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Wednesday, May 1, 2019

Dr. Warren Coats Proposes Currency Board Rules for the Federal Reserve - Includes Q&A

Readers may recall that we have previously featured the Real SDR Proposal of Dr. Warren Coats here on the blog. Dr. Coats is retired from the IMF and is widely recognized as an expert on both monetary policy and the SDR used by the IMF.



Recently, Dr. Coats wrote a new article published on the Adam Smith Institute blog proposing that the US Federal Reserve should move towards the adoption of Currency Board rules in an effort to reform the present monetary system. Below are some excerpts from this new article. The concept of a Currency Board may be new to many readers so Dr. Coats kindly agreed to do a brief Q&A for readers here on some basics for how Currency Board rules would work. You can find that Q&A interview further below the excerpts quoted from his new article.





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"After years of discretionary management of monetary policy by the Federal Reserve, there is a strong case for re-fixing our fiat currency system to a hard anchor. Though the dollar was far more stable under the gold and gold exchange standard era than after it’s delinking from gold in 1971, those systems came with significant weaknesses that contributed to their ultimate abandonment. To avoid these, three key elements of the Fed’s operation should be modified. These are: 1. The monetary policy rules determining how currency fixed to a hard anchor is issued and redeemed; 2. The monetary anchor itself; and 3. What the currency is issued or redeemed for."

. . . . .

"A reformed monetary system should require the Fed to adhere strictly to currency board rules. Such rules oblige a central bank to buy and sell its currency at a set price in response to public demand. Under the Gold Standard, the price of the currency was set as an amount of gold (a gold anchor). For existing currency boards, the price is typically an amount of another currency or basket of currencies. The Fed would provide the amount of dollars demanded by the market by passively buying and selling them at the dollar’s officially fixed price for its anchor. All traditional open market operations by the Fed in the forms of active purchases and sales of T-bills or other assets or lending to banks would be forbidden."

. . . . .

"The United States could adopt the hard anchor currency board system described above on its own and others might follow by fixing their currencies to the dollar as in the past. The amendments to the historic gold standard system proposed above would significantly tighten the rules under which it would operate and strengthen the prospects of its survival."


(note: I added underlines above for additional emphasis)
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Followup Q&A Session with Dr. Coats:

I offered Dr. Coats the opportunity to expand a bit on his thoughts on Currency Board rules based on the questions listed below with the goal of providing some additional insight on how his proposal would work if implemented by the Federal Reserve.


Q: Where does a Currency Board get the money that it supplies based on market demand?      

A: "It creates it like any other central bank."


Q: Who does a Currency Board typically supply money to? 
  
A: "Currency Boards deal with the same customers as regular central banks—generally just depository institutions—banks, credit unions"


Q: What assets would a Currency Board normally accept in exchange for the money it provides?  

A: "It (a Currency Board) creates money like any other central bank, but it only issues it when purchased with the equivalent value of its anchor (The Bosnia currency is fixed to Euro and thus must be purchased with Euros)."


Q: Does a Currency Board ever loan money to either the Federal government or private banks and charge them interest?

A: "That depends on its law. Generally no. However, the Central Bank of Bosnia and Herzegovina may lend to banks (lender of last resort) to the extent that it has more than the 100% asset cover for its monetary liabilities (base money)."


Q: What impact (if any) would using Currency Board rules have on market interest rates?

A: "It would remove any central bank influence on market rates."


Q: What impact (if any) would using Currency Board rules have on US fiscal policy and/or budget deficits?

A: "Existing currency board central banks’ governments have lower public debt than most others because they cannot borrow from the central bank and thus are more disciplined."


Even though Currency Board rules are designed to bring discipline to the supply of money and provide a stable value to money over time, there are still many people who prefer to hedge against the potential abuse of any system by holding gold as a form of insurance. 

Q: If the US did adopt Currency Board rules, would you support the removal of capital gains taxes on gold and silver so that anyone who wanted to hedge themselves that way could do so without being subject to a tax penalty for holding some savings in gold or silver as a form of insurance in the event the money did lose value in relation to gold for whatever reason?


A: "People can and should be free to hedge (save) in any way they want—owning real estate, gold, GM or what ever. Gold should not be subsidized and should be treated like any other way of holding wealth. Actually I favor abolishing capital gains taxation whatever its source."


I would like to extend a thank you to Dr. Coats for taking time to respond to these questions for the benefit of readers here. Dr. Coats provided this additional comment related to the value of money:

"The value (price) of money, like everything else, is determined by its supply and demand. Fixing its price to gold, for which it can be redeemed, is a way of regulating its supply. Fixing it to anything else (such as SDR) with currency board rules does the same. Bitcoin’s supply is determined by a formula, but there is little real demand— just speculators."  -- Warren Coats



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My added comments: One thing that occurs to me is that if the US were to adopt this proposal by Dr. Coats and also do away with capital gains taxes as he said, this system might appeal to those who favor a return to an actual gold standard.

If followed as proposed by Dr. Coats, there would be rules inside the system to try and enforce monetary discipline and then people would also be free to hold any other form of savings (gold or whatever) as an insurance hedge without being penalized with capital gains taxes. This would make the individual free to assume any price volatility associated with their personal savings choices with no tax implications. Also, the government/central bank would have an additional incentive to maintain monetary discipline because people could easily choose to move savings to other forms of wealth if they believed that the monetary system rules were being abused.

Note: This article will be added to our permanent page of ideas for monetary system reform that can be found here.


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