Keynes and the BIS

Yesterday Krugman blogged about the inflation hawkishness of the Bank for International Settlements (BIS).    As some commenters noted, he passed up a good opportunity to title his blog post "Faulty Basel" or "Basel, Faulty" (Krugman, above all other commentators, loves wordplay).  Anyway it put me in mind of this, from John Maynard Keynes:  Fighting for Freedom (by Robert Skidelsky):

There was a last-minute Keynes explosion over the Bank for International Settlements.  Set up as a club for central bankers in Basle, Switzerland in 1930, it had maintained contacts with both sides during the war:  it had accepted the transfer of Czech gold to Germany, it had a German director, and Emil Pühl, deputy president of the Reichsbank, was a frequent visitor to Basle.  A resolution proposed by Keilhau of Norway and supported by other Europeans demanded its immediate liquidation.  The Americans and British had agreed to support a milder version recommending eventual liquidation, but at a meeting of Commission III on 18 July, the American representative Luxford put forward a resolution making membership of the BIS and IMF incompatible.  This passed over British and Dutch objections.  Keynes heard about it that evening, and it put him into a towering rage.  He stormed into Morgenthau's room, accused the Americans of double-crossing the British, and said that unless the American resolution was withdrawn he would quit the conference.  Mrs Morgenthau, who was present, reported Keynes as 'quivering, he was so excited about it'.  Morgenthau quietened him down, and Keynes left with a promise to send him a a new resolution next morning.  The eventual agreement was to call for liquidation of the BIS 'at the earliest possible moment'.  This moment never arrived, and the BIS continues to this day.  Keynes's intervention probably saved it.  He thought that the American action was part of a US Treasury sub-plot to discredit New York bankers opposed to the IMF who had had associations with the BIS.  Kept in existence, the BIS revived in the late 1940s as a centre for intra-European financial co-operation when the IMF was dormant.

 History is pretty weird.

A More Viable Bitcoin?

In my previous post, I expressed my doubts as to the long-term viability of the bitcoin.  But now I want to propose a possible alternative and consider whether it could thrive.

Here is what I have in mind.  I start a company called Gresham Inc. (a reference to Gresham's Law).  Gresham Inc. issues a product that is like a bitcoin in its technical attributes, but that is issued and traded differently.  We'll call it the "talent," which is an ancient unit of mass also used as a measure of value (by reference to a talent of precious metal).

Gresham sells talents for $10 each, initially.  It also buys them for $10 each (or perhaps for slightly less).  So to conduct an anonymous transaction, an individual could buy 15 talents for $150 and send them to the transferee.  The transferee can then exchange them for slightly less than $150.  The difference between what the buyer pays and what the seller receives is a transaction fee.

Gresham uses the proceeds from selling talents to buy U.S. treasury securities (or other dollar-denominated assets).  It then profits both from the transaction fees and from its income from the assets that it owns.  Of course, Gresham must also lay out cash to maintain its secure network for transacting in talents, so its profit is the difference between its revenues and its costs.

Gresham could increase the price of talents over time.  In this way, the holder of talents owns an appreciating asset, and so may be willing to hold it for a period of time.  However, Gresham would keep the rate of appreciation low enough that Gresham profits from the difference between the rate of interest it obtains from the assets it buys and the implied rate of interest from holding talents.  So for instance, if Gresham is receiving 2% on the dollar-denominated assets it buys, it might increase the value of a talent by 1% per year.  This would be competitive with a bank account in today's economy.

Gresham would function very much like a bank or a money market fund, except that the "securities" it issues would be useful for anonymous transactions.  Gresham would need to maintain significant liquid cash reserves, because it might have to redeem a large number of bitcoins at once—again, just like a bank or money market mutual fund.

It seems to me that talents would be much preferable to bitcoins.  In part, this is because much of the "seignorage" of bitcoins is wasted in useless computations.  Gresham would capture this surplus, share some of it with the holders of talents, and thereby profit.

Of course, Gresham would probably be taken down by the legal authorities.  But then, I expect the bitcoin also runs a pretty substantial risk of being shut down, unless it simply implodes before the authorities become too alarmed by it.

Skepticism About Bitcoins

If you don't know what bitcoins are, the Wikipedia page isn't a bad introduction.  I confess I don't entirely understand the mechanics of bitcoins, so take my description with a grain of salt.

Imagine that you can generate unique serial numbers (this is a pretty easy task, I believe people have been doing it for centuries).  And imagine that each serial number can be encrypted and stored digitally in the following manner:  if Person A wants to send a serial number to Person B, he submits his serial number to a network that modifies the encryption in some way, de-activating the old encryption and generating a new set of encrypted data, which is delivered to Person B.  In this way, Person A can surrender a serial number to Person B in a way that is, in theory, untraceable.  (I suspect there is something like an "analog hole" that actually prevents these transactions from being as anonymous as people would like, as when the U.S. monitored the SWIFT system, but I am way out of my depth in these technical areas.)

So a bitcoin is just a unique serial number that is encrypted as described above.  Bitcoins are generated digitally at a fairly slow rate, and as I am writing there are apparently about 11 million of them in existence.  They are traded online.  As the Cyprus banking system melted down, the value of the bitcoin apparently surged briefly to $147/bitcoin, implying a total value of around $1.6 billion.

What are we to make of this?  Is this the end of the liberal state?  Will the dollar, vitiated by years of recklessly loose monetary policy, give way to the technologically and morally superior bitcoin?

I think not.  In fact, I think at some point the value of the bitcoin will go to zero and stay there forever.  I think this because I think the bitcoin is at best (A) an anonymous payment system combined with (B) a useless commodity, and that on both counts it will be out-competed (in the latter case, it will be outcompeted by, among other things, useful commodities).

Let's start with the bitcoin's function as a commodity.  The idea here is that it can be a good store of value, and the implication of the post-Cyprus price spike is that it might compete with the banking systems of tax havens.  So for instance, a wealthy individual might buy bitcoins in lieu of entrusting his money to a bank.

I can see at least two problems with this.  First, the price of the bitcoin fluctuates wildly.  Apparently the bitcoin traded as high as $147 and then fell to $117 as the Cyprus crisis unfolded.  Now, imagine that you decided to store $10 million of your money in bitcoins and bought at $140.  If the price falls to $120, you have just lost about 14% of your money, or $1.4 million.  And of course, there is the potential to lose much more.  By comparison, taking principal losses on bank accounts is quite rare (which is precisely why Cyprus was such a shock).

Moreover, bank accounts typically pay interest.  So they provide income, while (usually) posing minimal risk of principal loss.  Bitcoins may provide "income" if they appreciate rapidly enough, but for bitcoins to compete with bank accounts two things would be required:  the price of bitcoins would have to increase indefinitely, and the rate of increase would have to be high enough to compensate for the risk of losing a double- or triple-digit percentage of principal.

Suffice it to say I don't think bitcoins will meet this requirement, unless people are willing to issue bitcoin-denominated securities or pay interest on bitcoin-denominated loans.  If that happens, then one could earn a return on bitcoins in the same way that one earns a return on dollars.  But it seems very unlikely to me that a bitcoin-denominated capital market will ever spring up.  Note that there are already plenty of commodities that act as stores of value, including gold.  And you can even buy gold-denominated financial assets.  Gold also has industrial uses, meaning that its value can't go to zero, unlike the value of the bitcoin.

So what about bitcoins as a technology to facilitate anonymous transactions?  Well, here the problem is that, as far as I can tell, one can easily produce an equivalent technology that doesn't involve the price fluctuations inherent in the bitcoin market.  A system could take many forms—a similar "currency," an encrypted portal, or simply an offshore banking system with robust privacy protections.

Now I have heard people say that a competitor cannot emerge because the bitcoin is a natural monopoly.  The cable companies, who watched their natural monopoly in television evaporate with the emergence of satellite TV, will chuckle at this conceit.  The thing to recognize is that the fact that a market would, in a perfect world, take the form of a monopoly does not mean that it will actually be a monopoly.  A monopoly will generally only persist if there are barriers to entry.

So are there barriers to entry in the "bitcoin market"?  The biggest barrier to entry is that any competitor would, at first, be small and relatively illiquid.  But this is easily solved.  Imagine a firm seeking to compete with the bitcoin.  It could issue a similar currency, but announce its willingness to buy or sell the currency at, say, $10.  (This is equivalent to "pegging" the currency to the dollar.)  Immediately, the new entrant's product would be vastly more liquid and more stable than the bitcoin. The peg could be removed gradually (for instance, by letting the currency "float" within a wider and wider range).  At worst, the currency would become as illiquid and unstable as the bitcoin already is.

Why would the firm be willing to peg its currency, even temporarily?  The answer is that the seignorage on the bitcoin is potentially tremendous.  Seignorage is the profit that flows from issuing a currency.  So for instance, when the central bank of the United States prints money, it uses the money to buy assets (traditionally treasury securities, more recently various private-sector financial assets).  Those assets generate income, which is remitted to the U.S. treasury.

So imagine that instead of the current scheme for generating bitcoins, the issuer simply sold them periodically.  At current prices, you could generate about $360,000/day by issuing bitcoins.  Now, that is your gross revenue—you would have to maintain a payment network for people to be willing to use your currency, and that would cost money.  But I imagine you could make a nice profit on revenues of $360,000/day even if you had to maintain a fairly expensive network.  You would be earning about $130 million per year, and I can't imagine a network would cost more than that to establish and maintain.  The anticipation of profits could motivate someone to "peg" a currency for a period of time, allowing it to be more stable and liquid than the bitcoin.

Do I expect a competitor to the bitcoin to emerge?  I don't know.  I think that depends on how well the bitcoin fares over the next few years.  But in any case, I expect the bitcoin to fail as a currency.  In fact, I expect it to be dominated by existing currencies to such a degree that predictions of its triumph will come to be seen as delusional.

The Madness of Clouds

Can any man, in good faith and free from financial conflict-of-interest, hold that this weather is entirely suitable for man's enjoyment? And yet to deny that after the passage of two months, Nature will reveal herself in all her glory, were the most damnable perversion.  How shall we reconcile these well-established facts, standing as they do in relation to one another as the Antipodes to our native isle?  I can no more avoid the conclusion, that th' passage of time works a mysterious change in the world, far beyond that which an untutored man could conceive, than I can bring my wife to that most cherished place, to which she previously did venture, accompanied by greater men than I, but now must needs visit alone.

And so it is that we rededicate ourselves to that cause, whose name I need not invoke, it being implicit in every action we take, guided by that Reason bestowed upon us as our birthright.  Happy we be, though the sky spit upon us from its cold mouth!  Happy we be, though the sun visit us not!  Happy we be, though the very sea swallow us up, provided only that the last word to pass our lips convey to the Heavens that truth revealed to us by the weather that does ensconce us in this gentle land.

Missed Connection

I noticed you on the train to Brooklyn, because you are one of the cutest women I have ever seen on the subway.  When we left the train, I wondered if I would ever see you again.  But there you appeared, 10 feet from me on another subway platform, waiting for the next train.  We ended up in the same subway car again.

This thing we have going on between us, we both know what it is.  Call me when you're horny.

Missed Connection

Me, grabbing a pint of ice cream in the Associated.

You, also in the ice cream section of the Associated.  You look a lot like Eugene Mirman, or at least I thought I saw a strong resemblance.

I wanted to say hi and see if you were Eugene Mirman, but I didn't.

I Wrote a Poem

A Pint's a Pound the World Around

"Which weighs more," he asks.

"An ounce of feathers or an ounce of gold?"

I have heard this one before, but even if I had not

I would know the answer:  "They weigh the same."

His lip curls a little, and he says:

"Wrong.  An ounce of gold is heavier."

I imagine a silly argument about buoyancy or air friction.

But he continues:

"Gold is measured in troy ounces

And troy ounces are 480 grains each.

Feathers, on the other hand, are measured

In avoirdupois ounces.  An avoirdupois ounce—"

My fists fly into his face.

They don't make sounds like a Hollywood movie.

Just little plops, and

It hurts my hands more than I had imagined.

His front tooth splits open my knuckle

And I watch blood pump out of his lip in little waves.

"I'm sorry, I'm sorry," he sobs.

And I accept his apology.

Truth and Science

So I want to start out by repeating my caveat that I am very untutored in philosophy.  These posts are definitely in the "idle speculation" category.  And while people seem to want to take this in a very sophisticated direction (see the back and forth between Sarang and Tarun), I don't really have that kind of ambition.  I am worried about what seem to me to be very low-level questions.

But so anyway, in comments on my previous posts, I think Sarang takes the following position:

1.  What we mean by "truth" is a relationship of ideas/statements to the mind-independent real world (correspondence theory of truth).  If we want to talk about some other concept of truth, we should find a new word, because "truth" is taken.

2.  The real world has no necessary connection to our observational data.  (That is, you can't rule out the possibility that a demon or whatever is fooling your senses—this is what I take to be a "Cartesian demon.")

It seems to me that an implication of this view is that science has nothing to do with the truth.  So for instance, Dave engaged in some discussion of the Ptolemaic model of the solar system.  The story, maybe not quite historically accurate, is that scientists had devised a model of circular motion of planetary bodies around the earth.  However, the models had to be heavily refined with more and more circles (epicycles), lest the models give wrong predictions about where we would observe planets to be in the sky.  The models became very precise but very convoluted, and, per Dave, they would not have given you much predictive power if you were to discover a new planetary body.  The Copernican model of planetary motion (with the Sun as the center of the planets' orbit), while less accurate at predicting the movement of known planets, was much simpler and could more accurately predict the paths of new planets as they were discovered (I am hazy on this part).  If you add the concept of elliptical motion to the Copernican system, you get a pretty simple and accurate model of planetary motion, or so I am told.

Okay, so that's an interesting discussion, but I don't see how the Copernican model can have any claim on the truth, if Sarang is right.  After all, the Copernican model is merely better at explaining/predicting empirical data, and empirical data has no necessary relation to the real world (see point 2 above) and therefore no necessary relation to the truth.  For all we know, the planets actually move according to the Ptolemaic model, but God or a demon or whatever distorts our visual data and makes us think that the Copernican model has more predictive power.  The Church was right and we have been fools.

Likewise, I don't see how you could believe that, say, it is true that global warming is happening, if our observations of temperatures, polar ice caps, etc. are suspect.  Again, the theory might closely fit the data, but the data themselves don't have anything to do with the real world.  Truth is transcendental, not empirical, and humans can access it only through, I don't know, divine revelation or something.  Certainly not through science.

So while Sarang finds my viewpoint inadequate because it doesn't allow for Cartesian demons, I find his viewpoint unappealing because it divorces truth from human understanding.  We have no grounds to say that A is true while B is false.  Maybe we are compelled to accept certain things as provisionally or apparently true (so that we can build bridges, navigate ships, etc.), but this is a concession to the exigencies of life, not a commitment to empirical truth.  While scientific theories can be coherent and useful and predictively powerful, none of this can make them true.  Likewise, a theory can be incoherent or useless or contradicted by the evidence, and none of this can make it false.  Which means, by the way, that we should not care whether scientific theories are true or false, but merely whether they appear to be true or false to us.  In this, it seems to me that our current linguistic conventions do not fit Sarang's view, since we behave as though the sine qua non of a successful scientific theory is that it not be "false."  Indeed we treat observations that contradict a theory as though they have some bearing on its truth!  We would do much better to focus on a theory's apparent or empirical truth (its relationship to empirical data), though per Sarang we really need a new word for this concept, since this is not what people mean when they say a theory is true or false.