JP Koning on Goldbugs, African Monetary History, and Fedcoin

JP Koning is an economic consultant who's worked in the Canadian financial industry, including jobs as an equity analyst, a financial writer, and in design publishing. JP also consults for a blockchain company, R3, and runs a finance and economic charting business as JP also runs a blog called Moneyness, and this is JP's place that many of us go to visit to get the institutional and historical details on central banks and money. He joins David on Macro Musings to discuss fascinating stories in monetary history in Libya, Zimbabwe, and Switzerland. He also shares his thoughts on Blockchain technology and Fedcoin, a hypothetical cryptocurrency stabilized by the Federal Reserve.

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: JP, welcome to the show.

JP Koning: Thanks very much for having me, David.

Beckworth: All right, so tell us about how you got into economics and into monetary economics, in particular, and all the history surrounding it.

Koning: Sure. I took economics for my undergraduate. It wasn't then that I got interested. It was only after I graduated that I started revisiting some of the things that I had learned in school. When I graduated, I went to work right off the bat in the Canadian finance industry. I got a job with a company that had a lot of gold bugs.

Koning: I don't know if your readers or your listeners know, but a gold bug is a specific type of person in the financial industry who has a strong predilection for investing in gold. They believe often that there should be a return to some sort of gold standard. I was working with a lot of these guys, and they'd spend a lot of time talking to me about gold and the gold standard. I was really interested in just stocks at that time, so I would kind of ignore them.

Koning: Over time I found that, as I tried to engage them, I had to learn more on their side, in order to be able to meet some of their points. The more I read, the more I guess my knowledge expanded. I learned a lot about gold standards through them, but at the same time, there's a lot more to understand about monetary economics than just the gold standard. Ever since then, it's just been a constant effort to learn as much as I can. I guess I owe the gold bugs for that one.

Beckworth: Well, we can thank them, indeed. Do you still come across a lot of gold bugs in the financial industry?

Koning: Oh yes. They're never going to disappear. They're kind of a small sect, or almost like a small cultural group within the finance industry. They're always there. I'm not a gold bug, but I always enjoy them. They always have a strong interest in history, so that's kind of why. I think that's also where I come from. I also try to come from a historical aspect. In that respect, I disagree with gold bugs, but I really like-

Beckworth: The history they do?

Koning: I like their approach.

Beckworth: There are some thoughtful gold standard advocates out there, like Larry White at George Mason University and a few others.

Koning: Yeah.

Beckworth: But many of the gold bugs do approach the topic not fully informed, and sometimes have the history misconstrued. Let's go to what you do. You do a fascinating job covering these facts about money and central banks that most of us, we completely miss or we don't appreciate. I want to go during the first part of this show and look at some of the institutional details and history of central banks around the world. We're going to take a little tour, here, for our listeners. We're going to go around to different parts of the world. The first thing that I want you to talk about, and you've written about this on your blog, that there are a number of central banks that actually have shares that trade on the stock market. People can own shares in a central bank. When I first read that, it blew me away. Tell me about that, and why do they do that?

You Can Own Shares in These Central Banks

Koning: Yeah, so you can own shares in five central banks. There's the Swiss central bank, the Belgian central bank, Japan, Greece, and South Africa. They are listed on the major stock market, except for South Africa. South Africa recently de-listed, and they only trade their shares on their own website. They all have these really odd share structures.

Koning: I should point out also that it's not entirely odd because the Federal Reserve is actually owned by .... It issues shares, too. The different being that they're not listen on an exchange. The bank shares, you are not allowed to exchange them. Once you have a share, once you're a member of a system, you have those shares forever.

Koning: For instance, in the Swiss case, the shares are traded on the Swiss stock market. They rise and they fall. They've actually had an incredible rise, over the last three or four months. The reason for that goes back really quite far in history, to the 1800s and early 1900s. Before these banks became owned by governments, they were really just bankers banks. Banks would often, to run a clearing settlement system, they would all become members of a central clearance system. One way you could govern the system is each individual bank would get shares, as a condition of entering. That would give them a way to decide how the system would function.

Koning: Then over the course of time, as monetary policy became more and more important, its legacy structure was removed gradually. For instance, in Canada, when the Bank of Canada was first established in 1935, it was a privately owned bank with shares that were traded. Then three years after, in 1938, they decided to nationalize it. All the shares are now owned by the government. That's pretty much the standard now, is governments own the shares of the central bank.

Koning: However, there's a cases in which ..., in the case of Japan, the Swiss, et cetera, et cetera. I'm not entirely sure why they do it. I have a feeling sometimes it's just not worth the effort, to clean up the old shares. You might have to change the central bank act, and that could take a fair amount of effort, so they just let these things stay outstanding.

Beckworth: Now, do they pay dividends?

Koning: Yeah, they pay dividends.

Beckworth: Oh, okay.

Koning: The dividend is almost always, historically, on time. In the case of the Swiss National Bank, the bank has capitalized 25 million francs, but they're only allowed to pay 6% dividend on that, which comes out to 1.5 million francs. That's only about a million and a half US dollars, so it's not very much. They've been paying that dividend for over 100 years now. That dividend would have been a nice dividend back in its time, but it's quite small these days.

Beckworth: The fact that they have these shares trading, does that at all influence monetary policy, in the sense that, do these shareholders, could they go and say, "Hey, we don't like the way monetary policy is going, so we're going to throw out the CEO, the board?" Or is it just more of you own a share and that's all you get out of it?

Koning: Yeah, that's pretty much all you get out of it because they've dramatically curbed the voting power of these shares. They're not the normal shares, where one share is one vote. You either get no vote, or in the case of the Swiss central bank they have a cap. Once you own a certain amount of shares of that point, you get no vote whatsoever. There's absolutely no way these shares can influence monetary policy, anymore. In the old days, before monetary policy became important, the process would have been quite important, but that's not the case these days.

Beckworth: You mentioned the US. The shares that are owned, that's at the regional district reserve banks, right, not the actual board of governors?

Koning: Yeah, that's right.

Beckworth: I mean, it's a slight difference here between we're talking about the Swiss National Bank. You mentioned also that the Swiss National Bank's shares have had a run-up over the past three months. Do you have any idea why?

Koning: Yeah, so it's kind of interesting. These shares, they're called shares, but if you look at the fine print, they're more like perpetual bonds. As I pointed out, the dividend payment is fixed. It never rises about 1.5 million dollars, shared among 100,000 shareholders. That's 15 Swiss francs per share. It's always like that, and it's probably, as long as the Swiss central bank is around, always going to be like that. You're basically talking about what is a perpetual bond, which is actually quite a rare security. As far as I know, there's not many perpetual bonds that trade out there.

Koning: This summer, the Swiss 50-year government bond fell below zero percent. I think it's still trading at zero percent, or maybe a bit below. In any case, I think what happened with the recent run-up in the Swiss National Bank shares is that, as longterm investors saw that their 50-year government bond was no yielding zero percent, they thought, "Well, look at these perpetual bonds at the Swiss National Bank. They're quote/unquote shares." Early this summer, they were yielding about 1.25%, so it was a really simple decision, for them to decide, "Why would we hold that negative yielding 50-year bond, when we could expand our term structure a little bit and get 1.25%?" That's why you've had what I think is a huge run-up in these shares.

Beckworth: Fascinating. Even the fact that they have a 50-year bond is fascinating, and then of course the negative yields, which have been the sharpest in Switzerland, is another interesting story we could talk about. There are a lot of interesting things going on, in Switzerland, and in general these central banks that have shares in the stock market. It'll be interesting to follow these and to see what happens.

Beckworth: Let's move to another interesting observation you have made about a central bank, and this is the central bank of England. You had a post back in August, where you noted that, up until recently, as in a month or so ago, they allowed their employees to keep personal checking accounts at the bank. So the bank's balance sheet was open to people, not just financial firms, but to people. You spent some time talking about that. You actually go back and talk about an even richer history than that, that goes back farther, when other people had access to it. Tell us about that.

Koning: What you're talking about, with the employee accounts, has a long history. Back when the Bank of England was first started, it was really just a private bank that had a government monopoly. It allowed anyone to open an account with them. That pretty much continued on through the first several hundred years of its history. Anyone could keep money at the Bank of England.

Koning: That only started to change around I think the 1920s, 1930s. Once again, it has to do with monetary policy becoming more important, the same thing we just talked about, with central banks choosing to no longer be privately owned. Right around that point, it became more of the job of the central bank to control the purchasing power of money, as opposed to being a commercial banker.

Koning: So the Bank of England fully got out of the business of providing retail ... to customers. It didn't get out immediately. It was a slow phase out approach. I think by the 60s, its last retail customer had passed away. Then it kept offering the employees accounts, up until, like I said, recently. It's not the case that central banks have always had this strict divide, where they only serve bankers, as a bankers bank. There is a history of serving a retail clientele, too. Nowadays, that would seem very odd, but it has happened.

Beckworth: Why this is fascinating is because there's been recent discussions, movements, and practice towards opening the central bank's balance sheet. I'm thinking of the Federal Reserve, in particular. You mentioned in your post, the Feds overnight reverse repurchase facility expands access to the Fed's balance sheets, not just banks anymore. Now money market, mutual funds, and other financial firms that shadow banking systems can now have access to the Fed's balance sheets.

Beckworth: That's great for one key reason. There's many reasons, but one key reason would be financial stability. There's not going to be any need to run on your bank account, because the Federal Reserve, it creates the money. It's fiat money. In general, the interesting idea that's been floated, John Cochrane, David ..., and others have talked about, is that you would never have to worry about your bank going broke or defaulting on its liabilities. Why not open up a central bank's balance sheet to the public, so there would literally be a Federal Reserve branch office on the corner in a small town? What are your thoughts on that? Do you think that's a good idea, or does it present potential dangers for doing effective financial intermediation?

Koning: Well, I would say first of all that the reason we have these ideas arising right now has to do with the financial crisis of 2008. People are casting around for a way to prevent bank runs and that sort of thing, and first bank bailouts. I would say if you take the approach that fractional reserve banking is inherently unsound, these approaches definitely have some merit, and they deserve to be investigated.

Koning: Myself, I'm Canadian. The Canadian banking system did very well in 2008. We didn't have a single bank go under. We didn't have any bank runs. We didn't have any bailouts. If you go back to the 1930s, you will also see that the Canadian banking system didn't have a single bank failure during the Great Depression.

Beckworth: Amazing.

Koning: Whereas the US banking systems had them in the thousands. I think there's two ways to approach it. You can either think, "Well, we either try to fix the fractional reserve banking by taking more of a Canadian-style approach." This isn't me just as a Canadian, waiving the flag. There's been a lot of academic talk. They've been talking about this for decades. I think you had Mike ... on recently, who talked about that.

Koning: The other approach, of course, is to come up with what you mentioned at the outset, which is to try and get more of a divorce between the business that's issuing deposits and running the payment system, and the business that's matching longterm .... I would say, for the time being, because the Canadian system did not go under, I still see some sort of hope with franctional reserve banking, but if, come the next crisis, our banking system ..., then I will definitely become a full reserve banker.

Beckworth: Yeah, it is fascinating that the Canadian banking experience, as you mentioned we had Michael on, that during the Great Depression thousands and thousands of US banks closed, but zero banks shut down in Canada. It's amazing. It's mind-boggling, that that could happen. At the same time, though, Canada did have the pain of the Great Depression. It, too, had a sharp collapse in economic activity, but it didn't happen along with it, a severe crisis in banking. It does speak to the more robust nature of the Canadian banking system. Again, as you mentioned, 2008, you guys did much better than us Yankees here, south of the border. That is fascinating.

Beckworth: I mean, there's other examples, too. The Scottish free banking experience had relatively stable banking, and it was a fractional reserve system. There are examples where it can work. I guess the question would be, given the realities on the ground, of special interests and the way the banking system is set up, with all the distortions, how safe is our banking system? What can we do differently?

Beckworth: I've had several guests on here presenting different proposals, and this is one of them. One of the dangers I see, in going down this path, is what happens to financial intermediation? Do we see capital still being allocated in an efficient way? I know that's not the only thing banks do, but if every bank becomes a branch of the Federal Reserve, is there a danger we're going to run into problems like we see in China, with state-owned enterprises being funded by government run banks? They never get rid of bad loans. They continue to rollover bad debt. That would be my concern.

Koning: No, that's definitely an issue, if you have a full reserve banking system. It's never been tried, so we don't know exactly what's going to occur. I would say there's also softer versions of this, where you simply have central banks enter into competition with the private sector, by providing the public with some sort of ... exchange, but not requiring that the public sector exit. You'd have sort of almost like a postal banking system, where there's an option for a government money product, and a lot of people will take that option. By not taking the private option, by not holding private deposits, you'll have a shrinking of the banking sector, but you won't have it disappearing. You'll have it running in competition with each other. Postal banking has had a long history, so we do kind of know what that would look like.

Beckworth: That was interesting. You mentioned that in your article, that these aren't mutually exclusive. It could be the case you have federal reserve branch offices, but you also have Bank of Americas and other banks, thereby competing. How they would differentiate themselves is, the Federal Reserve branch bank, what it would really offer is safety. There's never any doubt that it will default in its liabilities, on its deposits, whereas maybe Bank of America branch would maybe offer better service, better ways of arranging one-stop shopping, get your mortgage, get your deposits, car loans, all that. In theory, you're right. You mentioned the Bank of England. That environment sort of existed for a while, where the Bank of England was providing bank accounts to the public, and you still had other banks coexisting with it.

Koning: Yeah. One other interesting argument that I have heard is that, if you do introduce this government option, you can actually do away with deposit insurance because you're giving the public a very safe option. As a result, you either reduce the amount of bank deposits, and therefore reduce the reliance on deposit insurance, or you would just tell the banks that we're no longer providing deposit insurance as a product. That's one other benefit that I've heard.

Beckworth: That is interesting. Yeah, that would take away a potentially large distortion we now see in banking. Okay, let's move to another interesting fact that you have observed and written about, and that is the central bank of Libya. As we all know, there was a war in Libya. The US got involved. Libya is roughly split in two, the country, and the central banks have sort of ... Well, there was one central bank, but its branches have followed that split. Tell us more about that story.

Splitting of the Central Bank of Libya

Koning: Yeah, it was this summer or this spring, I can't remember. In any case, you have the Central Bank of Libya being split, like you said, between an eastern branch and western branch, one in Tripoli and ..., which is in the east. When there was no war, of course there was no issues. These two branches were basically one central bank. Once two different regimes took power, it suddenly became an issue because they were no longer talking to each other. They each had governors who were appointed by different regimes.

Koning: What happened is, the eastern central bank need to print out more notes because it was running short of notes, and it didn't get permission from the western side. Instead, it was printed by a Russian bank note printer. One problem here is, the notes that were printed were not exactly like the previously issued notes. You could tell right off the bat that it was not the same thing. At the same time, the US supported central bank announced that they would not be accepting these new Russian-printed notes as legitimate currency. They referred to them as counterfeit.

Koning: So you have an interesting situation developing, in which you have one Libya and one central bank, but you have two Libyan dinars. What happened in the end is, the US backed away and actually said, "Okay, we'll accept these new Russian-printed Libyan dinars as real currency." This sort of bifurcation never actually happened, but it could have happened. It would have been very bad for the country. You don't really want to have a sudden split in your currency, because it would cause all sorts of really difficult problems. What if one dinar is worth significantly less than the other? How do you set your prices? Do you set your prices in the existing dinar, or you going to set your prices in the new dinar? How will monetary policy run? You've got two dinars to set monetary policies on. You have all these really interesting problems. Although, also at the same time, problems that would have hurt regular Libyans. We're lucky that the US ended up backing down from that one. It would have been destabilizing.

Beckworth: Was there a period between when the notes were issued and when the US backed branch of the central bank accepted the new notes? Was there a period there, where these notes were floating-

Koning: No, there was a lot of brinkmanship, but in the end, pretty much a day or a couple days before these things were finally brought into Libya from Russia, they were given-

Beckworth: That was my question, was there ever a period where the two notes floated against each other inside of Libya and was there an exchange rate? But they never got to that. Okay.

Koning: No, but that was quite the situation. One reason I wrote that post is because I wanted to be following the situation, to be able to comment on it. That never happened, but that sort of situation has happened, where you get two different monetary instruments that are supposed to be the same thing, then the situation is they suddenly float against each other.

Koning: For instance, during the Greek crisis, you had a lot of frozen euro bank deposits, and also in Cypress you had frozen euro bank deposits. Those would have been trading at a slight deficit, a slight discount to a regular euro bank account, or a regular euro bank note. You do get situations developing. In this case, it never actually happened.

Beckworth: Yeah. I would say in general, we see people ... This is the case of the central bank making that move, but we often see people on their own, resorting and using other currencies as well, when they lose faith in a currency or they need something else. Like during the Great Depression, companies would issues notes, or the scrip would emerge as a form of currency.

Beckworth: This Libya case, it may not be entirely the same, but it reminded me a lot of the US during the Civil War and then up to 1879. The US was on the gold standard. It goes off of the gold standard in the early 1860s, when the Civil War begins, and that's when the famous greenbacks come out, the fiat money. The US government issues fiat money. The dollar is the greenback on the East Coast, that's where most of the population is, but if you go West, the dollar was still backed by gold. So you had the greenback on the East Coast, the yellowback on the West Coast.

Beckworth: We had Hugh Rockoff on, and he's written some articles about this, a really fascinating case. There were two dollars floating in the US. Most of the greenbacks of course stayed on the East and most of the yellowbacks were in the West, but there was an exchange rate. They floated against each other. I mean, it worked. It survived. It wasn't impossible. In 1879, when the US goes back to the gold standard, then it becomes one again, one currency.

Beckworth: Hugh Rockoff, when we were talking about this, he suggested this has implications for the eurozone. You could for example, in the eurozone, have a situation where maybe you do have multiple currencies. Maybe you have a currency that's really strong for the more austere, the core countries, and maybe you have a less valued currency, maybe it depreciates more for the periphery. It was just a thought, but nonetheless an interesting experiment, an unintended experiment, in the US, during the Civil War period and thereafter.

Beckworth: But Libya kind of came close to that, never did. Still a fascinating experience that I wouldn't have known about, had I not been reading your blog. There's something I guess I should ask you. I meant to do that early on. How do you find these stories? How do you go about doing your investigative work, uncovering these neat, kind of unusual monetary stories?

Koning: Well, I do a lot of reading. I'm always reading other people's blogs. I read a lot of academic papers. I'm always reading the news. Africa has a lot of interesting monetary stories. It's an under-covered country, in terms of monetary history or monetary policy. I actually used to live there, when I was a kid, so I have that connection. That's why I like to follow it. I've written about the Libyan situation. I've written a lot to do with Zimbabwe. I've written about Somalia. There's so many interesting international issues that pop up. I guess that's where I get my interest from.

Monetary History of Zimbabwe

Beckworth: Well, let's move to Africa again. Let's go to Zimbabwe. Like you, JP, I actually spent some time in Africa, too, as a kid.

Koning: Oh really?

Beckworth: Yeah, I spent six years living in South Africa and spent some time in Zimbabwe, actually. I was there when it was Rhodesia and when it was Zimbabwe. So I have a little bit of a vested interest, like you, in following what's happening in Zimbabwe.

Koning: Gotcha.

Beckworth: As probably all our listeners know, Zimbabwe had hyperinflation that reached a peak in 2008. It was 2008, right, when it hit?

Koning: Yeah, that's right.

Beckworth: Tell us what happens to the monetary system after that. It's a neat story, how they actually become a stable monetary system, after that. Tell us what's involved, once the hyperinflation reaches its end?

Koning: Yeah, sure. Well, first of all, one thing you'll often hear about the end of the Zimbabwe inflation is that Robert Mugabe, the leader of Zimbabwe, chose to put Zimbabwe on a US dollar standard, which is really not safe. The Zimbabwe dollar was dropped in favor of the US dollar by the population, spontaneously. It was not a ... dollarization. It just happened. It was only after Mugabe realized that there was nothing he could do about it, that he ratified it. He said, "Okay, well, I guess we got no choice. We're going to dollarize."

Koning: In any case, from then on, Zimbabwe has been on a US dollar standard, with an interesting twist. It's very similar to the old bimetallic standard days, when you had gold providing the large currency and silver providing the small-value currency. Instead of having gold and silver, they have the US dollar as the large denominations and the South African rand as the small denominations. Specifically coins. It was rands that had been recruited for coins.

Koning: That actually changed in I think it was late 2014. Zimbabwe decided to issue something called bond coins. These were small coins, in one cent, five cent, 10 cent, 25 cent denominations, that were meant to alleviate small coin shortages in the country. One problem with having a US dollar rand system is that there's an exchange rate. It wasn't a fixed system. The government didn't say that they are going to circulate at this fixed price. It was a floating exchange rate. If you're trying to make payments, let's say you want to get a taxi and you pay in US dollars, how many rand are you going to get back? There was a really annoying calculation you have to make.

Koning: With the introduction of these bond coins, you suddenly had a uniform currency, where you could have US dollar bank notes plus these bond coins, circulating in conjunction with existing South African currency. The idea was that South African coins would be displaced by these new bond coins, which is exactly what happened. After a while, the rands had a big, big fall. I think what happened is, it just became really difficult for people to keep making exchange rate conversions, so they just basically all moved to using bond coins for small value transactions, all of a sudden. The rand, as far as I know, doesn't circulate anymore.

Beckworth: That's a fascinating case of this kind of spontaneous or natural emergence of the dollar, as a currency. It was stable. People couldn't trust the Zimbabwe dollar. Probably many people have seen the Zimbabwe currency back then. In fact, I think you've written about the Zimbabwe currency from that period, too.

Koning: Yeah, yeah. They were actually all redeemed at a certain price, like fractions on the cent.

Beckworth: Yeah, so the government actually pulled them out, but there's a lot of them still out there. A student once brought me the largest note. These notes are in English. They speak English there. It's one of the official languages. They have a 100 trillion dollar note. Am I understanding, based on what you said, and I haven't looked on Ebay or anything recently, but those notes are actually worth something now. They're going up in value as a collectors item, is that right?

Koning: Yes, they're worth way more as a collectors item than the official price at which they'll be bought back by the government. So don't tender them.

Beckworth: Yeah. After you wrote that post, i went and bought some more. In fact, I have a complete set of notes from about 2006. What you begin to see is, they have notes that are similar in size to ours in the US, and then in 2007, 2008, you see this series of new notes that get larger and larger and larger, until they hit the 100 trillion dollar notes. My goal is to actually frame those at some point and put them on my wall. It's a really fascinating collection of notes. But I think even probably more fascinating is how folks just kind of, on their own, turned to a new currency. Well, they were using the dollar, but they kind of spontaneously turned to the dollar.

Beckworth: This is kind of on a tangent. I was going to come to this later with you, talking about currency in the US, getting rid of currency. Maybe we'll come back to that. One of the drawbacks of Ken Rogoff's proposal ... Ken Rogoff wants to eliminate physical currency in the US, but one of the drawbacks, and maybe this is not our concern and we shouldn't worry about the Federal Reserve, are countries like Zimbabwe, that use our currency, countries like Panama, Ecuador, El Salvador that rely on it. In large parts of Latin America, they still are unofficially dollarized. The US dollar provides for them a stable medium of exchange. I know there's great arguments for getting rid of cash and going below zero percent, but I do see that as one of the drawbacks, is places like Zimbabwe would have to look for something else.

Koning: Yeah, undoubtedly. I would say that Rogoff doesn't actually want to get rid of cash. He just wants to get rid of large denomination notes. That being said, one of the costs of dollarizing is the cost of getting all the dollars over, the shipping costs, et cetera. If you get rid of the 100s, that increases the cost of shipping notes from the US or Europe to Zimbabwe, right?

Beckworth: Yep.

Koning: If you can only bring in fives or tens, it doubles, triples your cost. If you're a country that's suffering through a hyperinflation, the more expensive the cost to dollarize, the longer your hyperinflation is going to be drawn out, before dollarization becomes justified. So yeah, if you get rid of the high denomination notes, definitely countries like Zimbabwe suffer. Countries that haven't dollarized but might dollarize in the future will suffer. All of those people in charge of monetary systems for would-be hyperinflation, without $100 bills, they're probably less disciplined because that makes dollarization less of a possibility.

Beckworth: Just the threat of dollarization imposes some discipline upon monetary authorities in these other countries. That's a good point. With that said, there are drawbacks of dollarizing. You get the monetary policy of the Federal Reserve, so any country that has linked its currency through a fixed exchange rate to the dollar or ones that outright dollarize, they are going to get the monetary policy created by the Federal Reserve. I've written about this. Go ahead.

Koning: Sorry to interrupt. That's one of the odd things about Zimbabwe, is that they had the highest inflation rate in the world in 2008, and then about three or four years later, they actually had the greatest rate of deflation. They were falling at about 1 or 1.5% per year. It's crazy.

Beckworth: They like extremes, huh?

Koning: Yeah.

Beckworth: It's a roller coaster ride, there. You explain also how, in the case of Zimbabwe, a dollar shortage can be solved through the marketplace, without having the government consciously trying to go to buy up dollars. Tell us how the market itself would pull in more dollars.

Koning: If there's a shortage of US dollars in Zimbabwe, what should happen is that Zimbabweans will bid their local prices down because they don't want stocks, they want dollars. A lot of the prices of local goods, they're international. There's an international market. For instance, bowls or various agricultural products like maize or corn. What should happen at that point is, large international firms, whose job it is to basically supply these agricultural products, will suddenly see that prices have fallen a little bit below the international price in Zimbabwe. They'll go to Zimbabwe, buy up all these commodities, bring US dollars into system. They'll close that gap and bring the Zimbabwe price, the local price, back in line with the international price. So you should never have a US dollar shortage for very long, never more than I would guess a few days or a week, in a dollarized country.

Beckworth: Yeah, so there's kind of a self-adjusting mechanism. Moving on, in the history of Zimbabwe here, this relatively stable monetary system has been shocked, if can say that, by recent developments. You'd written about this in June. You mentioned that Zimbabwe is printing bank notes again. Then you had a post a little bit later, in July, called Hyperinflation 2.0. What's going on now that leaves you concerned?

Koning: The bond coin, which I talked about earlier, that they introduced in 2014, was a good idea because it rectified a shortage of small coins. That's something that Panama and Ecuador have done, too. They've issued small coins.

Koning: With the bond note, that's something totally different. They're talking about introducing bank notes in denominations the same as the US, like one, five, 10, 20, and I think 50. I don't know if they're doing 100. They're basically blaming this on a shortage of US bank notes, which as I've just explained, shortage of bank notes should be rectified very quickly.

Koning: Over the last about six or seven months, we've had lineups at Zimbabwean banks every morning, as Zimbabweans try to get cash for the day. They've imposed withdrawal limits of maybe $50, $100. It's really, really difficult to get US money anymore, there. The government, like I said, is blaming it on shortages, which doesn't make sense. There can't be a shortage in paper money. As I said, the international and domestic price will diverge, and that will bring US dollars in.

Koning: There's another theory for why the bond notes are being introduced and why there are these long lineups. There are basically bank runs, with these lineups. What happens is, after the hyperinflation dollarization in Zimbabwe, the entire banking system migrated to Europe. What I mean by that is, all the domestic banks had clearing accounts with the European banks, US dollar clearing accounts. They basically, instead of having a central bank, which is normally where banks clear payments, they did it on the books of the European banking system. Because there was no more central bank, or at least they had ceased to function. If you were sending someone a check and they cashed it, and you each had two different banks, your bank would provide the other bank with US dollars on a European bank, your European banks would exchange US dollars.

Koning: The Zimbabwe central bank started to re-insinuate itself into the monetary system by once again opening itself up as a clearing bank and allowing Zimbabwean banks to keep accounts at the central bank.

Beckworth: Hey, JP, let me ask you a quick question, if I may interrupt. You're mentioning how banks would do their clearing through banks in Europe and overseas. I guess one question I have is, the technology to do that, that's only possible in this day and age because of the internet, because of instant real-time communications. I imagine 30, 40 years ago, something like that couldn't have been done, or would have been much more time-consuming and costly? Is that right?

Koning: No, it would have been possible.

Beckworth: Okay.

Koning: For instance, you would have used telegraph, or you would have used whatever. The clearing and settlement process probably would have been a lot slower, but yeah, there have been situations where entire banking systems have done their clearing in a different country.

Beckworth: That's interesting.

Koning: Like Canada in the 1800s used to do a lot of our clearance and settling in New York. That's where a lot of the reserves were. In the 1700, 1800s also, London was sort of the banking and clearing center of the entire world.

Beckworth: Interesting observation. Continue on, about how the Bank of Zimbabwe got back into it.

Koning: Yeah, so the Bank of Zimbabwe got back into the clearing and settling for Zimbabwean banks. It even started to require Zimbabwean banks to open accounts with them. What that involved is, Zimbabwean banks having their European bank wire US dollars to the Reserve Bank of Zimbabwe, the central bank's European account. All of a sudden, the Reserve Bank of Zimbabwe, the central bank, went from being nothing, a non-player, to having a large amount of US dollars in its account. Now when you had a check and you sent it to someone else, that would be cleared on the books of either your European bank, or you would have the Zimbabwe central bank do that for you.

Koning: That system works fine, as long as the central bank is honest and doesn't abscond with the funds. That seems to be the problem. A lot of people, a lot of credible people, are saying that the Reserve Bank of Zimbabwe has basically emptied all of its accounts. It has spent all its US dollars that it had in Europe, on things that it should haven't spent it on.

Koning: What happens is, let's say someone in Zimbabwe wants US dollars. They go to a bank and they're like, "Okay, we want US dollars. Can you give us US cash?" The bank, in turn, goes to the Reserve Bank of Zimbabwe and says, "Okay, we want to use US cash. Can you get it for us?" The Reserve Bank of Zimbabwe no longer has cash in the European bank. It's used all that cash up. The Reserve Bank of Zimbabwe says, "You're going to have to hold on. You're going to have to wait." The bank, in turn, goes back to the customer and says, "No, we don't have cash for you. You can only withdraw maybe $100." That's why you have these lineups at Zimbabwean banks. That's why you, in essence, have a bank run in Zimbabwe right now, because there are no US dollars in the government's account. They've all been used up.

Koning: In a sense, you have a really weird system, where the US dollars in your bank account are no longer actually US dollars. They're a claim on the Reserve Bank of Zimbabwe, the central bank, a US dollar claim on that central bank. In a way, you've got a divorce between US dollars, US paper cash, and your US dollar checking account, or savings. They're no longer US dollars. You actually have people in Zimbabwe are trading their US dollar bank account, at a deficit, to regular US dollars. I think the US dollar, there's a premium on dollars right now of 10 to 15%. If you want to buy US dollars, you've got to go into a back alley and say, "Okay, I'll wire you this money using my cell phone app or whatever, my banking app." The second person receives it. Then they pass them the cash. You don't have a universal US dollar anymore. You have two different dollars.

Beckworth: Once again, we can attribute it to monetary mischief by the central bank of Zimbabwe.

Koning: Yes.

Beckworth: Actually, that's not even entirely correct. To the monetary mischief of the government. The central bank is just really doing whatever Mugabe wants them to do.

Koning: Yeah.

Beckworth: That reminds me, maybe a nice little segue, I haven't seen you touch on Venezuela, but I thought we'd just talk about it briefly, here. It's the latest hyperinflation case. The IMF is predicting around 500% inflation this year for Venezuela. They're forecasting 1,600% inflation next year. A lot of interesting stories coming out of there. I was just doing some background digging on the Central Bank of Venezuela, getting ready for this interview. A gunman stormed into the central bank, recently.

Koning: Wow.

Beckworth: He got shot, but he's expressing his frustration probably, about what's going on, the high inflation. The Central Bank of Venezuela actually sued a website called because it was listing the actual exchange rate between the bolivar, the currency there, and the dollar, which was really, really high. The bolivar has lost a lot of value. It's depreciated. They didn't like that, and they were blaming this website for causing the high inflation. There's a lot of dysfunction going on there. Of course, again, I think that reflects more the government failures, not the central bank itself. It's just falling to pressures.

Beckworth: Interestingly, the Wall Street Journal had an article out this past Saturday, the October 15-16 edition, and they were mentioning how Venezuela has freed up the prices. They had price controls, which you often see this. You have hyperinflation, and the government comes along and imposes price controls to try to fix it. All that does is, it causes shelves in grocery stores to be barren, food not to appear, because as prices are going up and up, the costs of bringing the food to market goes up and up. If you put some kind of price ceiling on it, you're going to prevent that from happening. The Wall Street Journal was reporting that this price freeze was removed, and all of a sudden, food suddenly appeared, even though it's more expensive.

Beckworth: Interesting to see these struggles continue, in other parts of the world. Here in the advanced world, the US and Europe, we're worried about too little inflation. Overseas, they're constantly facing too much inflation. We've got to get that happy sweet spot in the middle. We all have our suggested approaches to do that.

Beckworth: All right, let's move from the interesting tour around the world of central banking, and I want to go to the payment systems, because you've written on that a lot. We don't have a lot of time left, but one thing you've written on that I haven't seen anywhere else is the Fedwire. Tell us what the Fedwire is, and what has it been signaling lately?

Central Bank Payment Systems and Fedwire

Koning: The Fedwire is just a payment system run by the Federal Reserve for large value transactions between banks. For instance, if you were to wire $1,000 to your cousin in California or whatever, you would go to your bank, and you would ask them to proceed with that payment. The bank would, in turn, enter some information into the Fedwire system. The bank account would be debited instantaneously for $1,000, and the receiving bank in California would be credited. Your cousin in California would have instant funds.

Koning: It's used for other things, too, like securities, settlements. A lot of corporate mergers would probably be carried out over Fedwire. For instance, housing purchases would be carried over Fedwire. Anything that's quite large.

Koning: I think it's middle of 2015 had what I called a Fedwire recession, on my blog, because the amount of value transactors over Fedwire has shrunk quite a bit. It was interesting. I noticed that it kind of corresponded with some of the things you had been talking about in your blog, with sort of that stealth tightening of monetary policy by the Fed. They had been tightening but actually raising interest rates, more the way they had been talking them up, in a way. You have sort of a tightening in Fedwire.

Koning: That being said, you do have a lot of transactions being run through Fedwire that might not be very useful to capturing the extent of monetary policy. I like to touch on it. It's an interesting data point, but I don't want to read too much into it.

Beckworth: Because the Fedwire is going to capture a bunch of intermediate inputs, so it could be double counted and triple counted, all those issues. Also, it includes all these financial transactions. What's intriguing to me, if you go to the equation of exchange, as a good monetarist will, it says MV, or money times velocity, equals price times ... The original version was T, transaction. We now say MV=PY, but originally it was MV=PT, and T was total transactions. I think Irving Fisher is the one who put that together.

Beckworth: The Fedwire, in spirit, I think it's closer to that. Although, again, there's this issue of double-counting. As you mentioned, I'm looking at the figure from your post, which you called The Fedwire Recession. This was June 28, 2016 on your blog. You do see this kind of sustained decline from sometime around 2015 or '14. I was just looking at that nominal GDP. If you look at nominal GDP, or gross domestic income, nominal gross domestic income, and you look at it percent change ... Now, the level is a little harder to see, but if you look at the growth rate of that, on a year over year basis, it has been declining since that point, as well.

Beckworth: Ambrose Evans-Pritchard has an article today in his paper, where he's made the note that nominal demand growth has been declining. It kind of matches the Fedwire. This is maybe just another interesting data point, but one that can help inform whether economic activity is slowing or picking up.

Beckworth: Let's move on. You've talked a lot about bitcoin and blockchain technology. Touch on those quickly, and then what I really want you to do is to focus in on the Fedcoin, instead of bitcoin. Tell us what it is and the hope and prospects for it.

Cryptocurrency, Blockchain, and Fedcoin

Koning: Fedcoin was more of an exercise in trying to figure out how to make a stable bitcoin. A lot of us were really excited by bitcoin. We found it really interesting when it first came out, and we've been following it. A huge problem with bitcoin is, it's incredibly volatile. Fedcoin is like, "How would we make stable-valued cryptocurrency?"

Koning: There are a couple ways to do it, but probably the best way to do it is to have a central bank behind it. That would involve altering one of the basic rules of bitcoin, which is that it has a deterministic money supply, that the money supply has been set ahead of time, in stone, by the bitcoin protocol. It will hit 21 million I think in 2140, 2141, or something, and there's nothing that can change it. That explains, to a large part, why it's so volatile.

Koning: The idea behind Fedcoin is to remove the deterministic money supply and put the money supply in control of the central bank. That way, you'd have a stable cryptocurrency. Basically, and David Andolfatto has described it quite well, you would think of Fedcoin as another denomination of bank notes. The Fed would be able to create as many Fedcoins as it needed, or destroy as many Fedcoins as it needed, in order to keep that denomination anchored to the other existing denominations at a set rate, for instance, one Fedcoin to one US bank note.

Beckworth: Are the prospects for it looking good, or not?

Koning: Well, I would say you definitely have, over the last year or two, you've had a lot of central banks talking about implementing some form of central bank digital currency. That's term can be applied widely. It could be a Fedcoin. It could just be like what we were talking about earlier, with just an open bank, like the Bank of England. It could be something as innocuous as that.

Koning: I first wrote about it in 2013 or '14, and David Andolfatto brought it up in 2015. Since then, definitely a lot of people are talking about it. Whether it's actually going to happen, that's so far in the future. We'll have to see. A lot of central banks, especially the Bank of England, have initiated sort of research project around investigating this idea. It's probably something that we're not going to really know more about for many years. We'll see. It's interesting.

Koning: It does run into a lot of the problems you and me talked about earlier, like what if it dis-intermediates existing banks? What if it's so good that it creates, by accident, the fall of the reserve banking system, where there just are no banks anymore? There's a lot of interesting questions. At the same time, it implements something else that we talked about earlier, which is sort of like the equivalent of the postal banking system. It gives consumers a safe option in which to keep money. Yeah, there's definitely some potential there, but we'll have to see what happens.

Beckworth: Very interesting, and a hot topic for sure. Our guest today has been JP Koning. JP, thank you so much for being on the show.

Koning: Thanks for having me, David.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.