Abstract

The U.S. dollar is the global reserve currency and the U.S. Treasury security is the global reserve asset. Conventional explanations suggest that this state of affairs is explained through path dependence following the collapse of Bretton Woods, the absence of a better alternative, and/or the prevalence of invoicing international trade in terms of dollars. These narrowly rational explanations of what I will refer to as the Treasury Standard miss the forest for the trees. In fact, the Treasury Standard is the latest stage of an evolutionary process aimed at financing large-scale, open-ended military conflict that arguably dates back to the Military Revolution. In this paper, I discuss the evolutionary process of the world financial system against the backdrop of this fiscal/military constraint. I then discuss the deliberate policy actions of the U.S., including its control of the international institutions created under the Bretton Woods system, that have brought about this outcome. Finally, I discuss the economic implications of this system and the role that the dollar plays in U.S. foreign policy.

Abstract

As it relates to Bitcoin, there are several interesting questions to address:

(1) Why does money exist and what role does it play in society? How does bitcoin fit within our understanding of the role of money in society?
(2) What is bitcoin worth?
(3) Is bitcoin (or can bitcoin be) a sound form of money?
(4) Should states or governments be involved? Should they buy bitcoin?

In this paper, I attempt to provide some answers to these questions by drawing on insights from mainstream economic theory.

Abstract

In this paper, I make the case for a nominal GDP level target in the U.S. I begin by arguing that the Federal Reserve’s current flexible average inflation targeting regime is deficient. I then argue that since a competitive monetary equilibrium is optimal, monetary policy should seek to replicate the competitive monetary model. Doing so resembles nominal GDP targeting. Finally, I offer the following practical reasons why policymakers might prefer a nominal GDP target. Nominal GDP targeting (a) does not require policymakers to determine whether current economic fluctuations are demand-driven or supply-driven nor does it require real-time estimates of the output gap, (b) automatically prevents the central bank from exacerbating supply shocks, and (c) leads to greater financial stability.

Abstract

In this paper we present a theory of note discounts, exchange rates between brands of notes, and the price level in convertible paper money regimes. We show that under perfect commitment to convertibility, notes and the underlying commodity are perfect substitutes and price level determination is identical to a pure commodity standard. Different brands of currency trade at par. With imperfect commitment to convertibility, the probability that the issuer reneges on the commitment to convertibility explains discounts/premia on notes and exchange rates between brands in competitive note regimes. In non-competitive regimes, the probability of reneging explains fluctuations in the price level. To support our model, we discuss historical events and time periods that are consistent with our theory.

Abstract

Many policymakers and economists are surprised by the recent high and persistent inflation. This naturally raises questions about what caused it and why it was so unexpected. This paper argues that the quantity theory of money provides a useful framework for forecasting inflation. Anyone equipped with the rather crude forecasting model would have predicted the high and persistent inflation in 2021 and 2022. The failure to foresee such an occurrence was due to the lack of money in monetary policy analysis.

Abstract

The New Keynesian literature focuses on rules-based interest rate policies, abstracting from the role of monetary aggregates. In the background, though, the quantity equation must hold — every transaction requires money, with money units used in multiple transactions within a period. What is often overlooked is that imposing a rules-based interest rate policy is equivalent to assuming a particular money velocity specification. Using this alternative specification, we derive the efficient money supply rule and show that determinate equilibria exist with money supply policy and a fixed nominal interest rate. We estimate a New Keynesian model with either conventional interest rate policy or our money market reinterpretation of the model, accounting for the policy rate lower bound (PRLB). The money market estimates exactly match the PRLB duration in the data, whereas the conventional estimates fall short by four years.

Introduction

The International Center for Law & Economics (ICLE) is grateful for the opportunity to submit these comments in support of FTX’s application to amend its DCO registration to allow it to clear margined products directly for retail participants.

The vast majority (some 96%[1]) of global crypto derivatives trading takes place outside the U.S., much of it on platforms operating non-intermediated retail models similar to that proposed in FTX’s application—but with one crucial difference: these offshore exchanges are largely unregulated. The reason for the disparity in domestic vs. foreign trading volumes is clear: regulatory constraints and costs in the U.S. make the operation of such platforms impossible or unviable. FTX’s proposal would pave the way to bring the technology and business models currently employed to facilitate virtually the entirety of the world’s crypto derivatives trading into the regulated structure of U.S. derivatives markets. The only thing standing in the way is the possible inflexibility of that regulatory structure in the face of disruptive competition.

The obvious market benefits of FTX’s proposal are that:

1. It would free capital that would otherwise be pledged as collateral, which could greatly expand liquidity in crypto markets or could be deployed elsewhere in the financial system;
2. It would introduce a competitive alternative to the current exchanges, thus providing investors savings on what they would otherwise pay in commissions, account origination fees, etc.; and
3. It would offer clear product differentiation: e.g., by introducing a new mechanism for counterparty risk mitigation and by offering direct access to retail investors (with inherently lower costs of participation, more and cheaper information, and technological enhancements like a direct-access mobile interface).

The latter two of these benefits (and to some extent even the first) go particularly to the enhancement of competition in U.S. derivatives markets.

Concerns that markets lack sufficient competition are at the forefront of current policy debates. Legislators are currently working on draft bills that seek to promote competition in digital markets, and President Biden recently issued an executive order advocating for a “whole of government” approach to competition.[2]

Unfortunately, the renewed focus on how governments may boost competition has a significant blindside when it comes to government-created barriers to competition. Rather than offering a solution, government regulations are all too often the cause of reduced competition. This is notably the case when regulation artificially narrows a market by preventing new and innovative firms from disrupting entrenched incumbents.

In other words, if the “whole-of-government” approach to promoting competition means anything, it means that regulatory agencies should work to remove state-created, artificial barriers to market entry that are not absolutely required to accomplish core regulatory functions. The CFTC has precisely that opportunity with FTX’s application.

The market for crypto (and many other) derivatives is currently a lucrative duopoly, dominated by the Chicago Mercantile Exchange (CME) and the Intercontinental Exchange (ICE). Both firms have long been shielded from robust competition by a protective, if well-intentioned, moat of government regulation. The CFTC now has a unique opportunity to open this duopoly to disruptive competition.

FTX’s application would bring both technological and business-model innovation to the derivatives market, carrying with them the promise of increased competition, reduced risk, more efficient pricing, and lower costs for investors. There is always reluctance to embrace the new, particularly in areas that deal so intrinsically with risk. But a sensible measure of caution must not be allowed to morph into costly intransigence.

FTX’s application, while ambitious in its aims, is, in fact, quite modest in its mechanisms. It is respectful of the existing, overarching regulatory paradigm implemented to protect consumers, investors, and the financial system as a whole; it contemplates significant protections and backstops to shore up any increased risk it might introduce; and it ensures that ongoing oversight by the CFTC is readily facilitated.

Indeed, approval of FTX’s application would not entail the abandonment of the CFTC’s core principles, but merely a recognition that the specific implementation of those principles may not be optimal for certain novel business models and technology. As Chairman Benham recently remarked:

[T]he digital asset market would benefit from uniform imposition of requirements focused on ensuring certain core principles, including market integrity, customer protection, and market stability. At the CFTC, we have seen that a regulatory regime focused on core principles can be successful in overseeing a wide variety of markets, and have no reason to think those same principles cannot be applied to digital asset markets.[3]

In short, the CFTC should jump at this opportunity to introduce some well-regulated experimentation into the derivatives market: the likely social benefits of this effort significantly outweigh the potential harms.

Read the full comments here.

[1] See, e.g., Philip Stafford, Crypto industry makes push into regulated derivatives markets, FINANCIAL TIMES (Feb. 21, 2022), https://www.ft.com/content/364dee59-fb51-400b-acd2-808d4ec41ab3.

[2] Executive Order 14036 on Promoting Competition in the American Economy, § 2(g) (Jul. 9, 2021) https://www.whitehouse.gov/briefing-room/presidential-actions/2021/07/09/executive-order-on-promoting-competition- inthe-american-economy (“This order recognizes that a whole-of-government approach is necessary to address overconcentration, monopolization, and unfair competition in the American economy.”).

[3] CFTC Chairman Rostin Behnam, Letter to the U.S. Senate Committee on Agriculture, Nutrition, and Forestry and House Committee on Agriculture (Feb. 8, 2022) at 4, available at https://www.agriculture.senate.gov/imo/media/doc/2022%2002%2008%20Ag%20committees%20digital%20asset%20res ponse%20letter.pdf.

Abstract

Early in his career, Milton Friedman proposed a coordinated rules-based approach to monetary and fiscal policy, which he then abandoned for a simple constant money growth rule. Both rules were motivated by his goal of long-run economic stability and his belief that discretionary policy would be destabilizing. What prompted Friedman to change his view was his interpretation of empirical evidence showing that monetary policy dominates fiscal policy in determining macroeconomic outcomes, rendering fiscal policy ineffective.