Ben Bernanke, Chairman of the Federal Reserve, in his keynote address this week at the Cato Institute 25th Annual Monetary Conference further elaborated his intention to increase the transparency and collegiality of the analytical processes that inform Fed monetary policy. One element of the new transparency will be to publish the forecasts of individual FOMC members in a fashion that enables the public to better observe the range, diversity and provisional nature of forecast projections.
The Fed move, in my view, indirectly acknowledges that collective wisdom can be harnessed in a way that generates predictions of greater accuracy and validity than any individual, regardless of expertise. As noted, however, by William Niskanen, Chairman of the Cato Institute, all of this systematic transparency goes out the window - suspended when a macroeconomic shock threatens an untimely recession. Abrupt ad hoc seat-of-the-pants mode comes into play whenever an asset bubble (likely induced by previous Fed reactions) starts to collapse.
Recent literature examines how, in certain properly conceived settings, collective wisdom, instead of manifesting a dysfunctional madness-of-crowds trajectory, may be the optimum predictive or analytical paradigm. James Surowiecki relates that an average calculated from a large number of guesses - such as the number of pennies in a large jar - tends to be more accurate than any individual estimate. Oddsmaking, pricing of futures contracts, perhaps even maintenance of factual content neutrality on Wikipedia further illustrate the phenomenon.
This note contrasts two qualitatively different institutional arrangements for systematic metering of a money supply; a conventional government central bank, using the Fed as example, vs. e-gold.
The Fed reality is discretionary and given to politically pressured interventions to overrule itself. The e-gold model is automatic and immune to override.
It is necessary to contrast:
- the processes by which information is channeled and assimilated into protocols that lead to monetary policy implementations, and,
- the levers by which adjustments are effected.
Both systems have two sets of levers:
- Procedures by which M0, the aggregate quantity of base money, may increase or decrease.
- Mechanisms that influence broad money supply (M1-2) by affecting the terms by which base money is made available to the banking system.
With the Fed:
- M0 is modulated by open market operations with primary dealers.
- M1-2 is influenced mostly by setting and maintenance of the Fed Funds rate and to a lesser degree by the discount rate. There is a bidding process whereby banks compete with each other for the deposits of the public but the choice is limited to which bank or financial intermediary to lend to rather than whether to lend money to the financial system at all.
In the case of the Fed and every other government central bank, both sets of procedures entail discretion. The Fed itself initiates the buy or sell orders that implement open market ops. The Fed funds target rate is obviously determined/ announced and, to some extent, made effective, by the Fed.
In contrast, once banks have embraced e-gold and an e-gold broad money supply, i.e., AUG denominated deposits, payable in e-gold, has emerged...
- M0 is modulated by open market operations with primary dealers.
- M1-2 is influenced entirely by the aggregated individual decisions of Users of AUG.
M0 (and other monetary aggregates), open market operations, and primary dealers in the AUG economy all have similar meanings, but also have key differences...
Unlike the Fed, e-gold Ltd, the core e-gold institution performing e-gold (M0 in the AUG economy) issuance and settlement, is unable to make open market operation decisions. e-gold Ltd is neither itself a financial institution, nor is it exposed to financial institutions to the extent that it has no bank accounts, and thus no way to receive, emit or order the emission of a conventional money payment.
As a result it is not able to buy gold and bail it into e-gold reserves for the purpose of issuing additional e-gold liabilities, nor (for the same reason) is it able to redeem e-gold –allowing a quantity of liabilities to be extinguished and freeing up physical reserves to be removed/delivered/sold. Additionally, lacking bank accounts, e-gold Ltd itself also has no ability to own or hold gold, as it has no ability to buy or sell physical gold.
Bailment and redemption decisions are driven by the trading balance requirements of Primary Dealers. Bailments increase the assets held by the e-gold Bullion Reserve Special Purpose Trust (which exists to back e-gold in circulation for the benefit of all e-gold Users collectively), and correspondingly cause new e-gold to be minted. Redemptions decrease the assets held by the e-gold Bullion Reserve Special Purpose Trust, and correspondingly cause existing e-gold to be extinguished (removed from circulation).
The trading balance requirements of Primary Dealers in the AUG economy are dictated by the aggregate individual decisions of all e-gold Users rather than by a central authority; therefore, the circulating amount of AUG M0 (e-gold) derives from collective wisdom rather than centrally controlled, politically influenced, monetary policy.
The unprecedented attribute of e-gold is that the real-time gross settlement system for base money (the portion of AUG consisting of direct liabilities of e-gold Ltd) is available to the general public, allowing each individual the ability to decrease or eliminate their exposure to the banking system or any other financial intermediary. Each and every e-gold user (in addition to deciding the quantity of AUG M0), directly determines, minute by minute, 24/7, how much base money (e-gold) is made available to the banking system for use as reserves (AUG denominated liabilities - i.e. AUG M1-2), and the interest rates at which she is willing to lend to the banks or other financial intermediaries across the full spectrum of maturities.
But what about crises?
Since e-gold has no ability to override the automated mechanisms that govern base money and broad money supply – what could be done in the event of a shock? The responsive assertion is that:
- The exquisite sensitivity of a huge cohort of individual e-gold users voting with their feet, with zero-latency of their feedback, and,
- The elimination of moral hazard,
is likely to attenuate the amplitude of swings in aggregate demand and forestall shocks of a bubble forming/bursting nature.
Vera Smith, in her landmark 1936 essay "The Rationale of Central Banking" concluded; "How to discover a banking system which will not be the cause of catastrophic disturbances, which is least likely itself to introduce oscillations and most likely to make the correct adjustment... is the most acute unsettled economic problem of our day".
This monetary holy grail - an automatically self-correcting mechanism for metering money supply and credit is why we created e-gold.
[set it and forget it!]
In another note, however, I will need to address transitional effects. To preview - in the long run e-gold is the ultimate leveler of playing fields. Getting there however will tend to temporarily create winners, losers... and whipsaw effects on exchange rates. The prudent course for early adopting banks will be to reserve their AUG deposits heavily at first, biding their time until exchange rates stabilize before becoming fully loaned up.