Provoked by a provocative piece

It seems to me that the term ‘provoked’ has a sort of negative connotation. Don’t poke the bear, you’ll only provoke him. On the other hand, ‘provocative’ can have a positive connotation. He expressed some provocative ideas, meaning interesting ideas. But doesn’t provocative mean things that provoke?

Tyler Cowen has a new piece in Bloomberg entitled:

Trump Likes the Idea of a Federal Bitcoin Reserve. Don’t Laugh.

The idea of a government fund invested in cryptocurrency may sound foolish, but there are reasons for the US Treasury to consider adding Bitcoin to its portfolio.

The article provoked (annoyed) me with some provocative (interesting) ideas.

I suspect that Tyler Cowen knows that his essay was provocative. Consider phrases such as “don’t laugh” and “may sound foolish.” Tyler went into this arena with eyes wide open, asking for trouble.

I want to be clear that when I suggest this is a loony idea, I do not mean it in the subjective sense that I disagree with the proposal. I mean it in the objective sense that it would be widely regarded as loony by almost all economists. But it’s equally true that my claim that the Fed caused the Great Recession with a tight money policy is viewed as loony by almost all economists (probably including Tyler). Being viewed as loony doesn’t make it wrong.

If Tyler did an article headlined “Actually, MMT makes a lot of sense”, it would be easy to quickly refute the claim without working up a sweat. It’s easy to show that MMT doesn’t make a lot of sense. But here Tyler is not presenting Trump’s views on Bitcoin reserves, he’s taken on the challenge of making his own plausible case for a Bitcoin reserve. In the end he’s wrong, but refuting his claims does require one to work up quite a sweat.

I apologize to readers for the length of this post, which is akin to killing a mosquito with a sledgehammer. But I have an ulterior motive. At the end, I’ll hijack the post and begin to consider other issues, such as methodology. How did Tyler end up with this view? How did I end up with my foolish view? Why is my foolish view on the Great Recession superior to Tyler’s foolish view on Bitcoin? These are much more subtle questions than the issue of whether Trump is spouting foolishness (hint–he is.)

The early parts of the essay are not very important. Tyler correctly points out that the Fed has holdings of gold. He points out that the Fed has purchased Treasury securities and high quality commercial paper. But the gold was purchased at a time when the US was still on a gold standard. We are not on a Bitcoin standard. The purchase of high quality commercial paper was not motivated by a desire to build up a commercial paper reserve, it was a part of QE. More broadly, the Fed wisely refrains from buying highly speculative assets such as Bitcoin, indeed they don’t even purchase common stock.

Separately, the US government maintains reserves of some critical commodities, such as its Strategic Petroleum Reserve. 

Yes, but Bitcoin is not a critical commodity.

Jersey City’s pension fund has plans to invest in Bitcoin, as the state of Wisconsin already is.

But the federal government has no money to invest. They’re broke. Even if you believe in fairy tales like the “Social Security trust fund”, how would voters feel about putting billions of dollars of that “fund” into crypto, and then seeing the price fall 80%?

El Salvador is another case in point. The country already is fully dollarized, and President Nayib Bukele has been taking steps to encourage crypto use and investment. So far his intended crypto revolution has not taken off, but the country does offer highly favorable terms for crypto users and investors.

But hasn’t this experiment gone poorly?

I see all of these claims as mere debating points. Tyler is anticipating complaints that Bitcoin is not something the government should be involved in, and trying to suggest that the idea is not so far fetched. But none of this makes a positive case for a Bitcoin reserve, that comes at the end of the essay.

There is only one claim that I strongly take issue with:

In short, there might be a number of governments that use dollars and crypto as a significant part of their natural monetary base

Sorry to beat a dead horse, but I cannot resist. In economics, the term “natural” has a very specific meaning. There is a natural rate of interest, a natural rate of unemployment, and a natural rate of output. But it would be nonsense to speak of a natural rate of inflation, a natural rate of NGDP growth, or, I’m afraid to say, a natural monetary base.

Even worse, Bitcoin is not part of the monetary base, because it’s not even money in the sense that base money is money. It’s not a medium of account. Rather than money, think of Bitcoin as a sort of fiat commodity, which serves as a store of value, occasionally a medium of exchange, but almost never a unit of account. Sort of like electronic gold. But gold used to be a medium of account, whereas Bitcoin was never a medium of account. So more like electronic platinum.

Finally we get to the meat of the argument—the actual case for the creation of a US Bitcoin reserve. To me, it reads like the sort of argument a very smart person would make if forced to defend a seemingly indefensible proposition. It’s the macroeconomics equivalent of a quadruple bank shot in billiards. Here’s how I’d summarize his argument:

Perhaps the dollar and Bitcoin are complements. Perhaps countries will increasingly dollarize in the future. Perhaps dollarizing countries will wish to hold Bitcoin in order to evade potential US economic sanctions. Perhaps they’d be more willing to hold Bitcoin if Bitcoin were highly respected. Perhaps Bitcoin would be more highly respected if the US government bought lots of Bitcoin. Perhaps countries would be more likely to dollarize if Bitcoin were more respected. Perhaps if more countries dollarized there would be more demand for dollars. Perhaps this proposal could allow the US could maintain a higher level of consumption (via greater seignorage.) Perhaps it would be a good idea to boost our consumption in this fashion, were it possible.

Wait, that’s not a quadruple bank shot; I count no less than nine uses of “perhaps”. Unfortunately, a number of these claims are unlikely to be true. But now you see why I said we’d have to work up a sweat to refute this proposal.

At first glance, the dollar and Bitcoin seem like substitutes, not complements. Tyler presents a possible rationale why they might be complements in a very specific case, but it still seems likely that they are net substitutes at a global level. In the past 100 years, the progress toward dollarization has been very slow (a few small places like Ecuador, El Salvador.) I’d expect private Bitcoin demand to remain vastly more important that government Bitcoin demand in dollarizing countries over the next 100 years. So I’d say the first “perhaps” is unlikely.

Yes, I do think it at least somewhat plausible that dollarization will increase in the future. So I’ll rate the second “perhaps” as uncertain. Ditto for the third claim, that dollarizing countries will wish to hold more Bitcoin reserves than non-dollarizing countries—plausible but uncertain.

I am skeptical that the decision to hold Bitcoin reserves will be strongly linked to its respectability. Bitcoin is currently used partly because of its anonymity, sometimes for nefarious purposes. If a country were to build a Bitcoin reserve to evade possible US sanctions, why would it care if the US government viewed the asset as respectable?

I’m also skeptical that US purchases would move the needle very much on respectability, but here Tyler’s claim is at least plausible.

I very much doubt whether countries would be more likely to dollarize if Bitcoin were respected, for the same reason that I indicated above when I suggested that respectability would not play a major role in their use of the asset as a way to evade sanctions. This seems like an extremely difficult bank shot—I just don’t see it.

Most economists would agree with Tyler’s claim that more countries dollarizing would increase the total demand for dollars. But is that true? In a normal country, currency demand is usually only around 5% to 10% of GDP. That’s because other assets like T-bills are also safe, and offer a higher rate of return. So here’s my question: What is the current demand for dollars in a high inflation country like Argentina? It seems possible that dollars are actually more in demand today (when the alternative is the high inflation pesos) than they would be were Argentina to dollarize, and inflation fell to low single digits. Thus even one of Tyler’s least controversial “perhaps” is perhaps a bit uncertain.

Even if massive Bitcoin purchases did lead to a bit more dollarization, and even if this did increase the demand for US currency, it’s not clear that this would enable higher US consumption. After all, Bitcoin is very costly to produce, if only in terms of energy consumption. All the energy poured into producing Bitcoin is no longer available to produce other consumer goods. There’s an opportunity cost of more Bitcoin. Note, this doesn’t mean I’m anti-Bitcoin, just that an argument for a US reserves needs to consider both costs and benefits. Private sector actors do this when using Bitcoin, but a government reserve would be paid for with our tax dollars. Is this a wise use of funds?

And finally, even in the exceedingly unlikely event that the first 8 banks in the billiard shot went perfectly, I’d still view increased US consumption funded by seignorage as a net negative. Dollarizing countries tend to be economic basket cases. What’s the point in trying to squeeze a bit more money out of those poor countries so that we can be a bit richer? Bill Gates takes money from middle class Windows buyers and helps the world’s poor. Is our goal to do a reverse Gates, and take money from the world’s poor so that we can be a tiny bit richer? Aren’t we better than that?

To be clear, I’m not saying that dollarization is a bad thing, just that I don’t view the specific seignorage-> US consumption argument as an appealing one.

Maybe you have a really smart friend that believes the CIA was behind the Kennedy assassination. You know his theory is nuts, but it’s hard to refute. He’s studied the issue much more than you have, and has lots of talking points. How did your really smart friend end up with this theory? Perhaps it was motivated reasoning. Perhaps he was looking for arguments that buttressed his theory, and not spending much time looking for arguments refuting his theory. But you really need to do both!! I suspect that if someone put a gun to his head, Tyler could have come up with lots of arguments against his proposal, along the lines of what I’ve suggested here. (In fairness, he mentions one or two.) Perhaps he was intrigued by the challenge of finding a rationale for a claim that he knew most economists would view (his words) as “foolish”. I know that I am occasionally intrigued by the idea of establishing an interesting contrarian theory.

Which brings me to the Great Recession, the real purpose of my post.

1. Perhaps a sharp fall in NGDP growth will cause a big recession.

2. Perhaps monetary policy can prevent big falls in NGDP, especially when interest rates are positive.

3. Perhaps interest rates were positive until mid-December 2008, a year after the Great Recession began.

4. Perhaps monetary policy should be set at a position where expected NGDP growth is about 4% or 5%.

5. Perhaps market forecasts of NGDP growth are our best forecasts.

6. Perhaps markets were very clearly signaling deficient NGDP growth ahead during the second half of 2008.

7. Perhaps the Fed ignored those market signals.

8. Perhaps a more expansionary monetary policy in 2008 would have prevented a deep drop in NGDP.

9. Perhaps if a more expansionary policy were not enough, the Fed could also have committed to level targeting, to eventually returning NGDP to the previous trend line. Maybe that would have prevented a Great Recession.

Another 9-bank billiard shot? Perhaps, but in this case I believe there is very strong evidence that all nine claims are true.

To conclude:

My objectively foolish theory >>>>>> Tyler’s objectively foolish theory.

(Again, by “objectively foolish” I mean regarded as such by almost all economists. In contrast, the philosophical use of “objective truth” is utter nonsense.)

PS. Josh Hendrickson has an excellent post on this topic.

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