Bitcoin and Beyond

The surging price of the world’s best-known cryptocurrency has made some investors rich and prompted skeptics to point to the excesses of the current bull market. Central bank digital currencies (CBDCs) may offer a surer route to greater financial inclusion, but are policymakers and the public prepared for this potentially radical innovation?

In this Big Picture, Harvard University’s Kenneth Rogoff thinks that the COVID-19 pandemic could accelerate the emergence of CBDCs, and outlines two ways in which monetary policymakers could introduce them. The case for a digital dollar, however, is far from clear-cut, says Barry Eichengreen of the University of California, Berkeley, not least because fear that a digital renminbi will challenge the greenback’s global dominance is overblown. But New York University’s Nouriel Roubini makes the case that CBDCs could replace both an inherently crisis-prone banking system and worthless private cryptocurrencies such as Bitcoin.

Chatham House’s Jim O’Neill is similarly unimpressed by the Bitcoin hype, and explains why cryptocurrencies like it will never be anything more than speculative vehicles. For that reason, says Willem H. Buiter of Columbia University, only those with a robust appetite for risk and the wherewithal to absorb heavy losses should consider investing in them. By contrast, Brian Armstrong of cryptocurrency exchange Coinbase argues that cryptocurrencies with strong consumer-privacy protections should be a key feature of the post-pandemic recovery.

Either way, conclude Katharina Pistor of Columbia Law School and Co-Pierre Georg of the University of Cape Town, central banks may soon need to expand their remit and develop a new regulatory infrastructure to manage both public and private digital currencies.

The Case for Deeply Negative Interest Rates

Only monetary policy addresses credit throughout the economy. Until inflation and real interest rates rise from the grave, only a policy of effective deep negative interest rates, backed up by measures to prevent cash hoarding by financial firms, can do the job.

CAMBRIDGE – For those who viewed  as a bridge too far for central banks, it might be time to think again. Right now, in the United States, the Federal Reserve – supported both implicitly and explicitly by the Treasury – is on track to backstop virtually every private, state, and city credit in the economy. Many other governments have felt compelled to take similar steps. A once-in-a-century (we hope) crisis calls for massive government intervention, but does that have to mean dispensing with market-based allocation mechanisms?

Blanket debt guarantees are a great device if one believes that recent market stress was just a short-term liquidity crunch, soon to be alleviated by a strong sustained post-COVID-19 recovery. But what if the rapid recovery fails to materialize? What if, as one suspects, it takes years for the US and global economy to claw back to 2019 levels? If so, there is little hope that all businesses will remain viable, or that every state and local government will remain solvent.

A better bet is that nothing will be the same. Wealth will be destroyed on a catastrophic scale, and policymakers will need to find a way to ensure that, at least in some cases, creditors take part of the hit, a process that will play out over years of negotiation and litigation. For bankruptcy lawyers and lobbyists, it will be a bonanza, part of which will come from pressing taxpayers to honor bailout guarantees. Such a scenario would be an unholy mess.

Now, imagine that, rather than shoring up markets solely via guarantees, the Fed could push most short-term interest rates across the economy to near or below zero. Europe and Japan already have tiptoed into negative rate territory. Suppose central banks pushed back against today’s flight into government debt by going further, cutting short-term policy rates to, say, -3% or lower.

For starters, just like cuts in the good old days of positive interest rates, negative rates would lift many firms, states, and cities from default. If done correctly – and recent empirical evidence increasingly supports this – negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment. So, before carrying out debt-restructuring surgery on everything, wouldn’t it better to try a dose of normal monetary stimulus?

A number of important steps are required to make deep negative rates feasible and effective. The most important, which no central bank (including the ECB) has yet taken, is to preclude large-scale hoarding of cash by financial firms, pension funds, and insurance companies. Various combinations of regulation, a time-varying fee for large-scale re-deposits of cash at the central bank, and phasing out large-denomination banknotes should do the trick.

It is not rocket science (or should I say virology?). With large-scale cash hoarding taken off the table, the issue of pass-through of negative rates to bank depositors – the most sensible concern – would be eliminated. Even without preventing wholesale hoarding (which is risky and expensive), European banks have increasingly been able to pass on negative rates to large depositors. And governments would not be giving up much by shielding small depositors entirely from negative interest rates. Again, given adequate time and planning, doing this is straightforward.

Negative interest rates have elicited a blizzard of objections. Most, however, are either fuzzy-headed or easily addressed, as I discuss in my 2016 book on the past, present, and future of currency, as well as in related writings. There, I also explain why one should not think of “alternative monetary instruments” such as quantitative easing and helicopter money as forms of fiscal policy. While a fiscal response is necessary, monetary policy is also very much needed. Only monetary policy addresses credit throughout the economy. Until inflation and real interest rates rise from the grave, only a policy of effective deep negative interest rates can do the job.

A policy of deeply negative rates in the advanced economies would also be a huge boon to emerging and developing economies, which are being slammed by falling commodity prices, fleeing capital, high debt, and weak exchange rates, not to mention the early stages of the pandemic. Even with negative rates, many countries would still need a . But a weaker dollar, stronger global growth, and a reduction in capital flight would help, especially when it comes to the larger emerging markets.

Tragically, when the Federal Reserve conducted its 2019 review of policy instruments, discussion of how to implement deep negative rates was effectively taken off the table, forcing the Fed’s hand in the pandemic. Influential bank lobbyists hate negative rates, even though they need not undermine bank profits if done correctly. The economics profession, mesmerized by interesting counterintuitive results that arise in economies where there really is a zero bound on interest rates, must share some of the blame.

Emergency implementation of deeply negative interest rates would not solve all of today’s problems. But adopting such a policy would be a start. If, as seems increasingly likely, equilibrium real interest rates are set to be lower than ever over the next few years, it is time for central banks and governments to give the idea a long, hard, and urgent look.

That 1970s Feeling

Policymakers and too many economic commentators fail to grasp how the next global recession may be unlike the last two. In contrast to recessions driven mainly by a demand shortfall, the challenge posed by a supply-side-driven downturn is that it can result in sharp drops in production, generalized shortages, and rapidly rising prices.

CAMBRIDGE – It is too soon to predict the long-run arc of the coronavirus outbreak. But it is not too soon to recognize that the next global recession could be around the corner – and that it may look a lot different from those that began in 2001 and 2008.

For starters, the next recession is likely to emanate from China, and indeed may already be underway. China is a highly leveraged economy, it cannot afford a sustained pause today anymore than fast-growing 1980s Japan could. People, businesses, and municipalities need funds to pay back their out-size debts. Sharply adverse demographics, narrowing scope for technological catch-up, and a huge glut of housing from recurrent stimulus programs – not to mention an increasingly centralized decision-making process – already presage significantly slower growth for China in the next decade.

Moreover, unlike the two previous global recessions this century, the new coronavirus, COVID-19, implies a supply shock as well as a demand shock. Indeed, one has to go back to the oil-supply shocks of the mid-1970s to find one as large. Yes, fear of contagion will hit demand for airlines and global tourism, and precautionary savings will rise. But when tens of millions of people can’t go to work (either because of a lockdown or out of fear), global value chains break down, borders are blocked, and world trade shrinks because countries distrust of one another’s health statistics, the supply side suffers at least as much.

Affected countries will, and should, engage in massive deficit spending to shore up their health systems and prop up their economies. The point of saving for a rainy day is to spend when it rains, and preparing for pandemics, wars, climate crises, and other out-of-the-box events is precisely why open-ended deficit spending during booms is dangerous.

But policymakers and altogether too many economic commentators fail to grasp how the supply component may make the next global recession unlike the last two. In contrast to recessions driven mainly by a demand shortfall, the challenge posed by a supply-side-driven downturn is that it can result in sharp declines in production and widespread bottlenecks. In that case, generalized shortages – something that some countries have not seen since the gas lines of 1970s – could ultimately push inflation up, not down.

Admittedly, the initial conditions for containing generalized inflation today are extraordinarily favorable. But, given that four decades of globalization has almost certainly been the main factor underlying low inflation, a sustained retreat behind national borders, owing to a COVID-19 pandemic (or even lasting fear of pandemic), on top of rising trade frictions, is a recipe for the return of upward price pressures. In this scenario, rising inflation could prop up interest rates and challenge both monetary and fiscal policymakers.

It is also noteworthy that the COVID-19 crisis is hitting the world economy when growth is already soft and many countries are wildly overleveraged. Global growth in 2019 was only 2.9%, not so far from the 2.5% level that has historically constituted a global recession. Italy’s economy was barely starting to recover before the virus hit. Japan’s was already tipping into recession after an ill-timed hike in the value-added tax, and Germany’s has been teetering amidst political disarray. The United States is in the best shape, but what once seemed like a 15% chance of a recession starting before the presidential and congressional elections in November now seems much higher.

It might seem strange that the new coronavirus could cause so much economic damage even to countries that seemingly have the resources and technology to fight back. A key reason is that earlier generations were much poorer than today, so many more people had to risk going to work. Unlike today, radical economic pullbacks in response to epidemics that did not kill most people were not an option.

What has happened in Wuhan, China, the current outbreak’s epicenter, is extreme but illustrative. The Chinese government has essentially locked down Hubei province, putting its 58 million people under martial law, with ordinary citizens unable to leave their houses except under very specific circumstances. At the same time, the government apparently has been able to deliver food and water to Hubei’s citizens for roughly six weeks now, something a poor country could not imagine doing.

Elsewhere in China, a great many people in major cities such as Shanghai and Beijing have remained indoors most of the time in order to reduce their exposure. Governments in countries such as South Korea and Italy may not be taking the extreme measures that China has, but many people are staying home, implying a significant adverse impact on economic activity.

The odds of a global recession have risen dramatically, much more than conventional forecasts by investors and international institutions care to acknowledge. Policymakers need to recognize that, besides interest rate cuts and fiscal stimulus, the huge shock to global supply chains also needs to be addressed. The most immediate relief could come from the US sharply scaling back its trade-war tariffs, thereby calming markets, exhibiting statesmanship with China, and putting money in the pockets of US consumers. A global recession is a time for cooperation, not isolation.

The High Stakes of the Coming Digital Currency War

Just as technology has disrupted media, politics, and business, it is on the verge of disrupting America’s ability to leverage faith in its currency to pursue its broader national interests. The real challenge for the United States isn’t Facebook’s proposed Libra; it’s government-backed digital currencies like the one planned by China.

SOUTH BEND – Facebook CEO Mark Zuckerberg was at least half right when he recently told the United States Congress that there is no US monopoly on regulation of next-generation payments technology. You may not like Facebook’s proposed Libra (pseudo) cryptocurrency, Zuckerberg implied, but a state-run Chinese digital currency with global ambitions is perhaps just a few months away, and you will probably like that even less.

Perhaps Zuckerberg went too far when he suggested that the imminent rise of a Chinese digital currency could undermine overall dollar dominance of global trade and finance – at least the large part that is legal, taxed, and regulated. In fact, US regulators have vast power not only over domestic entities but also over any financial firms that need access to dollar markets, as Europe recently learned to its dismay when the US forced European banks to comply with severe restrictions on doing business with Iran.

America’s deep and liquid markets, its strong institutions, and the rule of law will trump Chinese efforts to achieve currency dominance for a long time to come. China’s burdensome capital controls, its limits on foreign holdings of bonds and equities, and the general opaqueness of its financial system leave the renminbi many decades away from supplanting the dollar in the legal global economy.

Control over the underground economy, however, is another matter entirely. The global underground economy, consisting mainly of tax evasion and criminal activities, but also terrorism, is much smaller than the legal economy (perhaps one-fifth the size), but it is still highly consequential. The issue here is not so much whose currency is dominant, but how to minimize adverse effects. And a widely used, state-backed Chinese digital currency could certainly have an impact, especially in areas where China’s interests do not coincide with those of the West.

A US-regulated digital currency could in principle be required to be traceable by US authorities, so that if North Korea were to use it to hire Russian nuclear scientists, or Iran were to use it to finance terrorist activity, they would run a high risk of being caught, and potentially even blocked. If, however, the digital currency were run out of China, the US would have far fewer levers to pull. Western regulators could ultimately ban the use of China’s digital currency, but that wouldn’t stop it from being used in large parts of Africa, Latin America, and Asia, which in turn could engender some underground demand even in the US and Europe.

One might well ask why existing cryptocurrencies such as Bitcoin cannot already perform this function. To an extremely limited extent, they do. But regulators worldwide have huge incentives to rein in cryptocurrencies by sharply proscribing their use in banks and retail establishments. Such restrictions make existing cryptocurrencies highly illiquid and ultimately greatly limit their fundamental underlying value. Not so for a Chinese-backed digital renminbi that could readily be spent in one of the world’s two largest economies. True, when China announces its new digital currency, it will almost surely be “permissioned”: a central clearing house will in principle allow the Chinese government to see anything and everything. But the US will not.

Facebook’s Libra is also designed as a “permissioned” currency, in its case under the auspices of Swiss regulators. Cooperation with Switzerland, where the currency is officially registered, will surely be much better than with China, despite Switzerland’s long tradition of extending privacy to financial transactions, especially with regard to tax evasion.

The fact that Libra will be pegged to the US dollar will give US authorities additional insight, because (at present) all dollar clearing must go through US-regulated entities. Still, given that Libra’s functionality can largely be duplicated with existing financial instruments, it is hard to see much fundamental demand for Libra except among those aiming to evade detection. Unless tech-sponsored currencies offer genuinely superior technology – and this is not at all obvious – they should be regulated in the same way as everyone else.

If nothing else, Libra has inspired many advanced-economy central banks to accelerate their programs to provide broader-based retail digital currencies, and, one hopes, to strengthen their efforts to boost financial inclusion. But this battle is not simply over the profits from printing currency; ultimately, it is over the state’s ability to regulate and tax the economy in general, and over the US government’s ability to use the dollar’s global role to advance its international policy aims.

The US currently has financial sanctions in place against 12 countries. Turkey was briefly sanctioned last month after its invasion of Kurdish territory in Syria, though the measures were quickly lifted. For Russia, sanctions have been in place for five years.

Just as technology has disrupted media, politics, and business, it is on the verge of disrupting America’s ability to leverage faith in its currency to pursue its broader national interests. Libra is probably not the answer to the coming disruption posed by government-sanctioned digital currencies from China and elsewhere. But if not, Western governments need to start thinking about their response now, before it is too late.

How Central-Bank Independence Dies

Since the world’s major central banks came to the global economy’s rescue in 2008, they have had more and more tasks foisted upon them, even as some politicians question their expanded role and others seek to undermine their policymaking autonomy. To escape this dilemma, monetary authorities must get back to doing what they do best.

CAMBRIDGE – With the global rise of populism and autocracy, central-bank independence is under threat, even in advanced economies. Since the 2008 financial crisis, the public has come to expect central banks to shoulder responsibilities far beyond their power and remit. At the same time, populist leaders have been pressing for more direct oversight and control over monetary policy. And while central banks have long been under assault from the right for expanding their balance sheets after the crisis, now they are under attack from the left for not expanding their balance sheets enough.

This is a remarkable shift. Not too long ago, central-bank independence was celebrated as one of the most effective policy innovations of the past four decades, owing to the dramatic fall in inflation worldwide. Recently, however, an increasing number of politicians believe that it is high time to subordinate central banks to the prerogatives of elected officials. On the right, US President Donald Trump and his advisers routinely bash the US Federal Reserve for keeping interest rates too high. On the left, British Labour leader Jeremy Corbyn has famously called for “people’s quantitative easing” to provide central-bank financing for government investment initiatives. “Modern Monetary Theory” is an idea in the same vein.

There are perfectly healthy and legitimate discussions to be had about circumscribing the role of central banks, particularly when it comes to the large-scale balance sheet operations (such as post-crisis quantitative easing) that arguably trespass into fiscal policy. However, if governments undercut central banks’ ability to set interest rates to stabilize inflation and growth, the results could be dangerous and far-reaching. If anti-inflation credibility is lost, governments may find it very difficult – if not impossible – to put the genie back in the bottle.

Worry About Debt? Not So Fast, Some Economists Say

U.S. deficits may not matter so much after all—and it might not hurt to expand them for the right reasons

Now, some prominent economists say U.S. deficits don’t matter so much after all, and it might not hurt to expand them in return for beneficial programs such as an infrastructure project.

“The levels of debt we have in the U.S. are not catastrophic,” said Olivier Blanchard, an economist at the Peterson Institute for International Economics. “We clearly can afford more debt if there is a good reason to do it. There’s no reason to panic.”

Mr. Blanchard, also a former IMF chief economist, delivered a lecture at last month’s meeting of the American Economic Association where he called on economists and policymakers to reconsider their views on debt.

The crux of Mr. Blanchard’s argument is that when the interest rate on government borrowing is below the growth rate of the economy, financing the debt should be sustainable.

.. Interest rates will likely remain low in the coming years as the population ages. An aging population borrows and spends less and limits how much firms invest, holding down borrowing costs. That suggests the government will not be faced with an urgent need to shrink the debt.

Mr. Blanchard stops short of arguing that the government should run up its debt indiscriminately. The need to finance higher government debt loads could soak up capital from investors that might otherwise be invested in promising private ventures.

Mr. Rogoff himself is sympathetic. “The U.S. position is very strong at the moment,” he said. “There’s room.”

.. Some left-wing economists go even further by arguing for a new way of thinking about fiscal policy, known as Modern Monetary Theory.

MMT argues that fiscal policy makers are not constrained by their ability to find investors to buy bonds that finance deficits—because the U.S. government can, if necessary, print its own currency to finance deficits or repay bondholders—but by the economy’s ability to support all the additional spending and jobs without shortages and inflation cropping up.

Rather than looking at whether a new policy will add to the deficit, lawmakers should instead consider whether new spending could lead to higher inflation or create dislocation in the economy, said economist Stephanie Kelton, a Stony Brook University professor and former chief economist for Democrats on the Senate Budget Committee.

If the economy has the ability to absorb that spending without boosting price pressures, there’s no need for policy makers to “offset” that spending elsewhere, she said. If price pressures do crop up, policy makers can raise taxes or the Federal Reserve can raise interest rates.

“All we’re saying, the MMT approach, is just to point out that there’s more space,” she said. “We could be richer as a nation if we weren’t so timid in the use of fiscal policy.”

 .. By continuing to run large deficits, says Marc Goldwein, senior vice president at the Committee for a Responsible Federal Budget, the U.S. is slowing wage growth by crowding out private investment, increasing the amount of the budget dedicated to financing the past and putting the country at a small but increased risk of a future fiscal crisis.

Market interest rate signals can be misleading and dangerous. By blessing the U.S. with such low rates now, he says, financial markets just might be “giving us the rope with which to hang ourselves.”

Why Human Chess Survives

when Kasparov next had to defend his title against a human challenger, match organizers found it much more difficult to raise a suitably large purse than in pre-Deep Blue days. Sponsors would invariably ask “Wait, what I am paying for, isn’t the computer the real-world champion?” Fast-forward to today, and the top players cannot easily beat their cell phone.

Yet, rather than dying, chess has thrived. This is partly because the advent of computers and computer databases has made chess a truly universal sport. Once dominated by Russia, Vishy Anand of India held the title before Carlsen, and China’s Ding Liren seems on track to be the next challenger. Parents, despondent over their children’s addiction to video, are much happier to see them playing chess against a computer.

.. The advent of computers has required some adjustments in top tournaments. It helps that even the best computer programs do not play chess perfectly, because the number of possible games is greater than the number of atoms in the universe. Moreover, computers think so differently that it is not always helpful to know the computer’s favored move unless one can tediously follow reams of subsequent analysis. It is not unusual for a player to comment, “

The advent of computers has required some adjustments in top tournaments. It helps that even the best computer programs do not play chess perfectly, because the number of possible games is greater than the number of atoms in the universe. Moreover, computers think so differently that it is not always helpful to know the computer’s favored move unless one can tediously follow reams of subsequent analysis. It is not unusual for a player to comment, “The computer says the best move is x, but I played the best human move.”

.. if someone is suspected of cheating, the organizers can check their moves against the choices of the top computer programs. If there is too high a correlation, the player is subject to ejection.

.. just as tied World Cup matches end with a shootout, chess championship can come down to an “Armageddon” where the games are speeded up so much that it is virtually impossible to avoid big mistakes. In the end, Carlsen convincingly prevailed in the tie-breaker, in very human fashion. But we should all celebrate.