Thursday, November 14, 2019

"Controllable anonymity"


Reuters and Coindesk report that that the People's Bank of China's imminent central bank digital currency (CBDC) is going to have a feature called controllable anonymity. Perhaps some wires have been crossed in the translation, but it'd be hard to come up with a more Orwellian piece of double speak than this. Plenty of people on Twitter are sneering.

But in this post I'm going to take China's side, if only tepidly.

None of the news articles have made much of an effort to explain controllable anonymity. But we've actually known about this feature for quite some time. Back in 2018, the project's head, Yao Qian, provided a short description of it. It's not as Orwellian as it seems.

China's new CBDC, otherwise known as the Digital Currency Electronic Payment (DCEP) platform, requires users to provide their real identities when they sign up. In the link above Yao calls this real-name at back-end. So the People's Bank of China will be privy to the identity of each user. This is to guard against money laundering and tax evasion. So not much anonymity here.

The element of anonymity crops up in a different part of the transactions cycle. It seems that a payee will be able to control what sort of information they throw off to the counterparties that they are dealing with. Yao calls this voluntary anonymity, presumably meaning that payors/payees can volunteer how much of their personal information they wish to leak out to stores, suppliers, customers, or whatnot. This sort of fine-grained control over one's data isn't something that you can do with, say, a credit card. If I buy groceries at Loblaw, who knows what sort of personal information they are collecting about me.

Source: Technical Aspects of CBDC in a Two-Tiered System, by Yao Qian [link]

So the upshot is that China's CBDC will be providing a certain sort of privacy to users. Which reminds me about what Rodney Garratt and Morten Bech, two economists that specialize in payments systems, have written about payments anonymity. According to Garratt and Bech, there are two grades of payments anonymity. With third-party anonymity, a person's true identity is hidden from everyone who participates in a transaction, including the system operator. Banknotes are the best example of third-party anonymity, since the issuer—the central bank—has no idea who is using them.

Counterparty anonymity is less strong. This sort of anonymity prevails when personal information about the two counterparties to an exchange remain hidden from each other but the system operator is still privy to each user's identity. Yao's controlled anonymity presumably means that DCEP will provide Garratt and Bech's second sort of anonymity, counterparty anonymity.

Federal Reserve researchers like Charles Kahn, William Robers, and Jamie McAndrews have delved into the benefits of counterparty anonymity. The ability to cloak your information from sellers or payees reduces the risk of identity theft, the possibility that a counterparty might stalk you and rob you, or the odds of becoming a victim of direct advertising and other solicitations.

Here is Kahn:
"Suppose, for example, that I wish to make a perfectly legal transaction with a stranger but wish to ensure that there are no unpleasant ramifications down the road. It is not hard to think of examples where the information about the purchase of a good makes the individual vulnerable: a purchase indicating that the individual has high wealth, or a purchase that may be embarrassing, even if perfectly legal (certain medications, for example). More prosaically, making a purchase on the internet involves the revelation of identity in ways that make you subject to spam or harassment. In short, sometimes we want the ability to ensure that others cannot use the information in the history of our transactions against us."
Where does all this leave Chinese consumers with respect to payments privacy? It could be that they are worse off. If the People's Bank of China's new CBDC is being designed to replace cash, then on net Chinese citizens will lose the ability to transact in a way that is anonymous to all parties. Cash provides third-party anonymity, DCEP doesn't.

But it's also possible that Chinese consumers will be better off. If the new CBDC is designed as a complement to cash, then Chinese citizens may actually have more privacy options than before. Not only do they still have access to cash's third-party anonymity, but they also will gain strong digital counterparty anonymity. Surprisingly, this would mean that they will end up with more information-cloaking tools than us Westerners.

Once again I'm reminded of something Charles Kahn wrote. Privacy needs are different, so we should "expect a variety of platforms to emerge for specific purposes." In this context e-cash probably won't "play all the privacy roles that physical cash currently plays," says Kahn. It is possible that this multi-faceted approach to privacy is what is playing out in China.

Wednesday, November 6, 2019

From unknown wallet to unknown wallet


Antony Lewis recently published a useful article on stablecoins. In it he describes something called "permissioned pseudonymity". In traditional payments systems, people only get to access to payments services after opening an account. This requires that they provide suitable identification. So these systems are not pseudonymous. Usage and personal identity are linked.

Stablecoins operators, on the other hand, sever this link. Users can transfer stablecoins to other users without providing personal information. John Doe can pay Jane Doe, no questions asked. Antony calls this permissioned pseudonymity because regulators permit pseudonymous usage of stablecoin networks.

The above payment is an example of permissioned pseudonymity. It is a $30 million transfer between two unknown wallets along the USD Coin stablecoin network. The operator of this network, Centre, may have no idea who did this transfer.

I do wonder how long regulators will allow pseudonymous usage of stablecoins to continue. Most of the rules surrounding payments emanate from the Financial Action Task Force (FATF), a global committee of regulators that meets together every once in a while to determine how to fight ghoulies like money laundering and terrorist financing. The FATF guidelines are in turn applied by local regulators in each country with some modifications, and monitored by FATF for compliance.

FATF regulations are supposed to be technology-neutral. In short, the same principles apply to new technologies and incumbent technologies alike. This makes sense. We probably don't want regulators to picking winners and losers by setting one set of requirements for companies A-E and another set for F-J. The competition for market dominance only begins after they've complied with the same rulebook.

So far FATF hasn't had much to say on stablecoins. But you can be sure that something is in the works, and it isn't likely to be good for stablecoin operators. The problem is that granting permissioned-pseudonymity to stablecoin operators contradict technology-neutrality. It sets one set of standards for bank accounts and another for stablecoins.

Banks are already obliged to collect the personal information of all their account holders. If two people transfer $30 million along the bank payments network, you can be sure that the banks who manage these accounts have already gone through the costly process of collecting personal information. 

Why should stablecoins like USDC and PAX be exempt from this obligation?

Antony suggests that stablecoins qualify for an exemption because they meet regulatory concerns through other sensible means. Because stablecoins use blockchains, and blockchains record transactions, the information trails left by pseudonymous stablecoin users can be traced and monitored for suspicious activity. The stablecoin issuer can then toggle a kill switch and freeze potentially dangerous addresses.

This makes sense. But if stablecoin issuers can avoid identifying its customers by implementing a process of monitoring and freezing, it seems to me that the incumbent technology, the bank account, should also be granted the same opportunity. After all, account-based systems can do kill switches and tracing just as well as stablecoins can.

For instance, say that Citibank were to set up its own pseudonymous account payments network, call it Citibank HushAccounts. Customers can open a HushAccount without providing personal information. They can then use the HushAccount network to trade balances pseudonomously to other account holders. Citibank bankers monitor HushAccount transactional patterns and freeze anything that looks odd. Personal information only needs to be provided when a user wants to cash out of the HushAccounts system.

Of course, we already know that Citibank can't implement HushAccounts. It's illegal. Which underlines my point about technology-neutrality. Why can a stablecoin like USD Coin get away with pseudonymity but Citibank can't?

Let me put it differently. If stablecoin issuers can get away with not collecting user ID, then expect to see Citibank make a few cosmetic changes to its traditional account-based system so that it qualifies as some sort of stablecoin blockchain thingy. And now that it needn't collect as much information about its customers, it can fire a bunch of its compliance staff. Other banks would copy it. Soon we'd get hyper-stablecoinization. Every bank account would be converted into a stablecoin. But FATF rules aren't supposed to favour any one technology.

So for the sake of maintaining neutrality, I wouldn't be surprise to see regulators put an end to pseudonymous stablecoin usage. Stablecoin issuers will only be able to give out addresses to people who have passed through some sort of know-your-customer process.

There's a second possibility. As Antony points out, there is one notable regulatory exception to universal identification in payments. In many parts of the world, people can buy prepaid debit cards (or in Europe, e-money) without providing any ID. This provides the card owner with pseudonymous access to the Visa or MasterCard networks. I've written about these cards before (in fact, it's one of the most popular posts I've ever written). You can also trek over to my article at Sound Money Project on the topic.

Stablecoins, like prepaid debit cards, might be granted their own exemption.

There is a caveat to pseudonymous prepaid access. Regulators have set a very low ceiling for the amount of pseudonymous value that prepaid cards or e-money wallets can hold. In the case of the U.S. it's just $1,000. (In Europe, it's just 150 euros). Anything above that and a prepaid card holder must submit identification. There are other limits too. In the U.S. the cards must be non-reloadable, and people can't use them for person-to-person payments, at ATMs, or for international purchases. This makes for an extremely constricted payments product.

Regulators believe that by keeping the pseudonymous prepaid ceiling low and reducing the features that a card offers, they achieve two things. The risk of money laundering and terrorist financing are minimized. At the same time the unbanked and those without ID still get access to the retail payments system.

If FATF were to allow stablecoins to offer a limited amount of pseudonymity, the ceiling for it would probably be quite low, much like prepaid debit cards. No more $30 million person-to-person payments, just $20-$2000 ones. After all, it's hard to make an argument for why genuinely needy folks without IDs would need to make million dollar stablecoin transactions. 

I should point out here that I'm not saying that I'm a fan of FATF and its mission to unveil every single transaction. I've written many times about the benefits of financial anonymity. And a lot of smart people that I read think that the cost of enforcing anti-money laundering rules far outweighs any benefits that it provides. All I am saying is that I suspect that permissioned pseudonymity for stablecoins isn't going to last very long, in its current form. It'll either be banned altogether, or a very low ceiling will be set on it.



P.S. If I had to predict, I'd go with a ban. It's easy to get around a ceiling. If the ceiling is set at $1000, then users can set up 1000 pseudonymous accounts in order to get $1 million in pseudonymity.

Saturday, November 2, 2019

Bitcoin, 11-years in

Satoshi's first email [source]

Eleven years ago, Satoshi Nakamoto announced the bitcoin whitepaper to the world. Coinbase, a large cryptocurrency exchange, recently celebrated this milestone with a retrospective.

I'm going to remix Coinbase's narrative to tell a different account of bitcoin's last 11-years.

The thing that fooled us all for a while, myself included, is that we all thought bitcoin was solving a monetary or payments problem. It was labelled a coin, after all, and coins fall within the realm of monetary economics. To further complicate matters, Satoshi told his story using phrases like "electronic cash system" and "non-reversible transactions". Perhaps we deserve to be forgiven for not seeing bitcoin's underlying nature. After all, tearing down the existing monetary system and building a new one was a fresh and exciting narrative.

Anyways, Coinbase still believes this old tale. "As with other technologies, money has gone through many upgrades over the years," its marketing team writes. "Bitcoin is the latest breakthrough in a technology that’s millennia old."

What is now apparent is that bitcoin was never a monetary phenomenon. No, bitcoin is a new sort of financial betting game. It is a digital, global, highly-secure, and fairer version of the old-fashioned chain letter.

The premise behind bitcoin-the-game is that the current wave of buyers must guess when (or if) a subsequent wave of buyers will emerge, this second next wave's participation being contingent on when (or if) they believe a third wave of buyers to emerge. If they guess right, the early birds win at the expense of the late ones. And they can win a lot of money, as Coinbase points out in its post:

Source: Coinbase

Think of bitcoin as a pure mind game, a Keynesian beauty contest in which we "devote our intelligences to anticipating what average opinion expects the average opinion to be." Those old fashioned chain letters that you (or your parents) used to get in the mail were an early type of beauty contest. The price that Alice was willing to place on a chain letter was a function of whether she expected the next recipient, Bill, to play by the rules and send it on, Bill's expectation in turn depending on the odds that Jack would join the game.

But chain letters had a major flaw. The chain order could be easily compromised by a fraudster who miscopied the list and put their name at the front. Bitcoin fixes this by introducing robustness to chain letter-type games. Bitcoin's blockchain is an unbreakable public record of where in line game players stand. Altering this chain order would require tremendous amounts of computer power, as Coinbase illustrates in this chart:

Coinbase: Source

Bitcoin-the-game has been spectacularly successful. As Coinbase points out, it "went from an idea in 2008, and a first transaction in 2009, to over 27 million users in the US alone in 2019, or 9% of Americans." Below, Coinbase has charted the number of active bitcoin addresses that have been created over the years:

Source: Coinbase

Why did bitcoin-the-game succeed?

First, it's a fun and cutting-edge game. Many people dream of thrusting themselves out of financial obscurity into millionaire land. Bitcoin is a technologically-sophisticated way to get there. No one wants to play grandpa's lottery.

Secondly, the way that bitcoin is designed helps it spread. Most of the legacy financial games that bitcoin competes with (poker, lotteries, sports betting) are regulated by the government. Strict rules prevent game providers from reaching a wide audience. For instance, online casinos may be prevented from serving out-of-state players, problem gamblers may be banned, and those who are under 18 must be excluded. These financial games are usually centralized. This means they are hosted on a single website, or at a physical location like a casino, or by a government-run lottery corporation. Which makes it easy for regulators to shut down game providers who break the rules.

But bitcoin is different. Because it is a decentralized and digital financial game, it can't be regulated or shut down. And so it can serve the entire globe with impunity. Which it has done by spreading into every crack and cranny on earth. As is illustrated by another of Coinbase's charts:

Source: Coinbase

Based entirely on whisps and storms of psychology, the price of bitcoin is inherently volatile. Its core volatility has stayed pretty much constant over the last 11-years. Users should expect the same for the next 11 years. Even if more people join a Keynesian beauty contest, the average opinion of the average opinion will always be a fickle, inconsistent thing, and so price will always be jittery.

So what about bitcoin-as-money? Yes, people do use bitcoin for payments. But this gets dwarfed by its popularity as a financial game. The problem is this. Bitcoin payment functionality is implemented on top of a highly volatile chassis, a fun but fickle beauty contest. Which hobbles the effectiveness of the payments platform. Regular folks won't use the stuff to pay. They don't want the value of their spending stash to fall by 20% overnight. And game players don't want to waste their tokens on buying goods & services. That could mean potentially missing out on a life changing jackpot. That's why the promise of mainstream bitcoin payments has died a thousand deaths over the last 11 years.

That being said, the demand for bitcoin in economically volatile regions such as Venezuela has hit record highs. Coinbase suggests that thanks to inflation and capital controls, bitcoin is finally being used as the electronic cash for which it was originally designed.

Source: Coinbase

Coinbase could be right. In places like the U.S. with functioning monetary systems, bitcoin is just too awkward to serve as a payments alternative. But in places where monetary breakdowns have occurred, regular folks may be more willing to put up with the inherent pitfalls of transacting with bitcoin. And so we finally get to see bitcoin-as-money emerging.That's a good thing.

But bitcoin's popularity in Venezuela is also consistent with the bitcoin-as-game narrative. When people are desperate to improve their lives, they may have little other option but to roll the dice. In Run Lola Run, Lola needs to quickly make 100,000 Deutschmarks to save her boyfriend's life. She races to a casino and plays roulette. Likewise, in the face of societal collapse,  Venezuelans may simply be gambling on whatever potentially life-changing bet they can find. Bitcoin is one such a bet. Unwinding what portion of Venezuelan usage is due to bitcoin-as-game versus bitcoin-as-money is tricky.

Coinbase goes on to spout the typical cryptocurrency industry nonsense about legacy payments. It claims that "sending an international wire transfer by major US banks costs around $45, can take days to process, and can be done only during banking hours." And here is the chart it uses:

Source: Coinbase

That may be a good critique from ten years ago. But with SWIFT gpi having rolled out a few years back, multinationals can make near real-time cross border payments using the traditional correspondent banking system. For individuals and small businesses, fintech Transferwise offers instant remittances over fiat rails. These can settle on weekends in nations like the UK, which have real-time retail payments systems. I've touched on this before.

Continuing along with hyperbole, Coinbase makes the claim that bitcoin remittance fees are minimal compared to fiat. But this ignores the sizable foreign exchange fees that one must pay when converting fiat into bitcoin and back into fiat. I've gone into this calculus before.

What's next for Bitcoin? asks Coinbase in closing. Let me give it a shot. It's possible that bitcoin-as-game will stay popular for a very long time. And if it does, that could be a good thing. As I've suggested before, there is a demand as-such for financial games and bets, specifically early-bird bets. Compared to many of the fly-by-night games out there, bitcoin provides a fair and trustworthy option.

What about the original vision that got us all so excited, bitcoin-as-money? Crippled by bitcoin's game-based engine, bitcoin payments are probably never going to move beyond the niche role that they currently occupy. That's better than nothing. When those on the fringes are temporarily cut off from the conventional payments system, they'll always have an option for making transactions. It might not be a user-friendly option, but at least it's there.

Thursday, October 31, 2019

Is the strength of U.S. sanctions due to U.S. dollar hegemony?


I often hear the idea that the U.S. dollar is the means by which the U.S. implements sanctions. And since the U.S. dollar pervades all corners of the globe, the U.S. government's sanctions are uniquely powerful. For instance, Reuters reports that Russian resource giant Rosneft is shifting all its contracts over to euros in order to "shield its transactions from U.S. sanctions."

Another version of this idea was recently floated by David Marcus, the head of the Libra payments project:
"The future in five years, if we don’t have a good answer, is basically China re-wiring” a large part of the world “with a digital renminbi running on their controlled blockchain,” Marcus said. He warned about the prospect of “having a whole part of the world completely blocked from U.S. sanctions and protected from U.S. sanctions and having a new digital reserve currency” with no alternative."
The shared assumption of both the Rosneft and David Marcus quotes is that the U.S dollar is the primary pathway for projecting U.S. sanctions. By going out of their way to adopt a different currency, euros or renminbi, a nation or corporation can sidestep the sanctions threat.

But that's not quite right. Sure, the U.S. dollar is the world's reserve currency. However, the U.S.'s ability to apply strong and effective sanctions has very little to do with the U.S. dollar itself.

To see why, we need to visit how sanctions work. If the U.S. doesn't like a particular company, say Rosneft, and wants to cripple it, it starts with primary sanctions. The government tells U.S. companies to stop dealing with Rosneft on threat of fine.

But the real story begins with secondary sanctions. Here, the U.S. government tells Americans that on top of breaking ties with Rosneft, they must stop doing business with all other foreign entities (European, Canadian, Japanese, etc) that does business with Rosneft.

A foreign company now has a choice. If it is a European refiner, it will have to choose between continuing to buy crude oil from Rosneft or no longer accessing U.S. markets. This means being shut off from U.S. energy exports, doing without Texan oil & gas technology, forgoing U.S. repairs and refinery parts, being exempt from Silicon Valley tech expertise, being excluded from purchasing American assets, and having its existing U.S. subsidiaries threatened. There are also financial repercussions. It will lose access to New York's capital markets and the dollar payments system.

Given a choice between Rosneft or America, which will our refiner choose?

As I wrote a while back at Bullionstar, their are additional costs to being blacklisted by the U.S. government. Blacklisted executives would have to face the possibility of "no longer being able to send their kids to Ivy league schools, travel to Las Vegas for holiday, or seek medical care at Johns Hopkins or the Mayo Clinic." They wouldn't be able to visit the U.S. for business purposes, or explore U.S. job opportunities. I doubt that Russia has enough good job opportunities, universities, vacation spots, and high end hospitals to compensate.

This impressive list of penalties is why the U.S. government's secondary sanctions are so powerful. Almost every foreign company will prefer to give up Rosneft and keep doing business with America.

Now, Rosneft might nudge and wink at its European customers and say "hey, let's just deal in euros. That way we can get around the sanctions. We'll keep doing business together and you won't lose access to the U.S."

But using euros doesn't change the economic calculus facing our refiner. Even if it does business with Rosneft in euros rather than dollars, it is still doing business with Rosneft. And the moment that the U.S. justice department catches a whiff of this (say one of its bankers rats it out), the European company will be blacklisted. And that means losing the entire list of goodies that is associated with access to America. The risk is simply too high.

Fancy payment options like bitcoin or gold don't solve this either. Say that Total, a big European refiner, buys Rosneft oil with bitcoin. Total execs hopes that a bitcoin payment might prevent its bankers from tattling on it to U.S. authorities. But it's very difficult to camouflage the opposite side of that trade--massive movements of crude oil back to Europe. There are just too many bodies involved in that sort of operation. A large law-abiding organization like Total can't take the risk of being discovered. And so, bitcoin or not, it will disconnect Rosneft.

To summarize, what makes American secondary sanctions so effective isn't U.S. dollar hegemony. It is the impressive amount of technology, wealth, goods, services, and experience generated by American companies and individuals. When firms are threatened with losing access to this treasure trove, they will make whatever sacrifices are necessary to keep it.

As for Libra, in an effort to sell his new payments system to American regulators, David Marcus conjured up a world "completely blocked from U.S. sanctions" thanks to a new digital renminbi. But even if firms have the ability to make transactions in digital renminbi, this doesn't change the fact that America's home-grown economic bounty is massive, and foreigners value that bounty above any other, U.S. dollar or not. There are other reasons for regulators to welcome Libra. But bolstering U.S. sanctions isn't one of them.

Friday, October 25, 2019

A free market case for CBDC?


Central bank digital currency, or CBDC, is a form of highly-liquid digital debt that most governments have, till now, held back from issuing. But there is a growing push to change this. Free market economists are generally not big fans of CBDC. They see it as government encroachment on the banking sector.

In this post I'm going to push back on the free market consensus.

(This post was inspired after reading posts by Tyler Cowen and Scott Sumner).

Look, we're always going to have a government. Right? And that government is going to have to raise funds somehow in order to keep the lights on. The question is, how? Should it issue 30-day Treasury bills? Fifty-year bonds? Perpetual debt? Paper currency? Why not issue currency-ish debt instruments in digital form?

Let's start with a parable. Imagine a world in which the government has only ever issued 30-year bonds. But next month it wants to shift some of its borrowing from the 30-year bond range to the 10-year range. Government officials believe that this will reduce the government's interest costs and diversify government sources of funding.

Seems like a good idea, no?

But wait. The grocery industry has historically relied on funding itself with 10-year bonds. Till now, it hasn't had to compete with the government for the attention ten-year bond investors. Grocery store owners are furious over the impending decision. We could have difficulties funding ourselves! they fret. We might have to cut back on selling food!

Meanwhile, the restaurant industry in our imaginary world prefers to fund itself by issuing 30-year bonds. If the government raises more money in the 10-year end of the debt market and less in the 30-year end of the spectrum, restaurants will face less competition for investor attention. Go for it! say restaurant owners.

Which sector should the government choose to favor, grocery stores or restaurants? The choice seems entirely arbitrary. Government shouldn't be picking winners or losers, right? Civil servants should choose the most cost-effective form of financing.

The same argument goes for CBDC.

Bonds, bills, and CBDC are all just forms of transferable government debt.* But instead of having a fixed maturity like a bond, CBDC never matures. And whereas the interest rate on a bond is fixed and its price floats, the interest rate on CBDC is periodically adjusted while its price is fixed to $1. Either way, the government can use these instruments for funding projects and investments.

(For the rest of this post I'll use the terms CBDC and fixed-value floating-rate perpetual debt interchangeably.)

For whatever reason, modern governments choose not to fund themselves in the fixed-value floating-rate corner of the debt market.** No industry benefits more from this than banks. Individuals and businesses who want to buy fixed-value floating-rate perpetual debt have only one option available to them: bank-issued deposits. Regulations prevent all other industries from participating in this end of the debt market. So these non-banks have to turn to the 3-month to 30-year segment of the debt market where they must face the full brunt of government competition.

The presence of government competition means that non-banks' funding costs will be more onerous than otherwise. Conversely, banks' funding costs will be less onerous given a lack of government competition.

I don't see any compelling reason for why the government should avoid one end of the debt market and, in the process, favor the banking industry over other industries. I mean, if the government can cost-effectively issue CBDC in a way that reduces its overall interest obligations, then that's a win for taxpayers, no? It shouldn't go with an option that hurts taxpayers because it wants to help out a certain sector, should it?

The argument could be made that the banking industry is far more important than other industries because it does a lot of lending, and if lending slows then everyone loses. 

If the banking sector really deserves to be subsidized, why doesn't the government just pay the subsidy in a more transparent way, say by taking money directly from the pockets of individuals and non-banks and giving it to banks? 

Also, banks aren't the economy's only lenders. There are many non-bank lenders too. Sure, if a government were to issue CBDC, banks would now face more competition in the fixed-price floating-rate corner of the debt market, and perhaps would choose to lend less. But at the same time the government would be issuing less 30-year bonds, or 10-year bonds, or treasury bills. Non-bank lenders that issue debt in these ends of the debt market would face less competition than before, and might lend more.

In the end, it's a wash. One industry's loss is another's gain.

So let governments issue CBDC and compete for the attention of the fixed-price floating-rate investor, just like they already compete for the attention of the 30-year bond investor. This would remove an inefficient distortion, namely a subsidy to banks and a penalty on non-banks. This seems to be the free market position, no?




*It could be argued that one type of debt is a currency, and can be transferred from you to me, while the other isn't. But I don't buy that. Both types of debt are liquid. They can be bought and sold on exchanges. Or they can be transferred bilaterally. With bonds, a bilateral transfer can be conducted by conveying an old style physical bearer bonds, or by transferring a bond to a recipient using Treasury Direct.

**The government does issue banknotes, which are sort of like perpetual floating-rate debt, where the decision has been made to keep the rate at 0%. And it does issue reserves to the banking sector. But the quantity of banknotes and reserves is quite small relative to overall government borrowing.

Tuesday, October 15, 2019

Getting up to monetary mischief

By Harcourt Romanticist [source]

This post is dedicated to the protesters in Hong Kong. I am awed at how courageous they have been in the face of continuing pressure from China's Communist party. The same regime is complicit in persecuting Uighur Muslims and imprisoning two Canadians, Michael Spavor and Michael Kovrig.

There are all sorts of creative forms of non-violent mischief that citizens can use to protest against oppressive governments. This post explores a sub-category of non-violent mischief: monetary mischief.

Money stamping

One of the most popular forms of monetary protest is to overstamp currency. This involves stamping banknotes or countermarking coins. Coins and banknotes are vital to trade and circulate widely. Which makes them a great way to advertise a cause or complaint. The message automatically propagates itself via hand-to-hand commerce.

The monetary authorities will react to the threat by hastily withdrawing marked notes and coins from circulation. When bills or coins enter the wholesale cash systemi.e. when they are collected by banks, cash-in-transit firms, or ATM companiesthey are typically sorted by machines (or hand) for fitness. Defaced currency will get filtered out and returned to the central bank (or mint) to be destroyed and replaced.

This form of protest goes far back in history. For instance, below is a photo of a 1903 penny that has been defaced with a suffragette rallying cry:

"It was said at the time, that the suffragettes had copied the practice from anarchists, who were defacing similar coins with the phrase ‘Vive l’Anarchie’." Source: British Museum

Wayne Homren, editor of E-Sylum, has recently explored some modern U.S. examples of money stamping as protest:

Source: E-Sylum

Source: E-Sylum

Here are a few examples from Ireland during the Troubles:

© Fitzwilliam Museum. "The one illustrated in Figure 6 is a 1971 UK two-pence which has been stamped with ‘SMASH H BLOCK 8' on the obverse bust. The H-blocks at the Maze/Long Kesh prison housed prisoners convicted of scheduled offences after 1 March 1976, with H-block 8 reserved for IRA prisoners. The hunger strikes of 1981 came in protest at the removal of Special Category Status from prisoners and led to the deaths of ten IRA hunger strikers." Source: Richard Kelleher, Money and Medals Newsletter 77

Hong Kongers still use plenty of cash. Which would seem to make Hong Kong ideal for money stamping. However, I haven't seen many examples of this form of mischief being used by Hong Kong protestors. About the only evidence I've located is provided below. It is a warning from a Thai money changer that it will not accept Hong Kong notes that have been stamped with political messages:

Source: Facebook

Which leads directly into my next point. For every form of monetary mischief, the authorities have a defence. The simplest line of defence against overstamping is to declare the practice illegal. Luckily for protestors, it is almost impossible to enforce this law. Money stamping can be safely performed behind closed doors. If a money stamper is caught passing along a note or coin, they can just say they accidentally received it as change or from an ATM.

A more effective line of defence is to declare that any stamped banknote is henceforth no longer money. This is basically a form of demonetization, a very focused one. To initiate this defence, the central bank refuses to accept any note or coin that has been altered. Good bills can continue to circulate. If the central bank refuses to accept marked bills, then wholesalers like banks (and forex dealers like the Thai one above) will likewise refuse, and so retailers won't accept it. And so angry members of the public who have stamped their notes with protest messages will find that their cash has become unspendable.

To avoid being left out of pocket, protesters will avoid stamping their currency in the first place. Which is why this line of defence is fairly effective.

Small, not large denominations

Protestors have a good counter to the threat of demonetization. They can focus on stamping large amounts of small denominations, not small amounts of large denominations. In Canada and U.S., the relevant small denominations are $1 coins/bills, $2s, and $5s. In Hong Kong's case, the relevant small denominations would be the HK$10 and HK$20 notes, which are equal to around US$1.20 and US$2.40 respectively. 

There are two reasons for focusing on small notes. First, it is far safer for a student protestor to overstamp a few HK$10 notes. If the notes are to becomes unspendable thanks to a demonetization, the protestor may have to do without a meal at McDonald's. But if a protestor stamps a few HK$1000 (US$126) bills and they subsequently becomes worthless, that will be far more damaging to their finances.

The second reason for focusing on small denomination notes is that their supply is much less flexible than larger denominations. Think about it for a moment. For each $500 that a central bank printing press produces, it takes fifty times the effort to create an equivalent amount of $10s. Which means that it will be harder for the central bank to replace a large amount of defaced $10s than to replace an equivalent value of defaced $500s.

This difference in replacement rates is important. When notes that have been stamped with political slogans are declared void by the monetary authorities, the supply of banknotes will be reduced. A shortage has been created. The central bank can quickly remedy a shortage of large denominations like HK$500s. But fixing a shortage of HK$10s will take more time. The monetary authorities are left with a choice. They can either allow the shortage of small denomination notes to continue, or they can bring it to an end by re-allowing defaced notes to circulate.

Either way, the government ends up looking bad. Shortages of change are extremely inconvenient to businesses. Those in charge will be derided as incompetent. But allowing small denomination defaced notes to return to circulation will allow the protesters to continue advertising their cause.

Cashing out of bank accounts

A second form of monetary protest is mass cash-outs of bank accounts. In 2010 Eric Cantona, a former French footballer, started to champion this form of mischief. I'm pretty sure he wasn't the first to come up with the idea. (Anyone else have prior examples?). Anyways, here he is:
"We don't pick up weapons to kill people to start the revolution. The revolution is really easy to do these days. What's the system? The system is built on the power of the banks. So it must be destroyed through the banks.

"This means that the three million people with their placards on the streets, they go to the bank and they withdraw their money and the banks collapse. Three million, 10 million people, and the banks collapse and there is no real threat. A real revolution."

"We must go to the bank. In this case there would be a real revolution. It's not complicated; instead of going on the streets and driving kilometres by car you simply go to the bank in your country and withdraw your money, and if there are a lot of people withdrawing their money the system collapses. No weapons, no blood, or anything like that."
Last January French protestors, the gilets jaunes, gave it a try.

How effective are mass cash withdrawals?

Banks rely on multiple sources of funding, one of which is its base of retail depositors. They also tap investors (who buy their bonds and shares) as well as depositors from the government and corporate sectors. If a portion of their retail depositors close their accounts, this will probably hurt the banks. But given the diverse nature of bank funding, I think Cantona overplays his hand when describes it as a "really easy revolution."

Banks also have access to the most powerful lender of all, the central bank. If protestors do succeed in pressuring certain banks with a cash-out campaign, the central bank will step in and support the targeted bank by lending it funds. Since the bank is being pressured for political reasons, and not because it is fundamentally unsound, the central bank will be quite liberal in support. Ultimately, central bank support should staunch the run.

Like the gilets jaunes in France, protestors in Hong Kong have launched their own cash-out campaignwith a twist. Hong Kong pegs its currency to the U.S. dollar. Not only are protestors cashing out of their bank accounts. They are also converting their Hong Kong funds into U.S. dollars in the hope of pressuring the peg.
I combed through Hong Kong Monetary Authority statistics to see if the cash-out campaign is having any effect. Banks and other financial institutions will typically keep a small amount of banknotes and cash in their vaults to satisfy customer redemption requests. Below I chart out the evolution of the cash held by Hong Kong banks by year.
You can see that Hong Kong banks have currently stocked up on over HK$30 billion in currency, far more than the typical HK$20 billion they tend to hold in August. This amount exceeds the Christmas spike, when the public typically withdraws the largest amounts of cash for purposes of gifts and travel. (Apparently the early 2018 jump may have been related to the installation of facial recognition hardware on neighboring Macau's ATMs).

It's hard to say why cash inventories have spiked. It could be related to banks being worried about protestor-led cash withdrawals. Or alternatively, they may fear that even non-protestors may start to ask for cash-outs, albeit for economic reasons, not political ones.

As I said earlier, I think that cash-out campaigns probably won't have a big effect. Banks have very strong lines of defence. As for attacking the Hong Kong dollar peg, that's quite ambitious. In theory, it would work. But every depositor in Hong Kong would have to participate.

Again, focus on small denominations

If I was to start a monetary protest here in Canada that involved cash withdrawals, I'd set my ambitions lower. The way to make any cash-out campaign more effective is to focus on withdrawing small denomination notes. Go into the bank and ask to withdraw $1/$2 coins and $5 notes. (In Hong Kong, HK$10s and HK$20s instead of HK$500s). Or withdraw large denomination notes from ATMs and then go to stores and ask them to break them for you. If the store won't break them, than buy a $1 chocolate bar with a $20 and hoard the change.

Earlier, I mentioned that the supply of small denomination notes is not as elastic as the supply of large ones. By way of illustration, I've provided a screenshot of Hong Kong's cash supply:

Source: Hong Kong Monetary Authority annual report [link]

Like most countries, Hong Kong has far more small denomination notes and coins in circulation than large ones. As the chart on the right shows, the HK$10 and HK$20 constitute 11.6% and 35.7% of all bills in circulation. But the total value of these small denomination notes tends to be quite small, as the left chart illustrates. They comprise just 0.6% and 3.5% of total banknote value. You can see the same distribution in Canada, too. The value of $100 bills dwarfs the $5 bill, but we've got about the same amount outstanding.

So there are a boatload of small denomination banknotes in circulation that are responsible for bearing a large load of the nation's transactional work. But the combined value of these work-horse notes is quite low.

This set of features makes small denomination currency an easy target for a would-be monetary protestor. A motivated group of Canadians could conceivably hoover up a large share the small denomination note and coin supply, thus creating a shortage of change. If enough people participate, the Bank of Canada's printing press would not be able to keep up. This would impede the ability of the Canadian payments system to facilitate transactions.

Most people have forgotten what small change shortages look like. But anyone who has read a bit of monetary history will know that many of the large monetary disturbances in the last five or six centuries leading up to 1800 were coin shortages. They were a nuisance.

In this post I've explored two types of non-violent monetary mischief that protestors have turned to in the past. I'm sure there are more. For instance, I haven't mentioned any digital types of mischief. In the comments below, feel free to provide some examples. As for the Hong Kongers who my be reading this, I wish you the best. Hang in there.

Monday, September 23, 2019

A fifty-year history of Facebook's Libra

Last week, we finally got some information about what Libra's currency basket would look like.
If you haven't heard, Libra is a proposed global blockchain-based payments network. It is being spearheaded by Facebook along with a coalition of other companies including Uber, MasterCard, PayPal, and Visa.

The hook is that rather than going the conventional route and expressing monetary values using existing units-of-account like the dollar, yen, pound, or euro, the Libra network will rely on its own bespoke Libra unit-of-account as its "base language." Libra originally revealed in its whitepaper that the Libra unit would be defined as a basket, or cocktail, of other currencies. Now we know what that mix will likely look like.

Interestingly, the Libra isn't the world's first private unit-of-account. Back in the 1960s and 1970s, several financial institutions came up with their own bespoke units. I learnt about this strange and fascinating episode courtesy of a very readable paper by two economists, Joseph Aschheim and Y.S. Park.

As I gathered from the paper, the first private artificial currency unit was Luxembourg-based Kredietbank's European Accounting Unit (EUA). Originally devised in 1961 as 0.88867 grams of fine gold, the EUA was soon used to denominate a bond issue by SACOR, a Portuguese oil company. Over the next two decades, Aschheim & Park claim that around sixty or so bond issues would rely on Kredietbank's EUA as their accounting unit.

Between 1968 and 1971, the U.S. Treasury ceased to redeem dollars with gold. When the Smithsonian Agreement—a band-aid attempt to re-cement all currencies to the U.S. dollar—collapsed in 1973, the post WWII system of fixed currencies came to its final end. To help people cope with the sudden babble of floating currencies, several new private units-of-account joined Kreietbank's EUA.

N.M. Rothschild & Sons kicked things off in 1973 with its European Composite Unit, or Eurco. The Eurco was made up of nine currencies issued by members of the European Community, including Deutsche marks, French francs, and Danish kronor. According to Aschheim & Park, Rothshild developed the Eurco "to elicit investors' confidence" in long-term bonds, but as of 1976 only three bond issues had been denominated in Eurcos.

In 1974 Hambros Bank introduced the Arab Currency-Related Unit, or Arcru. The Arcru was comprised of twelve Arab currencies and designed to appeal to Arab investors flush with oil profits. The next year Credit Lyonnais created a bouquet of the ten currencies, both European and non-European, and dubbed it the International Financial Unit, or IFU. This was a far more broad-based unit than the Arcru or Eurco, the relative weights of the IFU's component currencies being based on each country's share of international trade.

Barclays Bank also got into the game in 1974 with the Barclays Unit, or the B-Unit. The B-Unit was made up of five currencies: the U.S. dollar, the British pound, the German mark, the French franc, and the Swiss franc. Aschheim & Park note that whereas the Arcru, IFU, and Eurco were primarily intended for denominating bonds, the B-Unit was designed to be used for making international payments.

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Which makes the B-Unit a direct predecessor of the Libra unit.

Look around you today, however, and not one of these private units-of-account listed below exists. Anyone want to pay me in B-Units? I didn't think so. I think this says something quite fundamental about the market's demand for artificial currency units. Businesses and consumers don't really like to use them.

Table from Aschheim & Park

If private artificial currency units have been failures, what about government-provided ones?

Take the International Monetary Fund's Special Drawing Right (SDR) basket, which has been in existence since 1970, almost fifty years. If there was a demand to make international payments using public artificial units of account, surely commercial banks would eventually have met that demand by implementing SDR-denominated payments systems. Indeed, Aschheim & Park speculate on the possibility in their 1976 paper. It's worth reading this section in full:
"International banks may soon be willing to accept deposits denominated in SDRs because a potential demand for SDR funds already exists, as manifested by recent SDR bond issues by the Swiss Aluminum Company, the Swedish Investment Bank, and Electricite de France. The process, indeed, is already under way. In July 1975 the Bank Keyser Ullmann in Geneva (a subsidiary of Keyser Ullmann of London) announced that it would henceforth accept demand and time deposits denominated in SDRs. These SDR deposits are to be convertible at any time into any currency at the SDR exchange rate applicable on that day. Similarly, in August 1975 the Chase Manhattan Bank in New York instituted a range of banking facilities in SDRs, including loans, deposits, and futures trading. As this process spreads and as more international transactions are denominated in SDRs, banks may begin to allow direct transfers between SDR accounts, internally and then between banks. In consequence, the SDR may be transformed from mere numeraire (international quasi-money) into an outright means of payment (full-fledged international money)."
Again, look around you today. How many banks let you open an SDR-denominated bank account and make SDR payments? None that I'm aware of. Maybe the IMF's SDR was never well designed, or maybe Barclays was too small to drive B-Unit adoption. Or more likely SDRs, B-Units, and the other artificial currency units mentioned in Aschheim & Parks paper are all monetary dead-ends. In pursuing the same path, Libra could be making a big mistake.

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What is it about artificial currency baskets that makes them non-starters? My first post about Libra delved into this question. Let me repeat my argument below to spare you the effort of clicking through.

In an alternative reality, let's imagine that Facebook only allows users to join and converse on its platform after having learnt Facebook's artificial language, Facebookish. English, French, Chinese, and all other languages are banned.

In this alternate reality, all Facebook users understand each other because each one is fluent in Facebookish. Comprehension is a great thing. But hardly any of us would be on Facebook to begin with. Who wants to go through the effort of learning a new language? Not me.

In the real world, Facebook has long since decided against the Facebookish approach. Instead, it supports a multitude of local languages—Arabic, Chinese, English, Hindi, and more. Sure, the drawback is that we can't always understand what other Facebook users are saying. But at least users don't have to go through the hurdle of learning new grammar and syntax. And Facebook has thrived as a result of this simple and obvious design choice.

The adoption of a Libra unit of account is the monetary equivalent of forcing users to learn Facebookish. Sure, at least with Libras we'll all be using the same currency units. But this ignores the costs we'd all have to incur as we learn a new monetary patois. From a very young age we all figure out how to "speak money". We speak in our local unit-of-account. As a Canadian, the Canadian dollar has always been the means by which I describe prices to people around me, and remember values, and engage in cost-benefit calculations. Facebook wants to force us all to learn a new monetary language, a Libra-based one. But in doing so it's setting a huge hurdle to adoption.

So I'll just repeat. No matter how skillfully it goes about designing Facebookish (or Libras), artificial languages and artificial units are dead-ends. They're utopian, and definitely not user-friendly. (Ok, I may have described it all better in my original post, so just head on over.)

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That being said, over the last few months I've been slowly warming up to Libra. Out of the millions of crypto projects that have come out over the last decade, it comes close to the Fedcoin vision I originally outlined on my blog back in 2014, and twice now for R3.

To begin with, a Libra token would be stable (unlike bitcoin) thanks to credible and strong issuers. Since it would be decentralized, the network would be resilient. And since a Libra is a token, and not an account, it should be relatively open for everyone to use. At the same time, David Marcus, the architect behind Libra, is making the right noises about financial privacy. (Whether his intentions are genuine or not, it's tough to say.)

From the Libra whitepaper

I think (and I could be wrong here) that there is a growing desire on the part of consumers for more financial privacy. Unfortunately, governments hew to a post-9/11 mindset that regards privacy as a pervasive threat. Facebook may be one of the only organizations with the financial heft to articulate consumers' desires for more privacy in a way that regulators can't ignore.

Having Facebook as financial privacy advocate is a fragile win, no? It would be too bad if Libra (and whatever level of financial privacy it promises to bring to mainstream consumers) never attains widespread usage because of a basic design flaw, one that obligates us all to adopt the monetary-equivalent of Facebookish

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If not an artificial currency basket, what should Facebook do? I think that most consumers who engage in cross-border transactions want to keep swimming in their domestic currencies up until the last minute. Only at the 'buy now' or 'send now' moment—i.e. when a purchase it to be consummated or funds transferred to a friend—do we want to leave the bubble of our home currency. Pre-accumulating some strange alien token, whether those be SDRs, B-Units, or Libra, just isn't on the table.

If it wants to stay customer friendly, Libra needs to design its network to allow for the flow of tokens denominated in state currencies (U.S. dollars, Chinese yuan, British pounds, Indonesian rupee). And then it needs to design a cheap, transparent, and easy way for these tokens to move from person to person. This is what PayPal does. It's also worked for Transferwise. Visa and MasterCard too. None  of these platforms have created their own curious units, PayPalios or TransferWise-units or Visa-oos. They've allowed customers to remain safely ensconced in their domestic currency bubbles until the final 'send now' moment.

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Putting aside my criticisms of Libra's decision to use an artificial currency unit, what do I think about its choice of basket?

I am left wondering what sort of process David Marcus and the folks at Facebook have used to generate the basket components. Potential Libra users will want to know ahead of time how they can expect a basket's components to be updated as time passes. After all, if their wealth is to be held on the platform, customers will wonder what is to prevent a sudden rewriting of the basket in a way that favors the network at their expense?

One important rule that everyone will want to know is what economic thresholds are being used to filter out or include various currencies. For instance, if the Korean won starts to become a popular international currency, at what point will Libra decide to include it in the basket? If so, would it boot out another currency to make way for the won, or keep it?

The current Libra components are definitely odd, and give no indication of what process the architects are using to populate the Libra basket. For instance, I'm not aware of any selection process or rule that would lead to the Singaporean dollar comprising 7% of what is supposed to be a "global currency." Don't get me wrong. I like Singapore. It punches above its weight. But Singapore doesn't account for 7% of world trade, or 7% of the world's population, or 7% of global anything.

Or why does the euro account for just 18% of the Libra basket while the U.S. makes up a mammoth-sized 50%? The European Union has twice the population of the U.S. and accounts for a far larger share of exports. And where is the Chinese yuan? Exiled for political reasons?

One wonders if the euro's small share has to do with the effect that Europe's negative interest rates might have on network profits. For each Libra it has issued, the consortium will have to keep a Libra's worth of assets in reserve. Far larger profits can be earned it it reduces the euro portion of the basket and increases the U.S. dollar portion. After all, that would mean more exposure to high-yielding U.S. dollar assets and less to negative-yielding European ones. But that's a terribly ad hoc way to construct a currency basket.

My last thought is this. If Libra has its heart set on choosing an artificial currency unit as the basis for its global currency, it should have probably just go with the IMF's SDR basket rather than brewing its own strange currency concoction.

The IMF's SDR basket (source)

Consider how exchange-traded funds which track an index outsource all of the decisions about index methodology and components to third-parties like Standard & Poors, MSCI, and FTSE. This makes the exchange-traded fund more credible. Using SDRs would pre-commit Libra to avoiding conflicts of interest and thorny politics, the IMF becoming the theater for determining the basket. One could find worse third-parties than the IMF.

Wednesday, September 18, 2019

The life and death of an internet monetary meme


Over the last few years I've increasingly crossed paths with the following claim on the internet: "The average life expectancy for a fiat currency is 27 years." Is this claim true? What definitions are being used? I mean, are we talking about inconvertible paper money here, or currency that was convertible into gold, too?

I finally got curious enough that I decided to chase down the source of this meme. After all, without knowing what data it is based on, it's hard to evaluate the claim's truthfulness. Below I give a description of my trek through internet history.

The average-life-of-fiat meme has become particularly popular among cryptocurrency types. For instance, here is Jimmy Song, a popular bitcoin educator/developer, confidently invoking the slogan back in 2017:
"When a society lacks prudence, what happens is that the society collapses or goes into chaos. It’s not a coincidence that the average lifespan of a fiat currency is only 27 years."
A long list of cryptocurrency luminaries have dutifully mentioned the meme including Dan Held (2018), Taylor Pearson (2019), Barry Silbert (2019), Tuur Demeester (2015), Francis Pouliot (2018), and Adam Back (2019). Grayscale Investments, a firm that provides cryptocurrency-based investment products, even includes it in their marketing material:

As is often the case these days, crypto bugs have cribbed their ideas from their older cousins, the gold bugs. Nathan Lewis, author of Gold: The Once and Future Money, mentioned the idea in written testimony to Congress in 2012. Ralph Benko, a gold standard advocate, invoked the meme in a 2011 article. And Max Keiser, a long-time gold bug turned cryptocurrency advocate, began mentioning it as early as 2013. Where did Keiser, Benko, and Lewis get the meme from?

One of the meme's earliest and most cited appearances comes from Washington's Blog, a platform for a group of anonymous financial writers. We know little about this group except for the fact that George, "website owner and lead writer – is a busy professional, a former adjunct professor, an American and a family man." 

In August 2011, Washington's Blog published an article with the brutally long title The Average Life Expectancy of a Fiat Currency is 27 Years... Every 30 to 40 Years the Reigning Monetary System Fails And Has To Be Retooled. The author failed to explain how the 27 years claim was derived. Instead, he/she relied on another article by a writer named Chris Mack for backup. In a disclaimer the author noted that "I don't know Chris Mack," and thus couldn't vouch for the figures. "However," he/she went on to say, "the general concept is correct."

That's an odd way to do analysis, no? I've to this number for you, 27. I don't know how the number was generated, or who came up with it. But it's good enough. So go ahead and use it.

After a bit of hunting, I found Chris Mack's article here (the link at Washington's blog is dead). It is dated January 2011, pushing back the meme's genesis by another few months. At the time, Mack was President of Trade Placer, a "real-time marketplace where you can buy or sell items such as gold, silver, platinum, wine and other collectibles." Now he is the CEO at Levidge, a platform for trading cryptocurrencies. Note again the well-trodden corridor between gold buggery and crypto buggery.

Anyways, in 2011 Mack wrote:
"According to a study of 775 fiat currencies by DollarDaze.org, there is no historical precedence for a fiat currency that has succeeded in holding its value. 20 percent failed through hyperinflation, 21 percent were destroyed by war, 12 percent destroyed by independence, 24 percent were monetarily reformed, and 23 percent are still in circulation approaching one of the other outcomes.

The average life expectancy for a fiat currency is 27 years, with the shortest life span being one month. "
Mack mentions a study by DollarDaze, but doesn't provide a link to the article. Aha, the missing data! I hopped over to DollarDaze's website, a blog dedicated to talking about the failings of the U.S. dollar. But there are no blog posts older than 2018. No study, folks.

This puts all the meme users--Jimmy Song, Grayscale, Max Keiser, and the rest--in an absurd situation. There are some words on some websites about a study, but ask our meme users where the study is and none of them can actually find it. Did it ever exist? Why are they so confidently transmitting data when there is no data? DollarDaze has got to be right, no? How could you doubt it, JP?

Since no one was able to help me, I turned to the Wayback Machine to see if I could pull up older versions of the DollarDaze website. It took a while, but I finally found pay dirt. Back in 2009 the editor of DollarDaze, Mike Hewitt, wrote an article entitled The Fate of Paper Money. I tried to track Hewitt down, but he seems to have disappeared from the internet.

No matter. Finally, some data to evaluate! In his article, Hewitt claims to have counted 176 currencies in circulation and 599 currencies that are not in circulation. Of the 599 in his discontinued list, Hewitt comments that the "median age for these currencies is only fifteen years!" He provides links to both lists (1 and 2).

I downloaded Hewitt's list of 599 defunct currencies and put it into an Excel spreadsheet. The median age is indeed 15 years, as Hewitt claims, and the average is 27 years, as Mack claims in his subsequent 2011 article. So voila, we finally have the basis for the modern internet meme that the average age of a fiat currency is just 27 years. It's based on Hewitt's list of 599 dead currencies, with Mack taking the average duration. (They conveniently don't include the list of 176 existing currencies in their calculation, which would have increased the number). 

Now for my criticisms.

The 27-years meme has been used for many years now as a prop for making gold and cryptocurrencies look good. "Ha ha, suckers! Only 27 years until your paper is worthless!" But many of the 599 defunct currencies in Hewitt's list weren't failures. Rather, they were replaced for political, economic, and cultural reasons.
For instance, the list contains all of the pre-euro currencies (Dutch gulder, French franc, Italian lira, etc). These currencies had good reasons for disappearing: they were swapped for a new monetary unit. Existing currency holders weren't robbed. They were fairly compensated for this switch.

Another example of monetary reorganization occurred in East Africa. From 1919 to the 1960s, Britain's former east African colonies relied on the East African shilling, produced by the East African Currency Board. When these countries gained their independence, the currency board was dismantled. In its place Kenya began issuing its own shillings at par with the old ones, as did  Tanzania and Uganda.

In each case, existing owners of East African shillings could convert their holdings into new currency. No wealth was being destroyed during any of these switches. But people who throw around the phrase the average life expectancy for a fiat currency is 27 years as a criticism of the very institution of currency are using the data in a way that implicitly assumes that the East African experience--and others like it--were negative. They weren't.

So the idea that Hewitt's list somehow measures the length of time between a fiat currency's birth and its impending worthlessness is just wrong. I'd go even go so far as to say that the plasticity of the listed currencies is one of their strengths. As national borders change and political circumstances shift, the writing on the bills should be updated too. 

Hewitt's list contains many data errors. He makes the odd claim that the Japanese gold oban and silver momme were created in 1904 and met their end in a hyperinflation in 1905. But these were both historic Japanese coins that had existed for centuries. Hewitt also lists the U.S. greenback ("US Paper Dollar) as lasting from 1862 to 1878. But this isn't correct. Greenbacks were repegged to gold in 1878, but they continued to be issued for many decades after.

Or take Hewitt's categorization of British Military Authority (BMA) lira as dying in hyperinflation. This is an odd claim to make. BMA Lira were issued in Libya by occupying British forces both during and after World War II to provide the nation with a circulating medium. These notes were basically a military version of the British pound, with 480 lira equal to a pound sterling. In 1951 BMA Lira notes were converted into Libyan pounds, issued by Libya's new currency board, at a rate of 480-to-1. No hyperinflation here.


Finally, take Hewitt's claim that the Hawaiian dollar was "destroyed" by WWII. Not so. I've written about the Hawaiian overprints before. To protect against a potential Japanese invasion of Hawaii (and a confiscation of dollars by Japanese soldiers) all dollars on Hawaii were overprinted. Once the threat of Japanese invasion had disappeared they were swapped for regular U.S. dollars and withdrawn . But not a single Hawaiian lost anything during the entire process.

I don't want to nitpick too much, but given that it only took me a few minutes to find these four mistakes, one can only conclude that the rest of Hewitt's list is riddled with errors.

Finally, there are some semantic issues. Fiat currency is generally considered to be inconvertible money. It can't be redeemed for gold or silver. The world really only shifted onto a fiat standard between 1968-71 as the dollar ceased to be redeemed in gold. But Hewitt's list is replete with many metallic currencies (i.e. the riksdaler riksmynt). Are people using his data to make a claim about currencies in general, or just fiat ones? The meme isn't clear on this.

So having examined the life of an internet monetary meme, I'd like to kill it. It's time for us to retire the idea that says that "the average life expectancy for a fiat currency is 27 years." God knows there's plenty of problems with currencies. But good criticism requires diligence and accurate data. The meme in question is an example of sloppy work and bad data.

I know that the crypts and the bugs and the fiats are engaged in constant meme warfare--the bugs and the fiats for many decades now, the crypts only joining the battle a few years ago. Messages must be crafted for best efficiency, whether this be to pump bitcoin to the moon, or to push gold into the stratosphere, or to lock the fiat system in place. But most of the serious people involved in these debates, no matter which side, still keep at least one foot in the truth. Let's flush the 27-years meme down the toilet, folks.