Monetary Policy Options (Notes for discussion)

  1. Babylonian Option (Code of Hammurabi): Year of Jubilee
    • Because Debt compounds (compound interest), it grows out of control
    • When it gets out of control, it must be reigned in
    • The Babylonians realized that compound interest would make their citizens “debt slaves”
      • A neighboring king could threaten to invade the indebted land and offer to forgive all the personal debts
      • Therefore, the king realized that he would have to forgive the debt himself, because otherwise his subjects would not fight to defend against the invader.
    • The nation of Israel was held captive in Babylonia and learned about this debt forgiveness.  This is where the “Year of Jubilee” comes from.
      • Roughly every 50 years, the personal debt is forgiven
      • This results in lenders choosing to “back off” and limit loan term lengths.
      • As the Year of Jubilee approached, lenders would stop making new (personal) loans that extended past the Year of Jubilee, resulting in a natural decline of leverage.
      • Business loans were not forgiven.
    • With the exception of the Romans, most other nations adopted the Babylonian debt forgiveness policy.  The US is following the Roman approach.
    • Professor Michael Hudson says that this attitude toward debt was part of the Roman dysfunction.  We have adopted the Roman policy that the debt always has to be repaid.
  2. The hard money standard (gold/bitcoin) tries to avoid governments debasing money by printing more fiat.  It tries to use a scarce asset like gold as a means to limit the power of governments to corrupt the money.
  3. Fiat Standard: allows governments to print as much as they want.  Stephanie Kelton says that MMT (modern monetary theory) enables monetarily sovereign countries to run big deficits, with the only limitation being inflation.  According to this school, governments should focus on inflation, rather than debt.
    • One question is what happens when the government issues more debt than the market wants to purchase without significantly higher interest rates.  Can the Federal Reserve buy up as much treasuries as the government wants?
  4. Soft Default: Critics of the Fiat Standard argue that monitoring debt is very important.  With debt in the US ~130% of GDP, the government can’t fight inflation by raising interest rates without spending large amounts on interest.
      • In the late 1970s, Paul Volcker was able to reign in high inflation by raising interest rates into the double digits.  The US can’t afford to do this now because the debt levels are so much higher (130% of GDP vs 30%).
      • One way the government could deal with the debt is to inflate the money supply over an extended period of time (a decade) until the debt is roughly half its current level (in relation to GDP).
        • I assume this is the unstated US governmental policy.
  5. Hard Default: Another option would be to arrange for a sudden and dramatic debasement of the currency.  Prices would double overnight, making it easier to pay back debts with devalued currency.
    • A hard default happens regularly in other countries
    • A hard default happened in March of 1933, when FDR reset the price of gold.
      • In 1971, the US had a soft default when it went off the gold standard.
  6. Transition to new System (soft default)
    • A final option would be for the federal reserve to inflate the dollar while people voluntarily transition to a new system, be that the Bancor or Bitcoin, or something else.  Those who remain in the old system the longest get the worst exchange rate to the new system.
    • This would be like the Babylonian option in that the debt would be forgiven, but it would be a one-time event and not establish this as a regular tradition.