denominated in dollars:

Now abolish the dollar currency and introduce a new currency, the rallod. The exchange rate between the rallod and the dollar is not constant. It can either be determined by the government or let by the market... since there no longer is dollar currency, the nominal interest rate on dollar securities can be negative as easily as it can be positive.
What can I say? Madness.

Buiter's conclusions:

I really don’t understand why central banks are not aggressively pursuing options for removing the zero lower bound. It is [sic]that they love the seigniorage so much? But they retain seigniorage revenue from currency issuance in the rallod economy. Is it hidebound conservatism and lack of imagination? Quite possibly. But if so, this is a costly mistake. Central banks should act to remove the zero lower bound on nominal interest rates now.
Obviously, this guy is totally nuts, but his proposals play into the hands of more government control of the economy, so he is likely to get more and more respect at conferences and from governments. Truly scary.


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