Speculative musings, from an inadequate historical background.
We tend to take it for granted that the world looks like this, from a monetary perspective:
The world is divided into currency areas. Each currency area has one alpha bank (the king). All the other banks are beta banks (subjects, who follow the king). The beta banks promise to redeem their money for alpha bank money at a fixed exchange rate. The alpha bank makes no such promise the other way. Asymmetric redeemability. The alpha bank is the leader, who decides on monetary policy for the whole currency area. The beta banks just follow along, because they fix their exchange rates to the alpha bank. The world is divided into monetary monarchies.
There may be sub-monarchs, who play alpha to the beta banks within their own sub-area, but who in turn play beta to some greater alpha bank. Like when the Canadian commercial banks fix their exchange rates to the Bank of Canada dollar, but the Bank of Canada in turn fixed its exchange rate to the US dollar. The Canadian commercial banks follow the Bank of Canada, but the Bank of Canada used to follow the US Fed. The Bank of Canada used to be a sub-monarch, before it floated the exchange rate and declared monetary independence, and then became a full monarch.
Does the world have to look like that? Is monetary monarchy inevitable? Is oligarchy an unstable system? Can two or more banks play both alpha and beta to each other, where each promises to redeem its money for the other's money at a fixed exchange rate, and so share monetary sovereignty? Or will monetary monarchy inevitably reappear, where the strongest bank becomes the new alpha bank?
In the couple of years immediately preceding the Euro, and the creation of the ECB, were the central banks of France and Germany true oligarchs, who shared the pooled monetary sovereignty over France and Germany by fixing their exchange rates symmetrically to each other? Could this have continued? Or would one of the pair have become the alpha, and the other the beta, if the ECB had not been created?
Suppose the Bank of Canada disappears. Because people stop using Bank of Canada currency, so nobody ever asks to redeem their Bank of Montreal deposit money for Bank of Canada paper money. And because the Canadian commercial banks stop settling their own accounts on the books of the Bank of Canada, so none ever holds either positive or negative balances at the Bank of Canada. The King is dead. How long before one of the Canadian commercial banks becomes the new King? What determines which of the commercial banks becomes the new alpha central bank? Will it be the strongest bank with the tightest monetary policy? I think it will. The tightest bank will refuse to redeem other banks' money for its money, if that would force it to loosen. The other banks must either follow the tightest, who becomes alpha to their beta, or else declare independence and float their exchange rates. Most banks aren't strong enough to declare independence; nobody will use their money if they do.
Gold used to be the alpha money, and gold miners the nearest thing to an alpha bank. But gold became less used as money, and people used beta paper money that followed alpha gold. Then the beta banks stopped fixing their exchange rates to gold. They stopped following the king, so the old king was no longer king. The strongest of the beta banks, like the Bank of England, became the new kings, within their own currency areas.
Bitcoin is not a beta money, because it does not fix its exchange rate to anything. Is it an alpha money? Does it have beta followers, who fix their exchange rates to Bitcoin?
(Synmetallism, where a bank pegs its exchange rate to a basket of currencies, does violate this simple monarchist perspective. The beta bank follows an average of two or more alphas. And inflation targeting is like synmettalism. The King agrees to be bound by his own laws. (Bimetallism is where you can redeem your money for fixed amounts of gold or silver. Synmettalism is where you can redeem your money for fixed amounts of gold plus silver.))
Worthwhile Canadian Initiative 
What do you mean by strong here? Is that just supposed to mean that its liabilities are highly valued?
Without a central bank, what would happen if the alpha bank tried to raise interest rates? Presumably the alpha bank would still have to accept liabilities of other banks in repayment of the loans it has made? Wouldn’t people just repay all their loans from the alpha bank, leaving it with assets yielding less than its liabilities?
Around 1700 the Bank of Scotland and the Royal Bank of Scotland started up. The first one to start up tried to act as alpha and supress the second, e.g. by refusing the take the second’s notes or cheques. But the would be alpha failed. They ended up in friendly competition.
I don’t see why monetary monarchy is inevitable. E.g. an economy with just commercial banks and some sort of commodity monetary base like gold, but no central bank would work, wouldn’t it?
A related question is whether an economy like the above but without any sort of commodity base money would work. My hunch is it would.
For a relevant article by George Selgin, see:
http://capitalismmagazine.com/2012/06/is-fractional-reserve-banking-inflationary/
Nick,
Some first principles background to this post and why I was previously confused in what you were saying about AR.
Start with the plain vanilla Canadian banking system case.
My interpretation of things is that BMO and the other commercial banks as beta banks have two obligations with respect to the Bank of Canada as the alpha bank,
a. They are obligated to use the medium of exchange issued by alpha, in the form of reserve balances
b. They are obligated to be market makers or dealers in the medium of exchange issued by alpha, in the form of currency
That b. part means BMO for example must be willing to exchange deposits that it issues for currency, and vice versa. The reason I was orginally confused by what you were saying is that I was reading your original 2009 wording as obligating only the first direction but not the second. I was reading it as if that was the asymmetry you were referring to. I guess nobody else read it that way. That’s why I prefer to view it as a balance sheet stock two way dealing obligation rather than a flow specification.
Does that market making dealer specification make sense to you.
Next, if you look at a sequence of alpha beta relationships, e.g. Canada tied to US FX which in turn is tied to gold, is it the case that asymmetric redeemability carries through consistently at each phase of the alpha beta series.
I haven’t thought this through, but have my doubts that a unique AR is a necessary condition for that alpha beta series in all its phases.
For one thing, the asymmetric redeemability requirement for the plain vanilla Canadian case carries over in exactly the same way as for the case of Canada tied to the US dollar. So the US dollar beta dependency is an add on to the relationship and not a replacement for the plain vanilla alpha beta relationship.
Indulge m
Nick Edmonds: In the US, in the early 19th century, banks made loans by issuing their own bank notes, which were (supposed to be) redeemable in gold (or silver)at a fixed rate (about $20.59 per ounce of gold (or about 0.5-ish ounces of gold per dollar; I don’t remember the gold par, but it was about 1/15 of the gold par). While banks could accept bank notes issued by other banks in repayment of loans, many insisted on being repaid in their own bank notes. So far as I know, none insisted on being repaid in gold (or silver)
For details about Bank of Scotland versus Royal Bank of Scotland skulduggery which I mentioned above, see 35.10 to 38.00 here:
Ralph:
Re your comment: “E.g. an economy with just commercial banks and some sort of commodity monetary base like gold, but no central bank would work, wouldn’t it?”
Depends on your definition of “work.” That pretty well describes banking in the US between the demise of the Second Bank of the United States and the creation of the Fed. My own judgment is that banking was hardly stable during that period; financial crises caused by widespread bank failures were common. (And so, apparently, was counterfeiting.) But you (and others) may disagree.
Donald,
I guess then that banks were not offering par convertibility between bank notes either then. Otherwise, if you couldn’t repay Bank A with Bank B’s notes, you’d just go to Bank A (or Bank B) and swap your Bank B notes for Bank A notes, then repay your loan. Likewise, if everyone’s offering fixed rate convertibility to gold, you convert your Bank B notes to gold with Bank B and then the gold for Bank A notes with Bank A, then repay your loan.
Nick R, you’ve argued previously that in a setup such as this:
1. Cashless society (no paper reserve notes and no coins).
2. A central bank (CB) which can buy and sell assets (open market operations (OMOs)).
3. A single commercial bank with a CB deposit (i.e. reserve deposit). This is the only existing CB deposit account.
4. The reserve requirement is 0%.
5. A non-bank private sector which holds deposits at the commercial bank.
That the CB would die as king and the sole commercial bank would effectively become the new alpha bank (a commercial CB). However, are you arguing that OMOs are not possible then? JKH and winterspeak both agreed that although inter-bank payment clearing is no longer needed that OMOs could still be used. I’ll post there links in a minute, but if that’s the case, then by your own reasoning on an excess supply of commercial bank deposits being possible, then surely the CB can still force excess deposits into existence through OMOs. And even if David Glasner is correct and the excess supply of deposits is used to pay off commercial bank loans (reflux), the CB can perform OMOs in excess of all outstanding loans and continue to force commercial bank deposits into existence.
Or are you saying that the OMOs could not happen?
Here’s winterspeak agreeing with JKH about OMOs in this case:
http://monetaryrealism.com/market-monetarism-monetary-base-overdrive/#comment-111815
Nick E: “What do you mean by strong here? Is that just supposed to mean that its liabilities are highly valued?”
Good question. I think that I should mean “strong enough to have its money accepted even if it refuses to redeem its money for other banks’ monies”. When the Bank of Canada floated the exchange rate, the Bank of Canada was strong enough to declare independence from the Fed. People still accepted the Canadian dollar, and valued it. Would the Bank of Montreal today be strong enough to declare independence from the Bank of Canada? If BMO refused to redeem it’s dollars for BoC dollars, would people still use and value BMO dollars? I don’t think so.
“Without a central bank, what would happen if the alpha bank tried to raise interest rates? Presumably the alpha bank would still have to accept liabilities of other banks in repayment of the loans it has made?”
If it were strong enough to be a true alpha, it could refuse to accept liabilities from other banks at par.
Ralph: good example with the Scottish banks.
“I don’t see why monetary monarchy is inevitable. E.g. an economy with just commercial banks and some sort of commodity monetary base like gold, but no central bank would work, wouldn’t it?”
Yes. Gold is the alpha money. But if gold stops being used as money, even though it is valuable for industrial uses, it loses its power. If all the banks float against gold, and refuse to redeem for gold, people would still use their money.
JKH: that makes sense to me. It is the beta banks who have an obligation of convert beta money into alpha money, and alpha money into beta money, at par. (Though they might refuse new customers, or put a limit on how much existing customers can deposit???)
“Next, if you look at a sequence of alpha beta relationships, e.g. Canada tied to US FX which in turn is tied to gold, is it the case that asymmetric redeemability carries through consistently at each phase of the alpha beta series.”
I think that’s right.
Tom: if the “central bank” buys a bond in an OMO, but nobody uses central bank money, what does the central bank buy the bond with?
Nick R, I was thinking (and perhaps JKH and winterspeak were thinking the same thing when they talked about OMOs in this situation) that the CB would have an arrangement (much like I understand now exists) with the commercial banks (only one in this case) to act as its agent in buying and selling assets on the open market. Suppose Joe puts a $1 bond up for sale and the CB want to buy it. Can’t it instruct the commercial bank to purchase it on it’s behalf and then pay the commercial bank $1 in reserves to compensate it (perhaps plus a fee for acting as agent). Is that not similar to how the CBs conduct OMOs now? They certainly don’t pay with paper reserve notes do they?
JKH, how were you thinking OMOs would be conducted in this situation when you made this comment here?
“A single commercial bank does not require a reserve account for commercial interbank clearing purposes.
However, the CB could make use of a reserve account connection in a 1 commercial bank system if it started messing aroud with OMO etc. for purposes of interest rate control.”
http://monetaryrealism.com/market-monetarism-monetary-base-overdrive/#comment-111633
Here’s winterspeak’s similar comment about this example right below JKH’s:
“And in the example, the central bank could still use a reserve mechanism to set interest rates via OMO”
… are you saying the commercial bank would refuse to act as agent for the CB in this case? What if its legal charter required it to do so?
… or the CB could write a check to Joe. But can’t the commercial bank be compelled to accept CB checks as part of its charter?
Tom: I can buy and sell bonds. But that does not mean I can do OMOs, or control Canadian monetary policy.
But when you sell a bond you can’t force a net increase of commercial bank deposits. The cb in my example could if the commercial bank were compelled to accept its checks.
“Sell” should be “buy” above.
“Tom: I can buy and sell bonds. But that does not mean I can do OMOs, or control Canadian monetary policy.”
Even not when you could generate unlimited amounts of deposits that the treasury (and any other market participant) would accept? If the current rate is 3% and you say:” I will buy every bond at 2%”, how do you not control monetary policy then?
Nick,Tom
Tom raises an interesting line of questioning which is background to the thrust of this post, but worth pursuing I think.
Consider two different systems.
One with one alpha and multiple betas.
One with one alpha and one beta.
No currency is issued.
Everything is electronic.
So leave aside asymmetric redeemability for the moment.
Just assume alpha has government power behind it.
So consider the single beta bank system.
Alpha specifies that beta has a deposit account with alpha.
This account can have a positive or a negative balance depending on circumstances.
Clearly, such an account is not reqired for multiple beta clearing.
So what is it.
Well, it is a clearing account between alpha and beta.
Why is that useful.
Well, suppose alpha has the power to do something called OMOs.
Suppose beta owns an investment dealer.
So alpha can buy bonds from non banks using that dealer service.
The result will be an alpha balance sheet of bonds and a clearing account that looks like the aggregate reserve account of a multiple beta system.
Alpha with its government power can set the interest rate on that clearing account. It’s an administered rate.
What does that do.
Well, it starts to look like a quantitative easing profile.
So alpha has pricing leverage in terms of setting the interest rate on the clearing account and setting the rate at which its prepared to deal in bonds.
In other words, it has a degree of interest rate control comparable to QE.
The clearing account interest rate would serve as a signal for a risk free pricing benchmark for the beta bank. Beta would add risk premia to that for its lending.
Thinking out loud here, but the difference seems to be that the type of reserve pricing involved here is pure QE.
i.e. there is no pre QE base such as in a channel or corridor system that is used to price reserves purely on the basis of monopoly control over an interbank clearing system
With a single beta bank, its all QE type interest rate control with interest paid on the clearing or reserve account, but no inelastic demand function for competing banks based on the normal mode of competition
I see no problem with the government assuring bond holders that alpha checks can be cashed at the beta bank for beta bank deposit credit or that beta will receive credit in its alpha account
this has me thinking that asymmetric redeemability is a sufficient but not necessary condition for alpha power
but that’s premised on no currency and single beta
still
the horror … the horror
JKH,
I’m not sure how much control the central bank can exert over short rates in what you’ve described. What’s to stop the commercial bank both lending and depositing at higher rates than that paid by the central bank? It’s the only lender in town, so it can’t lose lending business. And if there’s no public held central bank money, then it doesn’t have to take any deposits it doesn’t create itself. Maybe I’ve missed something in your description.
I’d expect that the central bank could still influence the term structure though, by bond purchases.
btw, in my view asymmetric redeemability is a necessary but not sufficient condition, but that’s all I’m saying.
Nick Rowe: “When the Bank of Canada floated the exchange rate, the Bank of Canada was strong enough to declare independence from the Fed. People still accepted the Canadian dollar, and valued it.”
What does strength have to do with it? Canada has never been a province of the United States. Are you claiming that people only accepted Canadian Dollars because they could redeem them for U. S. Dollar? C’mon.
Nick R,
This might interest you, as I wonder about the following many times:
“More fundamentally (and semi-consciously rather than in full awareness) it may have sprung from the realisation of the monetary authorities, be it the Federal Reserve or the Bank of England, that they are in the position of constitutional monarch: with very wide reserve powers on paper, the maintenance and continuance of which are greatly dependent on the degree of restraint shown in their exercise. The Bank of England, by virtue of successive acts of Parliament, has a monopoly of the note issue, at least in England and Wales. But the real power conferred by these Acts depended, and still depends, on maintaining the central role of the note issue in the general monetary and credit system; and this, in turn, was not a matter of legal powers but, of the avoidance of policies which would have led to the erosion of this role.”
– Nicholas Kaldor, The New Monetarism, 1970. I think he is saying that the monarch exists because if exerts too much power, it will lose its powers.
JKH,
I am wondering whether the big wildcard in the reserve/bank deposit money system is the Treasury since it has a reserve account but no customer deposits. Somehow the money through taxes or private sector treasury purchases has to get to that account. Would that not be the reason the beta bank has a reserve account even if there is only one bank? And maybe we need to start at the very beginning with zero balances: Where would the first reserve deposit coming from? Would it not be coming from the Fed into the Treasury account? I think that is where the gold certificates are coming in the Fed carries on its balance sheet.
Nick E.,
I’ll use US order of magnitudes.
So suppose we have the alpha Fed and a $ 10 trillion behemoth beta bank.
The Fed can still do OMO-QE to buy assets from non banks and create deposits with beta and balances of beta with the Fed.
The Fed will price those balances just like it does with QE.
It will run a floor system in that sense.
Beta will use that price as a signal for the risk free rate.
If it doesn’t, the Fed will simply pile on the OMOs to create balances sufficiently large to upset beta’s overall pricing and interest margin strategy.
Of course, the Fed won’t need to do that, assuming the beta CEO has read Nick R.s posts on Chuck Norris.
In terms of Chuck Norris amunition, the Fed has the entire US debt to play with before it moves on to equities and everything in between.
Odie,
Haven’t thought about that until now – to be honest.
Very interesting point that shouldn’t be overlooked.
Treasury has the same banking relationship with the Fed that the beta banks do.
In that very strict sense, its like another bank clearing with the central bank.
So this entire idea of a single beta bank has to be qualified in that sense.
Very interesting.
I’ll think about that and come back later.
JKH, interesting, but what about the CB having to power to force MOE (in the form of bank deposits) into existence through OMOs? Does that fit into your scheme of things somehow?
Nick Edmonds, I notice that you too assume the CB can purchase things in this scenario:
“I’d expect that the central bank could still influence the term structure though, by bond purchases.”
Would those bond purchases amount to OMOs? I don’t see why not.
Also, you write:
“And if there’s no public held central bank money, then it doesn’t have to take any deposits it doesn’t create itself.”
But if the commercial bank refused checks from the CB, then how does the CB buy anything? Why can’t we just assume that in this scenario the commercial bank is legally obligated to accept for deposit CB issued checks that non-banks bring to it. If you don’t like checks, assume that the commercial bank is compelled by law to act as a purchasing (and selling) agent in the private marketplace for the CB. I don’t see a problem with this being a condition of the commercial bank’s monopoly. One of many conditions perhaps. And why should this be a problem for the commercial bank, since by “social construct” the CB’s deposits are worth $1 for $1 what its deposits are worth, and thus can contribute to the commercial bank owners’ equity (and thus their own deposits at the commercial bank being credited with the banks’ profits).
Odie, you write:
“Would that not be the reason the beta bank has a reserve account even if there is only one bank?” That’s why I set the hypothetical up with my 3rd condition above:
“3. A single commercial bank with a CB deposit (i.e. reserve deposit). This is the only existing CB deposit account.”
to remove that complication: in effect the CB is the only government in this hypothetical. But yes, having to act as intermediary between government CB deposits (not technically called “reserves” BTW, since only CB-deposits at banks are reserves) and other non-CB non-bank CB-deposit holders (international organizations like the IMF, … perhaps foreign governments?) and the CB and the non-bank private sector is another thing that makes CB deposits useful and thus valuable in our real system.
JKH,
“So this entire idea of a single beta bank has to be qualified in that sense.”
I agree it’s another intersting twist, but I specifically precluded any other CB-deposit holders from the simplest version of this hypothetical (see my comment to Odie above).
Min: “Are you claiming that people only accepted Canadian Dollars because they could redeem them for U. S. Dollar? C’mon.”
No. I am claiming the exact opposite. Obviously. Because we still accept Canadian dollars, even after the Bank of Canada floated the exchange rate. C’mon.
JKH: “So leave aside asymmetric redeemability for the moment.”
But that’s a problem.
“Alpha specifies that beta has a deposit account with alpha.
This account can have a positive or a negative balance depending on circumstances.”
Suppose it has a positive balance. What precisely does beta promise to pay alpha?
If I have a positive balance of $100 at BMO, that means BMO promises to pay me 100 BoC dollars. But if the BoC does not exist, and there are no BoC dollars.
If I have $100 positive balance at BoC (which I do, in my wallet) the BoC does not promise to pay me 100 BMO dollars. It does not promise me anything.
Odie,
The Treasury account is not a problem.
Treasury and the beta configuration maintain deposit balances with alpha.
Treasury recycles beta deposit liabilities via taxation and borrowing.
That’s independent of the beta configuration – single or multiple.
Tom – its a moot point so you can move the Treasury account over to the beta bank as another deposit liability.
horrendous problem trying to post on this blog in the last few hours
Tom,
“in a setup such as this:
1. Cashless society (no paper reserve notes and no coins).
2. A central bank (CB) which can buy and sell assets (open market operations (OMOs)).
3. A single commercial bank with a CB deposit (i.e. reserve deposit). This is the only existing CB deposit account.
4. The reserve requirement is 0%.
5. A non-bank private sector which holds deposits at the commercial bank.”
That the CB would die as king and the sole commercial bank would effectively become the new alpha bank”
Assuming the central bank was part of the government, then the commercial bank would have to pay the entire population’s taxes to the central bank on behalf of the population (acting as the intermediary between the government and population).
So the commercial bank would have to acquire at least as much central bank currency as was needed to pay the taxes.
If the central bank wasn’t part of the government then I can’t see why it would exist at all in your hypothetical scenario.
Nick R
“If I have $100 positive balance at BoC (which I do, in my wallet) the BoC does not promise to pay me 100 BMO dollars. It does not promise me anything.”
But if in a parallel cashless Canada, the BoC sent you a check for $100 to buy some of your assets, and BMO was required by law to accept that check (the stick) and likewise promised by BoC to receive $100 in reserves once they did (the carrot), then aren’t you by extension promised 100 BMO dollars?
JKH,
I think your comment is about the same topic as mine above:
“Treasury and the beta configuration maintain deposit balances with alpha.
Treasury recycles beta deposit liabilities via taxation and borrowing.
That’s independent of the beta configuration – single or multiple.”
If the Treasury banks at the central bank then “recycles beta deposit liabilities via taxation and borrowing” is incorrect.
If the
“The world is divided into currency areas. Each currency area has one alpha bank (the king). All the other banks are beta banks (subjects, who follow the king). The beta banks promise to redeem their money for alpha bank money at a fixed exchange rate. The alpha bank makes no such promise the other way. Asymmetric redeemability. The alpha bank is the leader, who decides on monetary policy for the whole currency area. The beta banks just follow along, because they fix their exchange rates to the alpha bank.”
Let’s try this scenario.
There is one currency area. This currency area has one alpha bank. All the other banks are beta banks. The beta banks promise to redeem their money for alpha bank money at a fixed exchange rate. The alpha bank makes THE EXACT SAME PROMISE THE OTHER WAY. THERE IS SYMMETRIC REDEEMABILITY.
The alpha bank is the leader, who decides on monetary policy for the whole currency area. The alpha bank sets the fixed 1 to 1 convertibility with the beta banks, sets the risk-free overnight rate, sets the minimum reserve requirement, and sets the minimum capital requirement. The minimum reserve requirement is zero. There is zero demand for currency. There is zero demand for central bank reserves. This could change (not permanent). For now, everyone is satisfied with an all demand deposit economy with demand deposits being MOA and MOE.
“The alpha bank makes THE EXACT SAME PROMISE THE OTHER WAY. THERE IS SYMMETRIC REDEEMABILITY.”
After reading the other comments, I am going to try to clarify. It may not be the last clarification. If the beta banks “produce” too many demand deposits and entities demand more currency, the alpha bank will always supply more currency at the fixed 1 to 1 rate thru the commercial banks.
Philippe, assume the central bank is the only manifestation of the government and that there’s a long hiatus on taxes, or that only the bank is taxed. That’s why I made only a single CB-deposit: that of the commercial bank’s. I didn’t want to get bogged down in details about foreign trade or facilitating gov spending (other than the CB’s) or taxes. The idea is to see if the official CB here is viable as a real CB or not. If not, why not? Is it the lack of currency? Is it because there’s only a single commercial bank? Do I have to assume that for OMOs to work the commercial bank is legally required to accept CB checks for deposit? I get different reactions to this set up… and I myself go back and forth. Sometimes I favor Nick Rowe’s interpretation, sometimes I can see Sumner’s interpretation, or other people’s interpretations. And I’m not the only one to bring it up… I think winterspeak independently came up with it here recently:
http://monetaryrealism.com/market-monetarism-monetary-base-overdrive/#comment-111214
I’m not sure where Nick stands wrt the CB doing OMOs or not… does it require that extra law (the law that says the commercial bank must accept for deposit CB checks and/or must act as the CB’s agent to buy assets; both in return for reserves of course) or not? JKH, winterspeak, and Nick Edmonds have implied OMOs would be possible (not mentioning that extra law… perhaps because it’s implied by stating as fact that the CB can do OMOs). I tend to think it can do OMOs too, but it seems to me it requires that law to work, which may affect the asymmetric redeemability to some extent… I’m not sure about that either. Currently I’m thinking the CB could still be alpha, and even w/ that additional law there still would be asymmetry in that the CB would be free to do what it pleased with it’s balance sheet, but the commercial bank wouldn’t: the commercial bank still has to be concerned with solvency I think, even though it has a monopoly. It’s possible it could make a bunch of bad loans, accumulate negative equity, and be put in receivership (say) by the CB and the shareholders would lose everything: something to be avoided by its shareholders.
Here’s a previous summary I wrote up on different answers to these questions (Rowe, Sumner, Sadowski and Coppola):
http://banking-discussion.blogspot.com/2014/03/toms-epsilon-example.html
And here’s a write up on the history of how I asked the question previously:
http://monetaryrealism.com/market-monetarism-monetary-base-overdrive/#comment-111365
You see, it’s really Scott Sumner’s example: I’m just borrowing it!
Also Sadowski told me once a bit of history about the banks being nationalized in France. I don’t know if all of them were, but I got that impression. So that’s one step away from this example perhaps… if France had gone cashless? I’m oversimplifying a bit of course.
Philippe, I suppose I can use your comment to add another to my list of questions: is the CB alpha because ultimately only its liabilities can be collected as taxes (with the commercial bank always acting as intermediary)? Might as well add one more to my list…
I don’t see what the point of a central bank would be in your example. The commercial bank would have no need for the central bank’s currency, unless it was forced to accept it for some reason. Having to pay taxes would give it a reason to acquire CB currency (by currency I mean reserve balances) but you’ve ruled taxes out. So basically there’s no government and the CB employees all work for free. I have no idea why anyone wants to use the commercial bank’s liabilities as money either.. or why it has a total monopoly. The whole scenario makes little sense.
Philippe, I said if a long hiatus on taxes, not no taxes OR only the commercial bank pays taxes. So if the commercial bank pays taxes, it needs CB money to do so. But maybe those restrictions aren’t terribly important, as JKH implies above. And the employees don’t work for free: they can get pay checks… which they could deposit at the commercial bank, … or the CB could be run by a computer I guess. But I’ll chalk you up in Nick R’s category: that the king is dead. Sumner and Sadowski didn’t seem to care about my extra conditions: they said the king lives.
“unless it was forced to accept it for some reason.” … sure, I propose that as part of the commercial bank’s charter that it either has to accept CB checks for deposit (for which it gets reserves) or it has to agree to act as the CB’s agent for performing OMOs (for which it also deals in reserves). I don’t see why it would object, since those reserves would allow it to perform those functions w/o any downside to its equity position: and perhaps a modest upside (e.g. it can collect a fixed fee from the CB for this service), which it can later use to pay taxes with.
Nick said: “If I have $100 positive balance at BoC (which I do, in my wallet) the BoC does not promise to pay me 100 BMO dollars. It does not promise me anything.”
I believe there are some promises there (fixed conversions) that apply to demand deposits, currency, and central bank reserves. What may not be fixed convertible is the price of some bonds.
“is the CB alpha because ultimately only its liabilities can be collected as taxes”
That’s a sufficient reason for its currency to have some value.
In a hypothetical world without an official government or taxes, you could have a private central bank which acted like any other bank, i.e. leveraging its capital by borrowing and lending at interest. It could be the de facto ‘alpha’ bank simply due to its superior size and capital. In that case its owners and backers would be the largest landowners, companies and plutocrats (or aristocrats in times past), i.e. the people that owned most of the wealth.
Philippe said: “Having to pay taxes would give it a reason to acquire CB currency (by currency I mean reserve balances) but you’ve ruled taxes out.”
Tom Brown said: “So if the commercial bank pays taxes, it needs CB money to do so.”
Why not have the gov’t bank at the one commercial bank and accept demand deposits for tax payments (no currency or central bank reserves required)?
Too Much Fed, the BoC doesn’t have to do anything except exchange paper notes for BoC deposits and vice versa. They turn the computer on to do that (after issuing some currency and reserves) and lock the doors and walk away. The BoC could just be a giant ATM machine for use only by banks (nobody else has a BoC deposit account… so you can push the buttons all you want, but it won’t work for you). But there’s no way to get BMO deposits out of it. BMO might agree to accept your BoC currency in exchange for a deposit (I think it’s up to the BMO), and once you have the BMO deposit, they definitely are required to turn it into BoC currency for you whenever you want.
But the BoC ATM machine deals exclusively in its own liabilities. It’s not programmed to know what a BMO deposit is.
Nick,
Tom assumed a single beta bank.
So alpha pays beta IOR on a positive balance with alpha.
Beta then sets its asset liability rates using IOR as the risk free benchmark.
Also, Tom assumed no currency I think.
The case of a negative balance with alpha is probably not necessary.
But beta would pay alpha the borrowing rate set by alpha and set its asset liability rates using that rate as the benchmark.
I guess there’s no asymmetric redemption in this example because there’s no currency. Weird example. Alpha is just the government bank and sets the rules.
If beta depositors want a risk free instrument, they can buy government bonds from alpha I guess.
Mostly it works like US QE does now, with beta having a positive balance at alpha paying IOR because of QE.
Because there’s no currency, its a pathological example relative to asymmetric redeemability.
Nick,
Returning to normal asymmetric redeemability, what’s your view on the prospects for disappearance of hand to hand currency because of technology.
What happens to the asymm idea then.
When I referred to recycling from taxation and borrowing, I meant recycling by spending.
Same as it works now with the Treasury account at the CB.
JKH,
“What happens to the asymm idea then”
The CB could replace paper currency and coins with direct CB deposit liabilities for anybody. To make them exactly like currency (if that was desired) they might be fixed by law to return precisely 0% nominal interest at all times.