ROCHESTER — The Lake Shore Limited runs between Chicago and New York City without crossing the Canadian border. But when it stops at Amtrak stations in western New York State, armed Border Patrol agents routinely board the train, question passengers about their citizenship and take away noncitizens who cannot produce satisfactory immigration papers.
The little-publicized transportation checks are the result of the Border Patrol's growth since 9/11, fueled by Congressional antiterrorism spending and an expanding definition of border jurisdiction. In the Rochester area, where the border is miles away in the middle of Lake Ontario, the patrol arrested 2,788 passengers from October 2005 through last September.
Admittedly, looking at only defaults under fiat currency excludes all the notorious cases before the mid-twentieth century. So I decided to do a little research, and discovered that Standard and Poor's reports 84 sovereign defaults from 1975 to 2002. The following is from their list of States (along with the dates) that defaulted either on their domestic debt, on their foreign debt, or on both. I've excluded cases like Mexico (1982-1990), where the default was not on government securities but on foreign-denominated bank debt, which shortens the list considerably. But some governments, like Argentina's have had more than one default.
Angola (1976), Argentina (1982, 1989-1990, 2002-04), Bolivia (1989-97), Brazil (1986-87, 1990), Congo (1979), Costa Rica (1984-85), Croatia (1993-96), Dominica (2003-04), Dominican Republic (1975-2001), Ecuador (1999-2000), El Salvador (1981-96), Gabon (1999-2004), Ghana (1979, 1982), Guatemala (1989), Ivory Coast (2000-04), Kuwait (1990-91), Madagascar (2002), Moldova (1998, 2002), Mongolia (1997-2000), Myanmar (1984, 1987), Nigeria (1996-88, 1992, 2002), Pakistan (1999), Panama (1987-94), Paraguay (2003-04), Russia (1998-99), Rwanda (1995), Sierra Leone (1997-98), Solomon Islands (1996-2004), Sri Lanka (1996), Sudan (1991), Ukraine (1998-2000), Venezuela (1995-97, 1998), Vietnam (1975), Yugoslavia (1992), Zimbabwe (1975-80).
What is more interesting is that a few have begun advocating a U.S. debt repudiation.
See for instance this 2009 op-ed by Scott Beaulier and Pete Boettke, this January 2010 article by Gideon Rachman in the Financial Times, or the following website. Indeed, as I reported in a previous post, similar musings have provoked Bruce Bartlett to attack advocates of default. And here is an article by John Seilter advocating a California default. (For a up-to-date source that monitors the pension crises facing not just California but other states, check out Jack Dean's website, Pension Watch.)
My own first article making the case for the repudiation of all government debt, which appeared in the August-September 1981 issue of Caliber (publication of the Libertarian Party of California), is now available as a pdf download on my personal webpage. I've accompanied the article with a caveat that includes the following:"If I were writing it today, the article would be a little less strident, and my discussion of the economic consequences of repudiation would be more sophisticated. I would tone down some minor hyperbole in the article's opening section. In particular, the 2007-08 financial crisis has convinced me that I was much too blase about the short-run consequences of a U.S. repudiation. But I still think my long-run economic analysis is correct, that my moral case for repudiation is justified, and that my historical examples (which could be expanded and extended to other cases) is telling."
I used that quotation in the Epilogue to Emancipating Slaves, Enslaving Free Men, with the following footnote:"I have been unable to find the source for this quotation attributed to John Emerich Edward Dalbert-Acton, 1st Baron, so it may be apocryphal. But if Acton did not actually say it, he should have. It is consistent with his thought and his other writings." I now have found a source that makes it highly unlikely that those were Acton's exact words but still leaves it somewhat uncertain whether he at some point made a similar reference to Rhadamanthus.
I initially found the quotation in an article by Murray Rothbard, who provided no supporting reference. Acton had said something related in his well-known correspondence with Bishop Mandell Creighton, which is also the source of Acton's oft-repeated maxim about power corrupting. Acton wrote with respect to the crimes of great men,"I would hang them higher than Haman, for reasons of quite obvious justice, still more, still higher, for the sake of historical science," but there is no reference to Rhadamanthus.
Only recently was I looking through the 1907 edition of Acton's Lectures on Modern History, edited by John Neville Figgis and Reginald Vere Laurence. Here is what the two editors write in their introduction about"Lord Acton as Professor" on p. iv:"For to Acton history was the master of political wisdom, not a pursuit but a passion, not a mere instrument but a holy calling, not Clio so much as Rhadamanthus, the avenger of innocent blood." So the reference to Rhadamanthus comes from them, although it is still possible that they are reporting on something Acton had previously said.
David Henderson comments here.
"A new strain of populism is metastasizing before our eyes, nourished by the same libertarian impulses that have unsettled American society for half a century now. Anarchistic like the Sixties, selfish like the Eighties, contradicting neither, it is estranged, aimless, and as juvenile as our new century. It appeals to petulant individuals convinced that they can do everything themselves if they are only left alone, and that others are conspiring to keep them from doing just that. This is the one threat that will bring Americans into the streets. Welcome to the politics of the libertarian mob."
"Now an angry group of Americans wants to be freer still--free from government agencies that protect their health, wealth, and well-being; free from problems and policies too difficult to understand; free from parties and coalitions; free from experts who think they know better than they do; free from politicians who don't talk or look like they do (and Barack Obama certainly doesn't). They want to say what they have to say without fear of contradiction, and then hear someone on television tell them they're right. They don't want the rule of the people, though that's what they say. They want to be people without rules--and, who knows, they may succeed."
The analysis, if not the evaluation, is in many respects similar to that put forward years ago by Jeff Riggenbach in In Praise of Decadence. And David Henderson comments on the article over at EconLog.
Here is Tyler Cowen's summary of the paper. I still think, however, that Roberts pays insufficient attention to the role of international savings flows and to the 2007 collapse of the repo market that is identified by Gary Gorton and is responsible for Scott Sumner's negative velocity shock.
So I was intrigued to notice that the most recent, 2010 edition of Frederic S. Mishkin's standard money and banking text, The Economics of Money, Banking & Financial Markets, observes that, despite the increased consolidation of the U.S. banking industry over the last twenty-five years, it still remains the least concentrated in the developed world. Mishkin, although no market fundamentalist by any stretch of the imagination, writes that"in contrast to the United States, which has on the order of 7,100 commercial banks, every other industrialized country has far less than 1,000. Japan, for example, has fewer than 100 commercial banks . . . even though its economy and population are half the size of those of the United States."
Not only does the U.S. have more banks, but they tend to be much smaller. In Mishkin's list of the ten largest banks in the world as of 2008, not a single one was from this country. They were all from the UK, Germany, France, Switzerland, the Netherlands, or Japan. Admittedly the list only focused on the assets of commercial banks per se, and not of their holding companies. And the subsequent bailout and Fed ballooning of bank reserves by nearly $1 trillion has pushed two U.S. banks into the Bankers Almanac list of top ten for 2010: JP Morgan Chase at seventh place, and Bank of America at tenth.
Yet these facts so far have not even been mentioned in the debate over financial reform. As nearly every knowledgeable economic historian concedes: the past, misguided restrictions on branching, dating back to before the Civil War and making the U.S. banking system the most fragmented in the world, also made it the most fragile, vulnerable to its record number of bank panics. Indeed, the U.S. system of unit banking was one of the major factors that contributed during the Great Depression to the worst banking crisis in world history.
Is it possible that some U.S. banks now exceed the optimal size from the standpoint of economic efficiency? We can expect that kind of simple-minded conclusion from the likes of Joseph Stigliz, but even Alan Greenspan, in a recent paper on"The Crisis," has stated:"Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution." How sad that an alleged defender of free markets would even imply that it is the market's fault when it does not conform to some Fed paper's estimate of what is efficient. Why did these large banks emerge in the first place if they did not capture some economic gain?
If large banks are indeed economically inefficient, this would normally create opportunities for hostile takeovers which could profit by breaking the big banks up. But of course, the same critics who decry markets for creating principal-agent problems between managers and shareholders are often the most strident opponents of corporate takeovers, the markets effective solution to such problems. All corporate mangers, of course, enjoy the partial protection of the federal Williams Act of 1968 and assorted state impediments to hostile takeovers, but less well known is the fact that control over financial institutions is strangled within a still more onerous and convoluted web of protections. The bottom line is that a hostile takeover of any inefficiently managed large bank is all but impossible for non-financial parties, and even when attempted by another financial institution, must virtually be orchestrated by the regulators themselves.
An article by James A. Wilcox in the November 2005 issue of San Francisco Fed's Economic Letter hints at a revealing possible explanation for large banks."Government policies may also increase the economies of scale that depositories face. Recent legislation, such as the Gramm-Leach-Bliley Act, the USA Patriot Act, and the Bank Secrecy Act, may . . . have the effect of imposing various sizable costs that are borne disproportionately by the smaller depositories. Such disproportionate, law-induced costs would increase the returns to scale in the banking and credit union industries and thereby strengthen the motives for consolidation." Although this line of research has not, so far as I know, been followed up on, it coincides with an anecdotal observation that one of my students who then worked in the banking industry made years ago. She reported that at least one-third to one-half of her work time and that of her fellow employees was devoted to complying with various government edicts.
So there you have it: the exact same pattern as health care. Government coercion creates unintended outcomes that become the justification for more government coercion that will have even worse unintended consequences down the road. Playing the game of trying to alleviate problems created by some interventions with other offsetting interventions runs up against the hubristic folly of central planning. No one knows enough to do that wisely and effectively, even in the rare cases where it might be politically feasible. If U.S. banks are indeed too big because of stupid government regulations (something we can never know with absolute certainty), then the solution is to repeal those stupid regulations, not break the banks up with more stupid regulations.
1. An early draft of our article on Greenspan exposed the Vockler myth, arguing that Vockler's monetary policy was not as tight as many believe and that his role in bringing down inflation in the early 1980s is grossly exaggerated. That section was edited out of all the published versions as too much of a digression, but Belongia offers some surprising (and even chilling) confirmation of our claim.
2. Belongia not only wholeheartedly agrees that interest rates are a poor way of gauging monetary policy, but he goes so far as to argue that, over the period when everyone claims that Greenspan's policy was expansionary, it was in fact too tight.
3. Belongia manages to score some significant points against the Taylor Rule, pointing out that if it had been subjected to the same standards that led to the rejection in the mid-1980s of money stock measures as a target for monetary policy, the rule would have been abandoned long ago. (For more on the ambiguity of the Taylor Rule, see this post by Brad DeLong.)
RPs are close money substitutes. Bank-issued overnight RPs were an important way banks got around regulations so they could pay high interest to large depositors in the 70s and early 80s, and were counted in M2 until 1997, when the Fed moved them into M3, where it already counted term RPs issued by banks. Gorton's analysis implies that I was seriously mistaken about the insignificance of the Fed's ceasing to report M3 in February 2006. M3 was discontinued just at the moment it was diverging from M2 and providing important information not otherwise available about certain monetary instruments.
Gorton's paper also clears up some other things that puzzled or intrigued me. Among them:
1. The huge drop at the outset of the crisis in RP borrowing by banks, to be replaced by borrowing from the Fed.
2. The prior, major transformation of investment banks from almost exclusively broker-dealers to enormous financial intermediaries in their own right.
2. The precise nature of the negative velocity shock that plays such a central role in Scott Sumner's explanation for the downturn.
4. How the subprime crisis precipitated this decrease in the velocity of reported monetary measures.
Some minor quibbles, however, I have with Gorton.
1. He doesn't make clear that, while bank-issued RPs were once counted in the official monetary measures (because of their immediate interchangeability with demand deposits), RPs issued by investment banks and other institutions were not.
2. He claims that no one knows the full size of the RP market, which he estimates at the incredible amount of $12 trillion. But surely most RPs must show up somewhere in the Fed's quarterly Flow of Funds accounts, which puts their total at only $2 trillion at their peak. Admittedly this reflects only RPs between sectors, and not intra-sectoral RPs made from one investment bank to another, but I still find it hard to believe that such lending and borrowing could raise the total by a full $10 trillion.
3. I think he underestimates the role of government intervention in creating this structural problem and precipitating the downfall.
Nonetheless, this is definitely a MUST read.
Hat Tip: Tyler Cowen
Hat Tip: Bill Evers
"Yet even though Washington's cautious attitude partly resulted from a misassessment, this was actually the best possible position it could have taken. This time around, unlike in 1956, no one in Moscow could suggest with even a jot of plausibility that the United States was stirring the cauldron in Eastern Europe. On the contrary, Bush personally urged General Wojciech Jaruzelski to run for Polish president, as a guarantor of stability, and he was obsessed with doing nothing that could derail Gorbachev. Sarotte suggests that American restraint made it easier for the Soviet Union, too, to step back and let events unfold on the ground in East-Central Europe. With some exaggeration, one might say that Washington got it right because it got it wrong."
The Fed also serves as a clearinghouse for banks, and that function is in tension with monetary policy. When the Fed was first created in 1914, it provided clearing services to all member banks for free, driving out of business the various private clearinghouses that had arisen and were solving some of the liquidity problems associated with the destabilizing National Banking System. Then in 1980, the Depository Institutions Deregulation and Monetary Control Act required the Fed to offer its clearing services to all depository institutions--whether banks or not, and whether members of the Fed or not--but at a fee that allowed the reemergence of private alternatives.
There are two ways to run a clearinghouse. The first, net settlement, involves waiting until the end of the settlement period (traditionally a day) and then transferring only net amounts. The second, a real-time gross settlement (RTGS) system, settles each payment as it occurs. The private Clearing House Interbank Payments System (or CHIPS, created in 1970), which now handles more than one-quarter of bank clearings in the U.S., netted all settlements at the end of the business day until 2001, when it switched to intraday payments. The Fed's current system, Fedwire, in contrast, has always conducted real-time settlements. Because banks may therefore lose all their reserves to other banks before any offsetting receipts come in, the Fed provides banks with intraday overdrafts to assist with their clearings.
Before paying interest on reserves, the value of these overdrafts was climbing to an amount exceeding bank reserves. Thus since 1987, U.S. banks reserves (counting vault cash) have hovered around $65 billion, but the average daylight overdrafts outstanding at any minute during the day rose from around $15 billion to nearly $50 billion. The peak value of daylight overdrafts at any moment could rise even higher, to over $100 billion. Alex Tabarrok over at Marginal Revolution provides a colorfully apt description of this process:"in essence, the banks used to inhale credit during the day--puffing up like a bullfrog--only to exhale at night. (But note that our stats on the monetary base only measured the bullfrog at night.)"
A clearing system using net settlement leaves the potential losses from a bank's failure to pay on the bank(s) owed money. But Fedwire's RTGS system transfers that risk to the Fed itself. The Fed has consequently tried to limit bank use of daylight overdrafts, first imposing net debit caps in 1985 and then imposing minute-by-minute interest charges in 1994. Once the Fed began paying interest on reserves, the banks had an incentive to substitute excess reserves for now more costly Fed credit. A technical article that models this change, Ennis and Weinberg, reveals that the Fed expected and hoped for this result in order to reduce the Fedwire risk from daylight overdrafts.
Being able to earn on interest on reserves would have caused the banks to hold more of them anyway, but the fee on daylight overdrafts only augments that effect. Much of the Fed's recent, more than ten-fold increase in bank reserves, to a current total of about $675 billion, has so far caused banks primarily to increase their reserve ratios rather than expand their loans. Some, like Paul Krugman, have interpreted this as a huge, deflationary flight to liquidity. Others, like myself, contend that it is only a matter of time before this leads to inflation. But as Alex suggests, the payment of interest on reserves could render both predictions wrong. The increase in reserve ratios could simply be a one-shot response of banks, hiking ratios to a new level. No one knows for sure, including I would add, the Fed itself.
The European Central Bank (ECB), like the Fed, has been pumping up its monetary base with wild abandon. And as in the U.S., private European banks seem to be increasing their reserve ratios, at least in the short term. But the ECB has paid interest on reserves since introduction of the Euro in 1999. In fact, because interest on reserves reduces central bank seigniorage, confining it to currency alone, this feature may have eased the negotiations over the inevitable conflicts in creating a European monetary union. The ECB also oversees a real-time clearing system with intraday credit, known as TARGET (Trans-European Automated Real-Time Gross Settlement Express Transfer).
So again, the accumulation of excess reserves may reflect the perverse impact of central banks paying interest on them. The Fed started doing this, confident from the experience of the ECB, and other central banks, such as those of Canada, New Zealand, and Australia, that have been doing so for some time. But the policy had never been tested in a period of falling interest rates, rising risk premiums, and rising preferences for shorter maturities.
I predict that future economic historians will look back on this change as a major blunder during the current credit tightening, making traditional monetary policy less effective. True, the broader monetary aggregates are already beginning to respond to the Fed's base explosion, with M1 annual growth up from 0 to 20 percent over the last three months, and M2 annual growth up from 5 to 10 percent over the same period. Yet irrespective of whether the long run brings deflation, inflation, or neither, paying interest on reserves has certainly applied deflationary pressure in the short run. It may eventually rank with the Fed's doubling of reserve requirements in the 1930s and bringing on the recession of 1937 within the midst of the Great Depression.
Moreover, the paying of interest on reserves was motivated by the misguided focus on interest rates, rather than money supply measures, as an indicator and target of monetary policy, a focus that has dominated central bank operations worldwide for the last two decades. It is also a focus that seems sadly to have taken in many libertarian and free-market economists. Although done in the name of controlling inflation, this focus actually reflects a move toward centralized economic planning on the part of central banks, given that the interest rate is a relative price, with a significant real as well as a nominal component, compared with such purely nominal targets as the money supply or the price level.
The irony is that the Fed is now less able to hit its interest rate target than ever before. It first adopted the corridor or channel system of the ECB, setting the interest rate on reserves below its Federal funds target, as a lower bound, with the discount rate above the target as an upper bound. But as the effective Federal funds rate fell not only below target but below the interest rate on reserves, the Fed on November 5 moved to the New Zealand system, where the interest rate on both required and excess reserves is set right at the target Federal funds rate. So far, this hasn't worked either. (For accessible descriptions of these two systems, see an article by Keister, Martin, and McAndrews.)
Why does the effective Federal funds rate remain below the Fed's target rate of 1 percent, despite the fact that the Fed is now paying interest on both required reserves and excess reserves at that target rate? The best explanation for the anomaly has been offered by Jim Hamilton. Fannie, Freddie, the Federal Home Loan Banks, and other GSEs, plus some international institutions have deposits at the Fed, and these do not earn interest. These institutions are also players in the Fed funds market. So their Fed funds loans would not be affected by the interest paid on excess reserves.
During World War II, Congress enacted YEAR-ROUND Daylight Saving Time, again to conserve energy. In September 1945, at the war's end, what was officially designated as"War Time" was again repealed, leaving the practice entirely up to states and localities. This created a patchwork system, in which different states would start or come off Daylight Saving Time on different dates, if at all. As a result, United Airlines reportedly had to publish twenty-seven different time tables each year. So it was the airlines, along with other transportation industries, that lobbied for national uniformity, which was embodied in the federal Uniform Time Act of April 1966.
Under this act, state governments can exempt themselves from Daylight Saving, as long as the exemption applies to the entire state (or if the state is divided into more than one time zone, to at least the area encompassing one of the zones). Only two states still take advantage of this option: Arizona and Hawaii. Congress also subsequently played around with the starting and ending dates, shifting them for assorted reasons, with the last change (so far!) being enacted in 1987.
Yet there has never been any solid evidence that Daylight Saving Time saves energy. For an economic critique of the practice, see the article by William F. Shugart II,"Time Change Could Prove Hazardous to Your Health":
"Almost everyone is aware that federal government spending in the United States is scheduled to skyrocket, primarily because of Social Security, Medicare, and Medicaid. Recent"stimulus" packages have accelerated the process. Only the naively optimistic actually believe that politicians will fully resolve this looming fiscal crisis with some judicious combination of tax hikes and program cuts. Many predict that, instead, the government will inflate its way out of this future bind, using Federal Reserve monetary expansion to fill the shortfall between outlays and receipts. But I believe, in contrast, that it is far more likely that the United States will be driven to an outright default on Treasury securities, openly reneging on the interest due on its formal debt and probably repudiating part of the principal."
Rather than summarize Kirchner's well-researched Policy Monograph, I can best give you a feel for his conclusions by quoting it directly:"The idea of 'bubbles' in asset prices quickly breaks down as soon as one tries to give it analytical coherence or empirical substance. Most commonly, the idea of a 'bubble' is little more than a tautology or circular argument."
Kirchner looks at theories of both rational and irrational bubbles, and finds them all lacking. In the process, he subjects the works Robert Shiller to withering critique:"Shiller's earlier work Irrational Exuberance was largely built around the observation of statistical mean reversion in equity prices, with the behavioural finance component tacked on in an effort to disguise the fact that he otherwise had nothing to say about the determination of asset prices."
In the process, Kirchner effectively defends the efficient market hypothesis (EMH) from behavioral critiques:"violations of the EMH are often misinterpreted as an argument against the allocative role of markets. In this respect, the EMH is analogous to the idea of perfect competition in markets for goods and services. No one believes that any real-world market for goods and services is perfectly competitive, and violations of the assumptions of the perfectly competitive model do not lead us to reject the model's usefulness or the role of markets in setting prices."
Continuing to quote Kirchner:"The behavioural finance and experimental economics literature questions the rational choice assumptions underpinning standard models of economic and financial behaviour. This literature is notable for failing to advance a generally applicable alternative behavioural model, but even if such a model were found, it might struggle to explain the irregular occurrence of 'bubbles.' Much of this literature relies on static experimental results divorced from real-world institutional settings. The irony of the behaviouralist literature is that it has no general behavioural model. Instead, this literature now serves mainly as a laundry list of actual or potential exceptions to the efficient markets hypothesis--to be ritually recited to either dismiss the role of markets as allocators of capital or to explain away market outcomes that do not conform with the prior beliefs of the analyst."
Kirchner continues with an excellent survey of"'Bubbles' as historical myth," which he wraps up with an account of Greenspan's policies, absolving Greenspan of responsibility for both the dot.com boom and the housing boom. Withal, his monograph merits close reading. With the added benefit that Kirchner favorably quotes David Henderson's and my Cato Briefing on Greenspan's monetary policies. :-)
Coda: Another economist who has recently risen to the defense of the efficient markets hypothesis is Scott Sumner, on his blog, "The Money Illusion." He points out an internal inconsistency in some behavioral critiques:"if investors are foolish to ignore the risk of Black Swan events, why should we trust probability values in anomaly studies?" More important, he offers a fundamental explanation for the housing boom that I have not seen elsewhere:"The housing bubble in 2004-2006 was partly driven by rapid immigration from Latin America (as was the bubble in Spain itself!), and also by a perception (which turned out false) that coastal zoning constraints were spreading into interior markets. Many Hispanic immigrants were snapping up older ranch houses, allowing native born Americans to move on to bigger McMansions. The immigration crackdown in 2007 dramatically slowed this immigration (as did the worsening economy.) Population growth estimates going several years forward fell sharply, hurting housing speculators. Ground zero of the sub-prime bust is in working class areas of the Southwest and Florida. Any guess as to who bought homes in those areas?"
