Typography

There's a fairly regular monetary phenomenon that needs a name. It's similar in nature to Gresham's law, yet the inverse version. Gresham's law is commonly stated as the phenomena by which "bad money drives out the good". But as any economist will tell you, that's not quite it. Bad money chases out the good, but only if authorities have chosen to enforce a fixed exchange rate between the two moneys. When the market ratio diverges from the fixed ratio, the undervalued money—the "good" one—will disappear from circulation while the overvalued money —the bad one—will become the exchange medium of choice. Bad money drives out good money because they pass by law at the same fixed price. That's the classic Gresham's law. However, it's possible to show how an authority can set a fixed price between two moneys yet rather than the bad coin chasing out the good, the opposite happens: the good coin chases out the bad. Before I show how, let'...

One of this blog's most recurrently popular posts is a 2012 ditty entitled the Idiot's Guide to the Federal Reserve Interdistrict Settlement Account . The Interdistrict Settlement Account, or ISA, is a highly esoteric "plumbing" mechanism that lies at the centre of the Federal Reserve System. After a century of being ignored, it suddenly became a popular topic for discussion in late 2011 and 2012 as the breakup of the euro became a real possibility. Groping for a fix, European analysts turned to the world's other large monetary union, the U.S. Federal Reserve System, to see how it coped with the sorts of monetary problems that Europe was then experiencing. Here's a short explanation of the ISA. Consider that there is no such thing as a unified Federal Reserve dollar. Rather, both the paper dollars that you hold in your wallet and the electronic reserves that a private bank holds in its vaults are the liability of one of twelve distinct Federal Reserve district...

Like Guntram Wolff over at the Bruegel blog , I hope that the much-rumoured capital controls on Cypriot deposits don't get enacted. So far the Euro authorities seem to have done everything right, albeit in a slow and circuitous manner. Insolvent banks are being closed, uninsured depositors, unsecured creditors, and shareholders are being bailed in, and solvent banks are slated to reopen. Wolff's main concern is that capital controls threaten the very meaning of a monetary union: With capital restrictions, the value of a euro in Cyprus is no longer worth the same as a euro held by any other bank in the eurozone. A euro in Nicosia cannot be used to buy goods in Frankfurt without limits. Effectively, it means that a Cypriot euro is not a euro any more. Enact capital controls and we'd see the emergence of an entirely new currency trading pair CYP€:onshore€, with Cypriot euros trading at a discount. The discount would emerge since the ability of CYP€ to buy things outside of th...

Well this is interesting. A bitcoin "fork" has emerged. I'm watching right now as the price of bitcoin on the Mt-Gox exchange plunges from $48 down to $37 or so, and now back up to $45. My guess is that the fork will be pretty much resolved before I wake up tomorrow—if not the mechanics, at least the optics. What's a fork? I like to think of bitcoin as a publicly distributed ledger. Anyone who owns a bitcoin has a spot in that ledger. The ledger is in turn updated every ten or so minutes to account for new transactions. Updating occurs in a decentralized manner. Competing "miners" work to add batches of recent transactions to the ledger by solving a complex problem. The winning miner earns some bitcoins while all the the other miners double check to verify that the block of transactions submitted by the winner are real and sync with the existing ledger. This all works fine as long as there are enough competing miners working to verify the process. If one mi...

(Disclaimer: this article is geeky. If you want to follow it, you should already know a bit about the European Target2 imbalances debate ( here is a good intro) and have read my description of the US Interdistrict Settlement Account) There is a tension involved in being a lender of last resort. Central banks are supposed to provide liquidity to solvent but temporarily illiquid institutions during a liquidity crisis. But they're not supposed to go as far as keeping bankrupt banks or governments alive. Hans-Werner Sinn ’s proposal to import the Federal Reserve's Interdistrict Settlement Account (ISA) into the Eurosystem seems to me to be an attempt to impose on National Central Banks (NCBs) the discipline necessary to prevent them from crossing this almost transparent line. But an ISA-type settlement mechanism in a European setting threatens to not only prevent NCBs from crossing the line; it could prevent them from fulfilling even their basic duty as lender of last resort. Thi...

Bankers clear and settle with each other at a clearing house Perry Mehrling had in interesting comment about how to settle the Eurosystem's Target2 imbalance problem. If there were Eurobills, balances could be settled periodically by transfer of assets, just as is done in the Federal Reserve System. More precisely, if there were a System Open Market Account at the ECB, in which all of the national central banks held shares, settlement could be made by transfer of shares. Perry is talking about adapting the structure of the Fed's Interdistrict Settlement Account to Europe. To understand the ISA, check out my Idiot's Guide to the Federal Reserve Interdistrict Settlement Account . In short, the 12 regional Reserve banks run up debts and credits to each other over the course of the year due to changes in payments flows. These debts and credits are settled each year by transferring securities that have been bought in open market operations from debtor Reserves banks to credit...

Last year and earlier this year, debate concerning the Target2 mechanism in Europe and its growing imbalances shed some light on the equivalent institution in the US, the Interdistrict Settlement Account (ISA). The argument has been made to import the ISA structure into Europe, in particular, the yearly settling of accounts between district Reserve banks. If the ECB were to operate this way, the idea goes, then there would be some sort of quid pro quo on Target2 imbalances - European national central banks (NCBs) would not be able to accumulate debts to each other ad infinitum. The observation was made that contrary to what one might expect, the ISA at the time did not seem to be balancing. Thus the idea that adoption of the Fed model would impose "firm limits" on intra-Eurosystem credit is invalid, since the Fed doesn't seem to always impose settlement on district Reserve banks. This April, though, the ISA seems to have been settled, as the charts below will illustrate....

Nick Rowe is pessimistic , and points to one of the dreariest articles I've read to date on the Europe situation. I noticed that Ireland seems to be doing much better than the other peripherals. See the chart below. Its stock market is relatively strong, having outperformed markets in Greece, Italy, and Spain while keeping up to the German DAX. At the same time, Ireland isn't seeing capital outflows anymore. While Greece, Spain and Italy's TARGET2 balance is deteriorating, Ireland's has been improving for over a year. (Note that data is to end of April). ( click here for expanded version) What are the Irish doing differently? Is Ireland presaging how the other peripherals might be stabilized, or are they just lagging behind? Note: For one explanation of the difference, see this Allied Irish Bank report ( pdf ).

Michiel Bijlsma and Jasper Lukkezen have a very good article on the Bruegel blog that deals with the question: why is there no Target2 debate in the US? On a purely technical note, they bring up an interesting point that Interdistrict Settlement imbalances can arise not just from capital outflows from one district to another, but from the daily redistribution of SOMA assets bought on behalf of the other Reserve banks by the New York Fed. I hadn’t previously considered this mechanism and consider it to be a good addition to understanding the debate. More controversially, they maintain that ISA imbalances primarily arise from SOMA redistribution and that regional capital flows contribute fewer imbalances. Perhaps, but that’s an empirical question. Continuing on a purely technical note, Bijlsma and Lukkezen note that when the FRBNY purchases from a counterpart with a depository account at one of the FRBs, this particular FRB then credits the counterpart’s depository account, which incre...

The Belgium-based think take Bruegel recently linked to my guide to the Federal Reserve Interdistrict Settlement Account . In my ongoing attempt to ensure the Target2 debate doesn't founder on faulty comparisons to the Interdistrict Settlement Account, here's another post. Although they have a better grasp on how the ISA works than most, the authors Michiel Bijlsma and Jasper Lukkezen do make an important error: The important difference between Target 2 and ISA, however, is that in the US all Reserve Banks are owned by the federal government. This means that in the US it is possible to safeguard the integrity of the system by changing the settlement rules. This is as exciting as a game of monopoly among friends. As all Federal Reserve banks are owned by the federal government, a loss in Richmond is irrelevant when there is an equal gain in New York. In the Eurozone, however, the ECB is owned by the national governments via the national central banks, not by the European Union ...

The argument about ECB Target2 imbalances, an argument which began in mid 2011 with this article, continues to be reignited in various arenas. One component of the argument is the comparison of Target2 to the Federal Reserve’s mechanism for settling inter-Fed settlement imbalances; the Interdistrict Settlement Account. Because the various debaters often have such diverging views on how the Interdistrict accounts are settled, I’m donating this post to the blogosphere with the goal of ensuring that the debate doesn't founder on faulty comparisons of Target2 to the Interdistrict Settlement Account. As such, I'm going to talk a bit about the history of Interdistrict settlement, how the process has changed over time, and how it works now. Once that's done I'll bring the discussion back to Target2 in order to pin down the comparison in a more robust way. I don't claim to know everything about these mechanisms; I've just spent a few weeks educating myself, so if I am ...