Typography

Source Whenever I try to come up with a metaphor for the monetary and banking system I think about the 2010 film Inception , one of my favorite films. After falling into a dream state, the protagonists sedate themselves within the dream so that they can move to an even deeper dream level, and so on; a dream piled on a dream piled on a dream piled on a dream. Conversely, by setting up a series of "kicks," the protagonists progressively wake themselves up from each dream level until they eventually reemerge back in reality.  Like Inception , our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is 'kicking' back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer. Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote l...

This continues a series of posts ( 1 , 2 , 3 ) I've been writing that tries to improve on Indian PM Narendra Modi's clumsy demonetization, or what I prefer to call a policy of surprise note swaps. The main goal of Modi's demonetization (i.e. note swapping) is to attack holdings of so-called "black money," or unaccounted cash. The problem here is that to have a genuine long-run effect on the behavior of illicit cash users, a policy of demonetization needs to be more than a one-off game. It needs to be a repeatable one. A credible threat of a repeat swap a few months down the road ensures that stocks of licit money don't get rebuilt after the most recent swap. If that threat isn't credible, then people will simply go back to old patterns of cash usage. It's worth pointing out that the idea of behind demonetization precedes Modi by many decades. In a 1976 article entitled Calling in the Big Bills and a 1980 a follow-up How to Make the Mob Miserable , Jam...

Donald Trump doesn't like the strong dollar, but is there anything he can do about it? Last month Donald Trump told the Wall Street Journal that American companies can’t compete "because our currency is too strong. And it’s killing us...” Trump's dislike of the strong dollar doesn't surprise me. I've known a few mercantilists over the years, and all of them have always been keen on trashing their home currency, the idea being that with a weaker currency domestic manufacturers will enjoy a shot to the arm. This in turn stems from the antiquated (and very wrong) idea that manufacturing is somehow the most important activity an economy can be engaged in. Tweeting about one's desire for a weak dollar is one thing, but are there any actual levers Trump can pull on to affect the exchange rate? U.S. exchange rate interventions are rare these days, with only two occurring in the last twenty years. In September 2000 U.S. monetary authorities intervened with other centr...

The topic of euro breakup has slowly been trickling back in the news, especially with the potential for Italy leaving the currency union, a so-called Italexit . In this post I want to explore one of the major conundrums that would-be exiteers must face; the problem of banknotes. Almost all euro exit scenarios begin with the departing country announcing a shot-gun redenomination of bank deposits into a new currency, in Italy's case the lira. The effort must be sudden—if redenomination is anticipated ahead of time, depositors will preemptively withdraw funds from the exiting country's banking system, say Italy, and put them in the banking systems of the remaining members, say Germany, doing irreparable damage to Italian banks. After all, why risk holding soon-to-be lira when they are likely to be worth far less than euros? Once the surprise redenomination has been carried out, the next step is to quickly introduce new lira banknotes into the economy. Lira deposits, after all, sh...

Earlier this month I criticized the architects of India's recent note demonetization for not using the traditional overstamping technique for replacing large quantities of banknotes. This week I want to examine another feature of Modi's demonetization: the concurrent change in note sizing. The new series of ₹500 and ₹2000 notes are smaller in size than the ₹500 and ₹1000 series that they have since replaced. This has caused huge logistical problems. Since each cartridge in an ATM must be manually configured to handle a certain note size, ATMs were not equipped hold the newly issued ₹500s, ₹2000s, or additional ₹100s for that matter. Instead, they were forced to operate at a fraction of their capacity. Indians, desperate to replace their demonetized notes with good cash, were left on the lurch. Let's explore the reduction in banknotes size. I'd argue that independent of the decision to crack down on black money, the decision to go smaller makes a lot of sense. But twinn...

 In a recent podcast with Robert Hall, Russ Roberts asks: "If the Fed was so aggressive, why didn't we have inflation? And does that mean that Milton Friedman and others were wrong?" It's a good question. Because I find monetary policy confusing, I want to try answering Russ's question with an analogy to an example that doesn't involve money. Say there are two types of gold rings, those with diamonds and those without. The price of gold rings with diamonds exceeds the price of rings without diamonds by a wedge that equals the price of the diamond. A technology emerges that can create diamonds at zero cost. The supply of diamonds will rapidly grow until they become like water; while boasting desirable qualities, a diamond will sell for $0. When this happens the price of gold rings with diamonds will equal the price of gold rings without. Using this analogy, we can understand why—despite having been so aggressive—the Fed didn't create inflation. Treasury de...

1913 Austro-Hungarian banknote with 1919 Czechoslovak overstamp When Indian PM Narendra Modi and his small group of would-be monetary architects were putting together their plan to suddenly demonetize the 500 and 1000 rupee note and replace them with new notes (including a new 2000 rupee note), they must have been missing a monetary historian. That's because there is a long history of nations suddenly demonetizing the entire circulating paper issue and introducing a new paper currency. These rapid switches have tended to follow a well-trodden script, one that Modi did not follow. Had he chosen to adopt it, the last two months might have been less chaotic. One challenge faced by any prospective note switcher is to print the new currency fast enough to replace the legacy notes. When the switch is a slow one that is planned long beforehand, like the euro introduction, this is not an issue. In the case of a rapid switch that cannot be prepared for, however, the printing challenge is ov...