Maybe Dollars Should Be Digital
(Bloomberg Opinion) -- American Vollgeld.
One weird thing about the U.S. financial system—and most modern financial systems—is that it is basically impossible to hold cash electronically. I wrote last month:
There is no convenient electronic form of just, in the strictest sense, cash. You can put your dollars in a bank account, but the bank could go bust. (Deposit insurance has limits.) You can buy Treasury bills, but those mature, and meanwhile can lose (a tiny bit of) value as interest rates change. You can put your money into a money-market fund, but that could, however improbably, lose value too. None of these risks are all that material over an overnight time horizon. But if you have a lot of dollars, and your quite modest goal is “I want to have always exactly this amount of dollars on every day in the future, accessible anywhere, with absolutely no credit or market risk of any kind,” you can’t do it. … It tells you something about the nature of dollars: that they are not pure entities that you can just conveniently own, that they are instead always somehow obligations of someone else, that they exist only as some form of debt.
There is something sort of metaphysically appealing about this situation. What, after all, is a dollar? It’s not particularly nutritious if you eat it; it doesn’t give off much energy if you burn it. A dollar is just a claim on some unspecified future real resources, an index to a set of mutual obligations rather than a real thing in itself. It makes sense that it would pretty much always exist as debt. What else could it be?
Still it is not exactly a convenient situation. You could easily imagine a world where people could just keep dollars—actual, irreducible dollars, dollars issued by the Federal Reserve—in an electronic account that they could access anywhere and use to make instant payments. Those dollars would still be intangible claims on real resources, but at least you wouldn’t have to worry about keeping them at a bank that might go bust.
Here is a proposal from Morgan Ricks, John Crawford and Lev Menand (and a related paper) to give “the general public—individuals, businesses, and institutions—the option to have a bank account at the Federal Reserve.” Their FedAccount would let anyone keep money at the Fed, track it online or in an app, and make instant payments. “FedAccount balances would be fully sovereign money,” they write, “just like reserve balances that commercial banks hold. There would be no possibility of default on balances of any size. Deposit insurance would be superfluous.”
I think the first thing to say about this proposal is that, on its own terms, it seems like a pure improvement. Building a payments app and an account-tracking website and the underlying infrastructure can't be that hard for the Fed. (“The Fed already does this very efficiently on a huge scale,” they note, about its business of running a ledger for banks to keep accounts at the Fed.) Giving free accounts to everyone would help the unbanked; creating run-proof “pure money” accounts would help with financial stability; making payments free would reduce frictions in the economy from credit-card fees and so forth; paying interest on the FedAccounts could make transmission of monetary policy simpler.
On the other hand, you know, there’s a whole big financial-services industry that would be … sort of … displaced, by the government, if this happened. Credit- and debit-card issuers would presumably have a tough time charging transaction fees if the Fed provided free payments, though I guess if you still want credit you’ll need a credit card. But the real problem would come for banks, who have, over the past few centuries, gotten pretty used to a business model of profiting on the spread between the deposits they take in and the loans they make. That model is harder if the Fed is giving out free guaranteed interest-bearing transactional accounts. Ricks, Crawford and Menand write:
How would FedAccount affect private provisioning of financial services? FedAccount might increase costs of credit by removing distortive subsidies from banks’ funding—but that would almost certainly be a good thing. In this regard, it is crucial to keep in mind that lending markets are competitive. Deposit banks have no monopoly on extending credit; they coexist with myriad other financial institutions that make loans and buy bonds. If profitable lending opportunities exist, the market should be expected to ferret them out. Relatedly, while some may be concerned that FedAccount would adversely affect small banks, we see no reason to expect any disparate impact. Large-scale migration to FedAccounts would require large and small banks alike to seek alternative funding, and discount window credit would be available to each. To the extent that small bank subsidies are desired, rates on discount window credit could be graduated. Nor do we worry that FedAccount would chill or undermine private sector innovation in financial services. Among other things, the Fed can adopt an open application programming interface (API) functionality that would allow third-party developers to design applications for FedAccount, thereby opening up avenues for innovation.
I am open to the notion that insured bank deposits are a massive inefficient subsidy to lending and that getting rid of them would be economically efficient, but it does seem like the transition costs would be high. Perhaps of more immediate interest: I bet there’d be a lot of lobbying against this! It’s tough, for a bank, to compete with the Fed in providing deposit accounts. And if you’re a bank, deposit accounts aren’t just a source of cheap funding; they’re also a great way to get customers in the door so you can sell them investment advice and mortgages and so forth. Institutionally I am not sure the banks will want to give that up for the conceptual elegance and stability of electronic government money.
By the way here are Ricks, Crawford and Menand gently making fun of the sillier (and yet … somehow … more popular?) version of their plan, which is to have central banks issue digital currencies but on the blockchain:
Central bank digital currencies (CBDCs) are a hot topic, but there is a frustrating lack of consensus as to what they are good for or even what they are exactly. Under some CBDC definitions, central bank accounts are CBDCs since they consist of “digital” ledger entries at the central bank. FedAccounts would therefore be CBDCs. But this is just semantics, and we see no advantage in using terms like “digital currency” or “digital wallet” in referring to central bank accounts, as opposed to more traditional terminology.
Others define CBDCs in terms of “distributed ledger” technology, exemplified by the blockchain technology that undergirds Bitcoin and other cryptocurrencies. In a typical version of this, the central bank would establish the distributed ledger and commit to redeem the associated “digital currency” for traditional base money on request. Given that much of the excitement about distributed ledgers arises from distrust of government and of central intermediaries, the central bank’s role here seems strange. Besides, in their current forms distributed ledgers are painfully slow and costly compared with centralized systems like Fedwire. And from a practical standpoint, FedAccount offers at least one enormous, decisive advantage over distributed-ledger CBDCs: FedAccounts would plug seamlessly into our existing, ubiquitous, time-tested money-and-payments system, rather than requiring widespread adoption of new, unfamiliar, and possibly unsound technologies.
If I were them I’d delete that passage and just write at the end of the paper: “Also the FedAccounts would be on the blockchain.” It doesn’t have to mean anything, but it would get people excited about the blockchain.
Elsewhere, a referendum in Switzerland on a “Vollgeld” proposal—which would ban private money creation by banks—was resoundingly defeated this weekend.
Late last month, the various sides of the Hovnanian Enterprises Inc. dispute settled their differences over Hovnanian’s plans to trigger its credit-default swaps, issue a weird new bond to juice the CDS payout, and get favorable financing from Blackstone Group’s GSO Capital Partners, which would be subsidized by that juicy payout on all the CDS GSO owned. In the settlement, Hovnanian didn’t trigger the CDS, did issue the weird new bond, and did get GSO’s financing; GSO didn’t get the juicy CDS payout but did get some payout from the CDS sellers.
After Hovnanian, everyone on every side of the market—even GSO!—apparently agrees that CDS is broken, because it allows for goofy tricks like this; the alternative view—that goofy tricks are the spice of life and should be rewarded, and that everyone involved is a sophisticated player who should be thinking up tricks of their own instead of complaining when they are tricked—has no real constituency, though I am kind of fond of it. And so now everyone is going to sit down to fix CDS. Mary Childs reports on their efforts:
Barclays analysts have analyzed potential fixes. Since Hovnanian skipped a $1.04 million payment to its own unit, they suggest boosting the $1 million threshold to, say, $5 million. Or make nonpayments to affiliates not count. Or scrap “failure to pay” entirely as a trigger in the CDS contract, and stick with “filing for bankruptcy.” Each idea has drawbacks, and all add complexity to a product already struggling to retain liquidity. But without introducing subjectivity in the contract language, it’s improbable that any update can prevent someone from gaming it.
There is a rules-versus-principles problem here: Basically everyone who looked at the Hovnanian situation (except me, fine) said “that just isn’t right”; an update to the CDS rules that said, for instance, “if a CDS trigger just isn’t right, then it will be deemed not to have happened,” would solve Hovnanian and a number of other problems. But leaving that to an after-the-fact principles-based subjective determination by a committee of representatives of big CDS-market players would lead to drama:
ISDA’s determinations committee, or DC, which rules on these issues, “functions best when there are bright lines,” says the association’s former chief, Bob Pickel. “If there are interpretive issues like intent, market assessment, or whatever, you’re just going to introduce a range of opinions and make it very hard for the DC to function.”
More than that, it makes the thing feel less like A Derivative—a predictable mathematical function of some underlying, that you can buy and model and rely on—and more like an invitation to further negotiations. If you fix a loophole in CDS by making it subjective, then you are really making the problem of CDS reliability worse. On the other hand, if you fix a loophole in the complex rules by adding more complex rules, then the people who make it their life’s work to find tricks in complex rules will just have some new toys to play with. “People briefed on the conversations say the group will suggest tweaks that introduce just enough subjectivity to close the loophole and prevent these triggers.”
Oh by the way:
Even within GSO, the creativity of the group spearheading these trades earned it a homemade epithet deriding its use of aggression—complete with a swear.
The name is a compound word beginning with “trick” and ending with something that can’t be printed in Barron’s, or here, but I’d be proud to work in a group with that name. I’d print it on my business cards, and then hand those cards to my counterparties and raise my eyebrows and nod intimidatingly and they would know I meant business.
People are worried about non-GAAP accounting.
I am so bored of the constant stream of articles to the effect of “ooh non-GAAP numbers are a fantasy and a fraud” that I found this Harvard Business Review article by Vijay Govindarajan, Shivaram Rajgopal and Anup Srivastava, titled “Why We Need to Update Financial Reporting for the Digital Era,” rather pleasing. Their argument is that U.S. generally accepted accounting principles do not reflect the economic reality of digital companies. There is a certain air of flim-flam here—ooh, the “digital era,” and I cannot begin to figure out what it could mean that “One CFO said that her valuation should be considered on a per idea basis instead of a per earnings multiple”—but this strikes me as not entirely wrong:
This is an outcome of the growing divergence between what companies consider as value-creating metrics and those reported as profits in the GAAP. Many CFOs consider financial reporting to be an exercise in mere regulatory compliance and find the resources spent on audits and financial reporting to be a waste of shareholder money. They consider the calculation of GAAP-based profitability to be more of a hinderance and distraction to their internal resource allocation decisions. One CFO commented that they now avoid inviting company accountants to their strategy meetings, while another said that CPA certification is considered a disqualification for a top finance position.
It’s clear to us from our research and from these interviews that the time has come for investor bodies and companies to rethink the financial reporting model from scratch. For instance, standard-setters might want to encourage disclosures related to (i) value per customer; (ii) earnings or revenue outcomes or other specific metrics related to specific projects in progress; and (iii) data on how the R&D and software talent of digital firms is being deployed. Relying on firms’ voluntary initiatives is unlikely to work because executives told us time and again that they will not disclose sensitive information, unless their competition is forced to do the same.
The basic argument is just that U.S. generally accepted accounting principles are not necessarily the best or only way to capture the economic value of every public company, and that the use of other measures—by companies, but also by analysts and shareholders—indicates that GAAP is not keeping up with reality. There is an efficient-markets flavor to that argument—if GAAP fully captured reality, we wouldn’t all spend so much time talking about non-GAAP numbers—that strikes me as more compelling than the alternative, which is that the accounting standards board is right about everything and that everyone who uses any other numbers is caught in a collective delusion.
Elon Musk’s Boring Co. closed a financing round on Saturday, which is normally a pretty straightforward process involving wire transfers and the delivery of securities to a depository, but since in this financing round Boring Co. sold, not securities, but flamethrowers, there was a big dumb inflammatory party:
Held in a parking lot adjacent to Musk’s rocket company, Space Exploration Technologies Corp., the event was a festival of all things Musk, set to the sounds of a mariachi band as customers snacked on complimentary churros from a food truck. …
At the front of the line, customers wielding demonstration flamethrowers roasted marshmallows as staff showed them how to power the flames.
Musk, of course, tweeted the terms and conditions for the flamethrower—which, for regulatory or more likely comedic reasons, Boring is calling a “Not-a-Flamethrower”—and they include this little rhyme:
I will not use this in a house
I will not point this at my spouse
I will not use this in an unsafe way
The best use is crème brulee
They gave up on both scansion and accents partway through the poem, but still it’s not a bad effort. It does seem to me like most of the time when you make crème brûlée you’d be in a house, but really what do I know about Elon Musk’s lifestyle. Perhaps he’s doing his dessert-making in a rocket on the way to Mars, where the flamethrower is … safer? Much more dangerous? I don’t know. I don’t know anything. Obviously we live in a simulation, which makes it feel a bit pointless to keep typing this newsletter. Computer, just do your thing, I am going to take a nap.
I mean, once you get past the existential despair of realizing that your whole life is lived inside a computer with a warped sense of humor, the story is pretty fun. It is full of bits like this:
Well, then you’d probably get electrocuted in a thunderstorm! Which might be better than barbecuing yourself with a Boring flamethrower. Also:
Dohrman plans to use his for lighting tiki torches and “household protection.”
He’s gonna burn his house down when someone knocks on his door to sell magazine subscriptions, but he’ll regret nothing.
Elsewhere in incendiary Elon Musk tweets:
I assume he is kidding but I now assign the same probability to all future events, so, sure. If anyone gets a SpaceX-package Tesla Roadster and uses the 10 small rocket thrusters to simultaneously caramelize 10 crème brûlées, send me a video of it and I will, I don’t know, slowly disintegrate.
Elsewhere, I have not read “Mark Zuckerberg, Elon Musk and the Feud Over Killer Robots,” but perhaps you are braver than I am.
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