Typography

My work as an inter-planetary monetary anthropologist has brought me to dozens of different planets to study their monetary systems. The monetary system of the most recent planet that I visited, the planet of Zed in the Xv2 galaxy, falls into the same classification as the systems on Vigil X and Earth (which I last visited in 1998 and, according to other anthropologists, hasn't changed much). As on Earth, markets on Zed tend to lie towards the free end of the spectrum. Zedians can own property. And property rights are enforced. Zedians often put their savings in institutions much like banks and earn interest. Banks in turn lend to individuals and business. However, one of the oddities of the planet of Zed is that its inhabitants universally adhere to an economic religion, Zodlism . One of the strictures of Zodlism is that all monetary instruments must yield at least 2% interest. Even a transactional account, say like Earth's checking accounts, must offer the account holder a mi...

Vitalik Buterin had a thought-provoking tweet a few days back about interest rates. Lending DAI to Compound offers 11.5% annual interest. US 10 year treasuries offer 1.5%. Why the discrepancy? — Vitalik Non-giver of Ether (@VitalikButerin) August 23, 2019 Today's post explores what goes into determining interest rates, not blockchain stuff. So for those who don't follow the blockchain world, let me get you up to speed by decoding some of the technical-ese in Buterin's tweet. DAI is a version of the U.S. dollar. There are many versions of the dollar. The Fed issues both a paper and an electronic version, Wells Fargo issues its own account-based version, and PayPal does too. But whereas Wells Fargo and PayPal dollars are digital entries in company databases, and Fed paper dollars are circulating bearer notes, DAI is encoded on the Ethereum blockchain. Buterin points out that DAI owners can lend out their U.S. dollar lookalikes on Compound , a lending protocol based on Ethere...

Freigeld , or stamp scrip, is designed to pay negative interest, but it can be re-purposed to pay positive interest. Remember when global interest rates were plunging to zero and all everyone wanted to talk about was how to set a negative interest rate on cash? Now that interest rates around the world are rising again, here's that same idea in reverse: what about finally paying positive interest rates on cash? I'm going to explore three ways of doing this. As for why we'd want to pay interest on cash, I'll leave that question till the end. ------- The first way to pay interest on cash is to use stamping. Each Friday, the owner of a bill—say a $50 note—can bring it in to a bank to be officially stamped. The stamp represents an interest payment due to the owner. When the owner is ready to collect his interest, he deposits the note at the bank. For example, say that 52 weeks have passed and 52 stamps are present on the $50 note. If the interest rate on cash is 5%, then th...

George Selgin had an interesting post describing how the Fed appears to be breaking the law by paying too much interest to reserve-holders. This is an idea that's cropped up on the blogosphere before, here is David Glasner, for instance. I agree with George that the the letter of the law is being broken. That's unfortunate. As Section 19(b)(12)(A) of the Federal Reserve Act stipulates, the Fed can only pay interest "at a rate or rates not to exceed the general level of short-term interest rates." With three month treasury bills currently around 0.33% and the fed funds rate at 0.4%, the current interest rate on reserves (IOR) of 0.5% exceeds the legal maximum. Unlike George, I don't think the Fed deserves criticism over this. If the letter of the law is being broken, the spirit of the law surely isn't. If there is a spirit residing in the law governing IOR, it's the ghost of Milton Friedman. Since the Fed's inception in 1913, IOR had been effectively...

John Cochrane has written  two posts  that question the ability to implement negative interest rates given the wide range of 0%-yielding escape hatches available to investors. These escapes include gift cards, stamps, tax & utility prepayments, and more. In a recent post entitled However low interest rates might go, the IRS will never act like a bank , Miles Kimball and his brother rebut one of Cochrane's supposed exits; the Internal Revenues Service. I've responded to Cochrane's other schemes here . Think of Cochrane's exits as arbitrage opportunities. As nominal rates plunge into negative territory, the public gets to harvest these outsized gains at the expense of institutions that issue 0% nominal liabilities. The Kimballs' point (and mine here ) is that because these institutions will lose money if they continue to issue these liabilities, they will implement policies to plug the holes. Cochrane's multiple exits aren't the smoking gun he takes them...

Here's a conundrum. Many commentators have been trying to puzzle out why stocks have been continually hitting new highs at the same time that bond yields have been hitting new lows. See here , here , here , and here . On the surface, equity markets and bond markets seem to be saying two different things about the future. Stronger equities indicate a bright future while rising bond prices (and falling yields) portend a bleak one. Since these two predictions can't both be right, either the bond market or the stock market is terribly wrong. It's the I'm with stupid theory of the bond and equity bull markets. I hope to show in this post that investor stupidity isn't the only way to explain today's concurrent bull market pattern. Improvements in financial market liquidity and declining expectations surrounding the pace of consumer price inflation can both account for why stocks and equities are moving higher together. More on these two factors later. 1. I'm with...

Central bankers are usually classified as either hawks or doves. This post is devoted to a third and rare breed; today's monetary policy canaries. Having taken their respective deposit rates to -0.75%, deeper into negative territory than any other bank in history (save the Swedes), the Swiss National Bank and Denmark's Nationalbank are the canaries of the central banking world, plumbing depths that everyone assumes to be dangerous. Other central bankers, in particular the ECB's Mario Draghi, will no doubt be watching the Swiss and Danes quite closely. The information these two nations generate as they go deep into the bowels of negative rate territory will give a good indication of the level to which the others can safely reduce their own rates before hitting their respective effective lower bounds. That there is an effective lower bound to rates stems from the fact that at some negative nominal interest rate, everyone will choose to convert deposits into cash, preferring...

Paul Krugman has two posts discussing the effective lower bound to interest rates. The first I agree with, albeit with a caveat, and the other I don't. In his first post Krugman takes Evan Soltas to task for including not only storage costs in his calculation of the effective lower bound, but also the extra convenience yield provided by deposits. Krugman's point is that once people are "saturated" with liquidity, as they seem to be now, then forgoing the liquidity of a short term marketable debt instrument (like a deposit) costs them nothing. If so, then the lower bound to nominal interest rates is solely a function of storage costs. I agree with Krugman on this count. Take the 2 1/8% Nestle bond maturing May 29, which may be one of the first corporate bonds in history to trade at negative rates: If it costs 0.50%/year to store and handle Swiss paper currency, then the rate on a Nestle bond can't fall below -0.50%. If it trades at -0.55%, an arbitrageur will c...

If you've been reading Bill Gross's last few letters, you'll know that he's been a bit grumpy of late. It's that dang new trend that has hit bond markets, negative interest rates . Gross has been using words like incredible, surreal , and inconceivable to describe their arrival.Negative nominal bond rates certainly seem odd. Just look at the chart below, which illustrates what could very well be the two lowest-yielding bonds in the world, maybe all of history: the 3.75% Swiss government maturing in July 10, 2015 and the 4% Danish government bond maturing November 15, 2015. But is the idea of a negative rates really so strange? Gross blames negative rates on central bankers who "continue to go too far in their misguided efforts to support future economic growth," in doing so " distorting " capitalism's rules. He's not alone; plenty of people claim that without autocratic price fixers like the SNB's Tommy Jordan and the Danmarks Natio...

On a recent trip to Ottawa, I stopped by the Bank of Canada. The door was locked and the building empty. Odd, I thought, why would the Bank be closed in the middle of a business day? A security guard strolled up to me and told me that the entire staff packed up back in 2010 and left the country. He hadn't seen them since. Bemused I walked back to my hotel wondering how it was that with no one guiding monetary policy, the loonie hadn't run into either hyperinflation or a deflationary spiral. Exactly 175 months passed between February 1996, when the Bank of Canada began to target the overnight rate, and September 2010, the date of the Bank's last rate change. Some 63 of those months bore witness to an interest rate change by the Bank, or 36% of all months, so that on average, the Governor dutifully flipped the interest rate switch up or down about four times a year. Those were busy years. Since September 2010 the Governor's steady four-switches-a-year pace has come to a ...

Having reduced the ECB's overnight target rate to +0.05% and the deposit rate to -0.2%, Mario Draghi confidently told those assembled at Thursday's press conference that the ECB wants to “make sure that there are no more misunderstandings about whether we have reached the lower bound. Now we are at the lower bound.” So it's official, according to its leader the ECB has run out of powder and can't reduce interest rate anymore. But that's simply not true. I figure that the ECB has at least a handful of interest rate reductions left in its arsenal before the true lower bound bites, especially given that it's now adjusting rates in smaller increments of 0.1% and not 0.25%. And if the ECB were to get rid of its pesky issue of €500 notes, it would have a whole extra round of reductions up its sleeve (more on that later). Shame on Draghi for claiming impotence when he actually has plenty of rate ammunition still left. The lower bound starts to bind when interest rat...