Dr. Warren Coats - Shrinking the Fed Balance Sheet and The Chicago Plan

Dr. Warren Coats, former head of the SDR Divsion at the IMF, sent out this message by email today (7-14-18).

"This coming week Chairman Powell will testify on the Hill re the Fed’s new operating strategy and whether to shrink its balance sheet. It is a good time to raise the prospects of introducing the Chicago Plan (100% required reserves). I set out the case for doing so in the following article: A Proposal for the Fed's Balance Sheet"

Below are a few excerpts from the article just released.

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Dr. Warren Coats

"To save financial institutions from the collapse that threatened them after the bankruptcy of Lehman Brothers in September 2008, the Federal Reserve purchased government securities and Mortgage Backed Securities (MBS) sufficient to increase the size of its asset holdings from $0.9 trillion to $4.5 trillion by the end of 2014.  These large open market purchases were not meant to increase the money supply, the traditional purpose of such operations, which after a sharp drop followed by a sharp increase in the growth rate of broad money (M2) has grown at its historical average rate of around 6% per year. Rather they were to support the market prices of government debt and hard to price MBS in the face of market panic (at least initially).

The Fed accomplished this trick (large increase in the Fed’s asset holding with only modest increases in the money supply) by paying banks to keep the proceeds of their sales of securities to the Fed in deposits with the Fed, so called “reserves,” in excess of what is required, so called “excess reserves.”    . . . . .

Please click here to read the full article by Dr. Warren Coats

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My added comments: Dr. Coats points out in this article that bank lending based on the issuance of equity by the bank would shift the risk of defaults to stock holders and away from regular depositors.

"Adopting the Chicago Plan would prevent banks from on lending our checkable deposits.  At the moment they are not doing that anyway. This raises the question of where banks would get the funds (our savings) to on lend in their financial intermediary role?  In an extreme version of the Chicago Plan (100% required reserves against all deposits and deposit like bank liabilities) all bank lending would be financed by equity rather than debt.

. . . . . . 

Equity rather than debt financed bank intermediation is a more stable structure as a result of shifting the risk of loses (loan defaults) from banks to the ultimate public investors.  The Federal Deposit Insurance Company would stop insuring 100% reserved deposits and its bank resolution functions would be moved to the Office of the Comptroller of the Currency (OCC) in the U.S. Department of the Treasury."

The True Gold Standard - A Monetary Reform Plan Without Official Reserve Currencies

A thank you to a blog reader (a former correspondent for Time magazine who prefers to remain anonymous) who alerted me another formal proposal to consider a return to the gold standard. In an earlier article, we featured the work of Dr. Lawrence White who also speaks favorably about returning to the gold standard. In that article, I made this comment:

"There are a variety of ideas on how gold might return to the monetary system, but until I learned of this information from Dr. White I had not run across a formal proposal for how to transition back to an actual gold standard."

The blog reader mentioned above picked up on that comment and sent me an email that encouraged me to look at another proposal for returning to a gold standard. The reader had this to say:

"In your June 23rd post:  "Dr. Lawrence White - Experts and The Gold Standard” you cite a range of proposals “for how to return to a gold standard.”   Let me add to it the following work:  The True Gold Standard - A Monetary Reform Plan without Official Reserve Currencies (Second Edition - Newly Revised and Enlarged). "

I am also advised from the reader that John D. Mueller made some contributions to the book linked just above. Mr. Mueller is The Lehrman Institute Fellow in Economics at the Ethics and Public Policy Center in Washington DC. He was a featured speaker at the Kemp Forum in Washington DC that we covered here earlier this year. The book was authored by Lewis Lehrman and offers his view on why we should return to the gold standard. Mr. Lehrman served in Reagan Administration and was on the US Gold Commission along with US Congressman Ron Paul.

I reached out to John D. Mueller for any comments he might have on the book. He replied with these comments:

"Lewis Lehrman is a remarkable man. Trained as a historian at Yale and Harvard, he became a successful businessman (helping found Rite-Aid drugstores)—in Lew’s telling, after Lew’s graduate fellowship was cut by 25% and Lew’s father remarked that perhaps he should try a field with more economic promise. Lew made and spent a couple of fortunes supporting public-spirited efforts including international monetary reform. One website organized by The Lehrman Institute,thegoldstandardnow.org, is a treasure trove of articles on sound monetary reform, and includes extended interviews with experts like Lew Lehrman and Dr. Larry White. Lew Lehrman’s occasional op-ed articles are also a crash course in American history: http://www.lewiselehrman.com/history.html. He has probably done more than anyone to explain the importance of Abraham Lincoln. And he has just published an excellent and interesting book on Roosevelt, Churchill and Company.

I can join in heartily recommending the book mentioned to you by your blog reader, The True Gold Standard - A Monetary Reform Plan without Official Reserve Currencies (Second Edition - Newly Revised and Enlarged). 

 (My role was limited to providing charts and appendices for the second edition.) In it, Lew Lehrman answers the question, how would one actually implement a workable gold standard? The provision mentioned in the subtitle—that any new system must eliminate official “reserve currencies”—is vital to the success of such a plan. I discussed the reasons in my recent talk at the Jack Kemp Foundation forum on exchange rates and the dollar."    --- John D. Mueller

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My added comments: Interestingly, in his presentation at the Kemp Forum earlier this year, John D. Mueller said he felt these were the three main alternatives for the global monetary system in trying to solve its problem (The Triffin Dilemma):

a)  muddle through until the (US) dollar standard's collapse.

b)  turn the IMF into a world central bank issuing paper (SDR) reserves.

c)  turn to a modernized international gold standard.

This is pretty much what we have been saying here on this blog as well. I will add that the Real SDR proposal (Dr. Warren Coats) that we have featured here is somewhat different than option (b) above as I understand it. While it does involve using the SDR as global reserve currency, it would change IMF rules so that the currency was issued under Currency Board rules (based on public demand, not IMF discretion) and also would anchor it to a basket of goods (not to the five currencies in the current SDR basket). I do not believe Dr. Coats supports giving the IMF arbitrary discretion to issue SDR's. Readers can look into this more in depth in this recent blog article. Robert Pringle has another more "out of the box" proposal he calls The Ikon also covered in that article.

At this point in time, it seems as though we are clearly still under option (a) above. This blog watches for any indications that change from option (a) might be underway to option (b) or option (c) or something else. These days some believe that something else might be decentralized cryptocurrencies (not issued by any central bank). Cryptocurrencies seem like the least likely alternative to me for a variety of reasons to lengthy to discuss here, but there are people who think otherwise. We covered what we think is the current status of cryptocurrencies in this recent article. Our goal here is to present readers with what we believe are the most likely scenarios for monetary system change and encourage them to learn as much as they can about them. 

We greatly appreciate all the contributions from the various experts we have featured here on various ideas and proposals for monetary system change. Readers here benefit from their knowledge and generosity. I would like to add a special thank you to John D. Mueller for taking time to offer his thoughts included above. 

Added note:  I received this additional comment by email from John D. Mueller. He kindly granted permission to add it to this article:

"Since option A is inherently doomed, I think we will wind up the only sustainable option, option C, after more or less painfully exhausting the alternatives."

All the best,

John

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John D. Mueller

The Lehrman Institute Fellow in Economics

Director, Economics and Ethics Program

Ethics and Public Policy Center (40th Anniversary)

1730 M St. NW, Suite 910

Washington, DC 20036

Dr. Judy Shelton agrees with John D. Mueller in this Twitter comment.