A rush for US paper dollars: the rejuvenation of the world's most popular brand

Here are Paul Krugman and James Hamilton on the renewed demand for dollar bills.

So what's behind the soaring demand for US paper dollars? A simple strategy for getting a grasp on US data is to compare it to the equivalent in Canada. Comparisons between Canada and the US serve as ideal natural experiments since both of us have similar customs and geographies. By controlling for a whole range of possible factors we can tease out the defining ones.

The chart below shows the demand for Canadian paper dollars and US paper dollars over time. To make visual comparison easier, I've normalized the two series so we start at 10 in 1984. On top of each series I've overlayed an exponential trendline based on the 1984-2006 period. I've zoomed in on 1997 for no other reason than to provide a higher resolution image of the typical shape of cash demand over a year.

Some interesting observations:

1. Not a huge surprise, but the demand for US paper has been accelerating far faster than the demand for Canadian paper. As James Hamilton points out, this is no doubt due to the huge transactional demand for US dollars overseas. The emerging countries in which US paper is demanded often have high growth rates, and their requirement for transaction media is correspondingly elevated. Unlike greenbacks, Canadian loonies are only demanded in Canada. As a slow-growth country, we don't require rapidly expanding amounts of physical transactions media.

2. Zooming in on any given year (I've chosen 1997) the demand for Canadian paper is far more jagged than the demand for US paper. Why is this? My guess is that the demand for US paper is diffused across multiple nations with diverging business practices and cultures. The demand for Canadian paper, on the other hand, is tightly linked to specific Canadian customs, holiday seasons, and payroll scheduling practices. The overseas demand that smooths out and counterbalance the peculiarities of domestic US paper demand don't exist for loonies.

3. There are some neat patterns in the chart. No, not all cash is demanded by criminals. There's always a cash spike at Christmas/New Years, and if you look carefully you can see jumps in Canadian cash demand coincide with major holidays, including Thanksgiving and the September long weekend. As Lenin once said, give me data on your nation's money supply and I can tell you when its holidays are. And note the huge Y2K-inspired rush to hold paper. Cash is still the ultimate medium for coping with raw uncertainty.

4. US paper demand started to slacken relative to trend in the early 2000s. One might be tempted to blame technological advances or changes in US preferences over payment media for slowing demand. Cash is a dinosaur, right? But this can't be the case. Canadians benefit from the same technologies as the US, nor do payment preferences change when one moves from 50 miles south of the 49th parallel to 50 kilometres north of it. If technology or preferences had changes, then Canadian cash demand would have deteriorated too, but as the chart shows, it continued to rise on trend. The best explanation for the US dollar's divergence from its long term growth just as Canada hewed to its trend is that foreign demand for US paper began to decline.

It's a reasonable explanation. Around 2002, the value of the US dollar begin a long and steady deterioration against most of the world's currencies, in particular the euro. It's very probable that consumers of the US$ brand punished the brand owner, the Federal Reserve, by returning dollars enmasse to their source, thus reducing the supply of paper dollars (or at least reducing its rate of increase). As incontrovertible proof, I submit exhibit A—a 2007 video of Jay-Z flashing euros instead of dollars (skip to 0:51).

5. So it seems to me that from 2003-2008 there was a mini run on the Fed by overseas cash holders. What Jaz-Z doesn't show is the process by which US dollars would have refluxed back to the US. Euroization, or de-dollarization, goes like this. A foreigner goes to their local bank to trade US dollars for euros. The local bank, flush with dollars, puts this paper on a plane for redeposit at their US correspondent bank in New York. The New York bank, which now has too much vault cash, loads these dollars into a Brinks truck and sends them to the New York Fed. And the FRBNY shreds the notes up.

This mini run would have put downward pressure on the federal funds rate. Here's how. Having accumulated excess cash from overseas, US banks would have sent this cash to the Fed in return for reserves. But now these banks have excess reserves. Desperate to get rid of them, they all try to lend their reserves at once, driving the federal funds rate down. To ensure that the federal funds rate doesn't fall below target, the Fed would has to sell treasuries in order to suck in reserves, thereby reducing the oversupply in the federal funds market and keeping the fed funds fixed.

The lesson being, when folks like Jambo in Zimbabwe and Julio in Panama get distraught about the quality of their Ben Franklins, the effects of their unhappiness will be felt, with some delay, all the way back at the Fed's open market desk.

6. US paper demand has since rebounded. Paul Krugman posts a chart that shows a massive accumulation of US cash holdings relative to GDP beginning in 2008. But Krugman's chart overstates the effect by constricting his time frame. As my chart shows, the rate of growth in US paper has only returned to the trend it demonstrated in previous decades.

Krugman attributes this increase in dollar holdings to the fact that the US is in a liquidity trap. When rates are near zero, people have no problems holding zero-yielding cash. I'm not so sure about his explanation. Canada had incredibly low rates for a few years, yet as our chart shows, Canadian paper never budged from its trendline growth. The same goes for the Euro. Rates have been low there, but we haven't seen a flight into paper money. Because cash is inconvenient and bulky, rates have to go pretty far below zero before people flee to paper.

No, the more likely explanation for the rebound in the US paper outstanding is the rejuvenation of the US dollar brand. The ECB has had to deal with waves of negative publicity for the last few years. Given the alternatives, the world wants to hold Benjamins again. This seems to be borne out in the chart below, which shows the ratio of ECB-to-Fed banknotes in circulation.



The US dollar, it would seem, is back. Cash holdings are only one sign off a currency's hegemony. It would be telling if there's also been a rebound in the use of the dollar to denominate bonds and other debt instruments, as well as increased holdings of US dollar-denominated assets in the reserves of major central banks. The US's "exorbitant privilege", as Barry Eichengreen calls it, continues apace.

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Note: As I was writing this, I stumbled on a paper by Ruth Judson via James Hamilton called Crisis and Calm: Demand for U.S. Currency at Home and Abroad from the Fall of the Berlin Wall to 2011. And what do you know. She uses Canada as a foil for determining US cash demand, just like I did. I haven't read it yet, but am quite looking forward to doing so and am willing to yack about it in the comments.

On Lenin, read White & Schuler.

Why the Fed is more likely to adopt bitcoin technology than kill it off

Paul Krugman has a recent post in which he casts bitcoin as a retrogression from our current fiat system. He's wrong about this. In the next few years, I put decent odds on the guardian of our fiat system, the Federal Reserve, adopting the very bitcoin technology that Krugman finds so dubious. Here is Krugman:

One thing I haven’t seen emphasized, however, is the extent to which the whole concept of having to “mine” Bitcoins by expending real resources amounts to a drastic retrogression — a retrogression that Adam Smith would have scorned.

Krugman has taken bitcoin's colourful jargon a bit too literally. It's best to think of "bitcoin" as a distributed ledger, or a record, and not as physical coin. And while Bitcoin miners do "mine", they're not performing a function that is analogous to gold mining. Rather, they're contributing to the tending and maintenance of the information that makes up the bitcoin ledger. The mining community listens for ledger transfer announcements, processes and verifies them, and then updates the distributed record. The reward for being the first to successfully add to the ledger is new bitcoin. Distracted by this reward, Krugman misses the underlying verification process it represents, thus drawing an incorrect analogy between bitcoin miners and gold miners.

It's better to think of a bitcoin miner as a gold assayer who verifies that a circulating gold coin isn't a fake, or, in our fiat world, as part of the verification process in a credit card payment. A bitcoin miner listens, processes, double checks, and polices the distributed ledger. Protecting a ledger is a valuable use of resources.

Rather than being retrograde, let's see how bitcoin technology could be adopted by the Fed.

The Federal Reserve owns one of the world's most important ledgers. The Fed's 3,000 or so member banks maintain accounts at the Fed. Put differently, they own allocations in the Fed's ledger. Every business day banks trade Fed ledger space amongst each other. The name for the system that facilitates these transfers is Fedwire and the name for the ledger space being transferred is "reserves".

The quantity and size of Fedwire transactions is breathtaking. In the fourth quarter of 2012, 33.8 million transfers were made with an average transfer value of $4.45 million. A total of $150 trillion in ledger space, or reserves, was exchanged.* Many types of transaction are carried out over Fedwire. When company A buys out company B for a billion dollars, the payment will probably be made over Fedwire. If the Fed conducts an open market purchase of $5 billion, it'll pay for that purchase by transferring ledger space over Fedwire. (The size of a single Fedwire transactions is currently limited to $9.99 billion). When John Doe wires a college $80,000 to pay for his daughters tuition bill, ledger space is being moved from John Doe's bank to the college's bank via Fedwire. The lifeblood of the US commerce pumps through Fedwire.

The Fedwire infrastructure is currently hosted at the Fed's East Rutherford Operations Center (EROC) at 100 Orchard Street, East Rutherford, New Jersey (see map below). While most of the world's attention is usually focused on the Fed's Washington headquarters at 20th Street & Constitution Avenue, the importance of Bernanke's office pales in comparison to 100 Orchard Street. All vital information pertaining to the Fed's ledger is maintained on computers at EROC. If a bank wants to transfer ledger space to another bank, the payment is routed to EROC where it is processed and the Fedwire database updated. This system is a hub and spoke system, with EROC serving as hub for its member bank spokes. In the picture at top, it is the system on the left, a centralized network.


View Larger Map

Because Fedwire is so important, it needs to be resilient. Should disaster strike at the East Rutherford hub, a secondary back up data center at the Federal Reserve Bank of Richmond is designed to resume Fedwire operationality 60 - 90 minutes later. A third backup center exists at the Federal Reserve Bank of Dallas.** The weakness of the system is that if the hub is destroyed (and the second and third backups) then the entire payments infrastructure disintegrates.

An alternative (and perhaps cheaper) way to build a resilient payments system would be for the Federal Reserve to adopt a bitcoin-style distributed ledger. The Fed's ledger would no longer be stored at EROC. Rather, all member banks would hold a copy. Much like a bitcoin miner "mines", a member bank would be an independent node responsible for helping to maintain the ledger's integrity. Should a bank want to exchange ledger space, the transaction would be announced to the network of member bank nodes who would in turn poll each other to verify the legitimacy of the transaction. Once a consensus has been arrived at, the payment would be processed and the Fed's ledger updated. As a condition of membership in the Federal Reserve System, banks would be required to act as verification nodes.

What would be accomplished is a decentralization of the information contained in the Fed's ledger. The ledger would be everywhere rather than at one spot. Transfers of ledger space would no longer be patched through the central processor at EROC but would be handled by a distributed network of cooperating nodes. Whereas the current hub and spoke system has two levels of redundancy, Richmond and Dallas, a distributed system has no central hub and therefore much more layers of redundancy. It would be very difficult to destroy it. Such a system is represented in our top chart by the network on the right, in which no entity is more important than the other.

All of this is an exercise in speculative economics, of course. But I like to think there's a grain of truth in it. Whether you agree with me or not on the possibility or likelihood of the Fed adopting a bitcoin-style distributed ledger as the basis for Fedwire, at least you'll see why Krugman has been too hasty in writing off bitcoin as a retrogression. Distributed ledgers are cutting-edge and will have many applications in the future.

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PS. In the burst of attention over the last few weeks, the press and pundits have all become a bitcoin experts, just like they were Cyprus experts in the previous news cycle. There are three blogs worth reading that offer more stable and permanent bitcoin fare. Peter Surda wrote his thesis on bitcoin, so do go by and check his blog The Economics of Bitcoin. Jon Matonis has payments industry experience and has been following bitcoin for far longer than myself or any journalist. He blogs at The Monetary Future. Finally, Mircea Popescu owns and operates MPEX, the largest bitcoin stock and options exchange, and knows all the excruciating detail of the system's inner functioning. He blogs at Trilema.


* Fedwire statistics
**Payments, Clearance, and Settlement: A Guide to the Systems, Risks, and Issues by the General Accounting Office (1997) PDF

The difference between Sumner and Krugman on liquidity traps

Daniel Kuehn and Robert Murphy wonder why Scott Sumner takes Paul Krugman to task on liquidity traps when they each seem to be saying the same thing - monetary expansion will get you out of a trap.

The phrase "monetary expansion" can mean many things. I think Krugman and Sumner have categorically different opinions concerning one specific sense of the phrase  – quantitative easing's ability to have independent effects in a liquidity trap, .

When it comes to thinking about monetary policy, Krugman, Delong, Eggertson, Woodford, and other New Keynesians begin with a frictionless model populated by rational agents. No individual has the power to set prices and everyone can attain any quantity of assets at a given price. There is no limit on borrowing. With these assumptions and interest rates at zero, quantitative easing is powerless. That's because all asset prices are uniquely determined by the present value of their future cash flows. A central bank that threatens to buy bonds/stocks/gold so as to push their prices above their fundamental value will be unable to do so. All central bank purchases will be met with a wave of hedge funds sales (and short sales), thereby ensuring that the prices of these assets stay at their fundamental value. QE can't get any traction, so it's irrelevant.

On the other hand, Sumner, Nick Rowe, Miles Kimball, and others attribute an independent effect to quantitative easing. This is because they either explicitly or implicitly do not accept the assumptions of the frictionless model used by Krugman et al.

The market monetarist's departure from the assumptions of a frictionless model begins with the colourful idea of Chuck Norris walking into a room and telling everyone to get out. If they don't, he'll beat them up. Because his threat is credible, people file out of the room without Chuck Norris having to lay a finger on them. Now take a central bank that threatens to move up prices through large scale asset purchases. Hedge funds refusing to accept the threat will be pummeled by the central bank. Rather than resist, hedge funds cry uncle. Asset prices rise above their fundamental value because Chuck Norris says so. That's how QE gets traction.

So the difference between New Keynesians and market monetarists seems to rest on a few assumptions. In a frictionless model, hedge funds will undo the effects of central bank purchases. In a market monetarist model, hedge funds can't beat Chuck Norris and QE has bite. It'll be a long time before Krugman and Sumner agree on the specifics.

Sources:
Nick Rowe, Miles Kimball (here, here and here) , Michael Woodford (pdf), Paul Krugman (and here). See my old posts Don't fight the Fed and QE Zero.

The Social Contrivance of Money... a bit contrived?

An Old Man and his Grandson, circa 1490. Domenico Ghirlandaio

The title of this post comes from this Paul Samuelson paper. Paul Krugman mentioned the paper last week, as did a few others, including Bob Murphy and Garett Jones. Nick Rowe has brought it up a few times (here for instance). So I trudged through it. Here are a few quick thoughts.

The setup goes something like this. Samuelson comes up with a science fiction world in which there's a young generation and an old generation. There are no durable goods. So if the current generation can't save, how can it prepare for a retirement in which it can hardly produce anything? Retirement will be "brutish".

On the other hand, what if they print "oblongs of paper" and "officially through the state, or unofficially through custom, make a grand consensus on the use of these greenbacks as a money of exchange." Then the current generation will be able to acquire some of these paper bits and exchange them in their old age to the young for consumption. The world is now a better place, thanks to the social contrivance of fiat money. [Note: by fiat, I mean intrinsically useless and valueless].

This is an interesting model. But just because the model says that the social contrivance of fiat money is an optimal solution doesn't mean that modern central bank money, which by all means appears to be like the fiat money in Samuelson's model, is likewise a social contrivance.

Samuelson never addresses the incredible degree of inter-generational coordination that would be required to arrive at a social contrivance that dictates that useless objects must be accepted. Why would future generations accept bits of paper if they don't know from the start that the next generation won't laugh at it? Think of the incredible amount of government resources that would be required to enforce the "grand consensus" or, absent force, the quantity of storytelling that would be necessary to instill the customs necessary for fiat to always be accepted.

Samuelson's "social contrivance" is in many ways similar to the idea of a Walrasian auctioneer. Both mechanisms do herculean amounts of work. But outside of an overlapping generations model, this work would be tremendously costly. Now I don't doubt that we could arrive at a social contrivance of fiat money if we really put the resources into it, but why bother? If we want items that are capable of storing wealth over time, we can skimp on the tremendous effort of running a fiat scheme by using things that already have some intrinsic value. A modern central bank that issues well-backed credit will do, as will commodities like gold. The intrinsic value of a commodity or credit item will adequately secure the confidence of the various generations that any exchange they participate in will be fair and quid pro quo. Intrinsic value thereby performs the same function as Samuelson's social contrivance… but at far less cost.

The other thing I noticed about Samuelson's model is that he misappropriates the word "money".  Money is commonly considered to be a highly liquid object, but in Samuelson's model his green bits of paper only get passed off once every generation. For the rest of time they are simply held. The bits of paper that restore his science fiction world to health could equally be called guano, social security, or whatever. In short, his model explains the possibility of fiat stores of value, but not fiat means-of-exchange.

So to sum up, using Samuelson's model of fiat money in order to explain modern central bank money doesn't follow. Social contrivances are expensive. Far easier to secure each generations' trust and participation by setting up a central bank that issues intrinsically valuable and well-backed notes and deposits. A central bank therefore spares society from spending the mass quantity of resources that a socially contrived fiat item would require.  Modern central bank liabilities may look like the socially-contrived green bits of paper in Samuelson's paper, but they aren't.

Greece is no Argentina

Paul Krugman compares Greece to Argentina. Devaluation in Argentina surely helped, and so would it in Greece. But there's a problem. See my comment:

The comparison to Argentina is a poor one. Argentina's central bank was a fully-operational currency issuer when it lifted its peg, and the peso already circulated along with dollars.

Greece's central bank is currently in-operational as a currency issuer; drachmas simply don't exist.

Should the Bank of Greece try to relaunch itself, will its drachma liabilities be voluntarily accepted as mediums of exchange? Probably not, for the same reason its bonds are worthless. Like the Greek government, the BoG simply has no credit. Compounding this is the fact that already-existing euros circulate in paper form, and the fact that so many Greeks have accounts in German banks they can use for payments. Given this broad array of payments choices, the free drachma will be stillborn.

Nor can drachmas be forced into circulation. A country that can't enforce tax laws can't enforce legal tender laws. No, the drachma won't be reappearing any time soon.

Krugman assumes that the euro is like a glove. You can put it on and take it off easily. In actuality the Euro is more like a Chinese finger-trap. It's easy to put on, but once you're in, getting out is well night impossible. As attractive as devaluation is, that's not the core issue. There simply is no way to get from here to there.

Greece will either stay in the Eurosystem, or will try to leave and end up with euro anyways. The latter is informal euroization.

On the problem of ensuring the acceptability of a new fiat money, see George Selgin.

GDP totalitarianism: Krugman's mischaracterization of Japan's plight as "star performance"

Paul Krugman points to Japan's apparent resurgence in GDP and asks: "There seems to be some kind of lesson here about macroeconomics, but I can’t quite put my finger on it …"

My comment:

The lesson here is that one needs to be careful when trying to understand natural disasters using flow-based identities like Y=C+I+G. The latter fails to account for large draw-downs in national wealth due to, say, tsunamis. Using a stock identity, and stock related data like national net worth, will be more helpful in this situation.

For a proper accounting treatment of Japan's experience, Krugman should refer to the 722 page UN System of National Accounts Manual (pdf). Krugman wants to use the production accounts for his analysis, which are represented as flows. He should be using the wealth account, in particular new worth, which is a stock. The tsunami will have resulted in a large fall in Japan's net worth. This is elementary, so I don't know why a Nobel-prize winning economist wouldn't know this.

I agree with Nick Rowe that GDP has a totalitarian grip on our way of economic thinking.

Escaping the zero-lower bound by only printing $20s

Scott Sumner had a good post on the difficulties of escaping the zero-lower bound when you speak in the language of interest rates. Here he is:

Krugman was way ahead of the profession in 1998 when he emphasized that monetary policy wasn’t about the current setting of the policy instrument, but rather the expected future path. But he didn’t take that far enough. That implies that the current instrument setting is primarily a signaling device. And that means you really need an instrument that doesn’t become mute when you most need it to speak loud and clear. In other words, nominal interest rates are the worst possible instrument. 

In the comments I proposed one way to escape the zero-lower bound:

The Fed simply has to set a negative federal funds rate or IOR, and to prevent everyone from holding their savings in 0% interest cash, impose a compensating burden on cash holders by issuing only $20 bills and lower. This will impose significant inconveniences on cash holders, mainly storage costs, and let the fed funds rate remain below 0.

One problem with this policy would be its negative effect on the $ brand. US $100 and $50 bills are prized all over the world. Cease issuing them, and people might permanently switch to Euros. This would cause the proportion the Fed's zero-interest liabilities to permanently shrink relative to its floating interest liabilities (reserves). That's fine when interest rates are negative or near zero. But when they start to rise, so will the Fed's interest costs, thereby shrinking the Fed's profits and the dividend it pays each year to the government. In other words, less seniorage. Zero-interest cash is a great funding source.

Debt, generations, savings, and economic categorization or the "Borges Problem"

I didn't comment much on the great debt debate, stirred up a Krugman post called Debt Is (Mostly) Money We Owe to Ourselves, but followed it quite closely.

Nick Rowe taught me (here, here, here, and here), and Bob Murphy clarified (here, here, here, here, here, here, here, and here), that present generations can indeed take resources from future generations via debt issuance.

I also learnt via Daniel Kuehn here and here that if you use a very unintuitive definition of "generations", than this is not the case. Basically, you can swap the meanings of terms to argue your way out of a tight spot.

My comment is from a Murphy post:

I’ve learnt that the method by which one aggregates individuals into groups, and the labels that one attaches to such groups, can have an important influence on a debate’s ability to reach resolution. If people are aggregating differently, and using non-standard words for their categories, then the debate will degenerate into shouting matches.

In a comment on a post called Why "saving" should be abolished, Nick describes this as the Borges Problem, which I rather like. Says Nick,

Let me first do one general response:

 There are lots of different ways we can divide up the world into categories see Borges on "animals" http://en.wikipedia.org/wiki/Celestial_Emporium_of_Benevolent_Knowledge%27s_Taxonomy

 Which would be the most useful way to divide up income, and define saving?

 Which of these 3 definitions of desired saving is the most useful?

Nick later on:

Notice also that the recent debate about the burden of the debt was also an example of the "Borges Problem". Do we divide the future up into time periods or into cohorts? We get very different results depending on how we categorise the world. And sometimes the categories we use are chosen by someone long ago who had a totally different purpose and/or a totally different theory to ours. Our way of seeing the world gets distorted by the dead hand of historical ways of seeing.

Yes! I did notice that. It caused me a lot of confusion. Nick also notes that the solution is to choose the most useful categorization out of all possible options, and proceeds to advocate a different category to which we should attach the word "savings". Interesting stuff. I'm not sure how Nick proposes we solve for "usefulness" though. Isn't the fact that almost everyone uses the same term for a given categorization a good enough claim for usefulness?

Here's another Rowe comment on Kuehn's blog which is relevant:

Put it another way: there's more than one way to aggregate. We shouldn't let our theories of what is happening in the world be determined by the choices made by long-dead National Income Accountants.

Anyways, in my comment on Nick's savings post, I proposed a more useful (at least to me) Borgian response to the categorization problem. Instead of categorizing the world on the basis of flows, categorize it as a series of balance sheets, or stocks. The result is that consumption, investment, and savings are all attached to entirely different bins (and more intuitive ones, to me at least) than in a world composed in terms of flows:

Nick, I agree with you that the conversation on debt was mainly about categorizations and the lack of standardized terms associated with categorizations. That made it very frustrating to follow.

So I am all in favor of standardizing terms, as you advocate in this post. 

I noticed you originally introduced C and I as flows and A and M as stocks. Then when you brought in the individual's economy, you introduced not a stock of antique furniture, but a flow of antiques, and not a stock of money, but a flow of money. Presumably you did this to preserve stock flow consistency.

The idea of a flow of antiques or money is very unintuitive to me. Why not go the other way? Not flows of consumption and investment, but stocks? Thus you have and individual's goods C, I, A, and M, which are all stocks. Sum them all up and you have S (the noun form of S, not the verb). This S can rise or fall. As a solution to the Borgian categorization problem, this configuration makes more intuitive sense to me.

And later:

N: "but if we think of income as a flow, then thinking of C and I as stocks is going to create problems."

 Me: You start out with the C and I that you have produced in your stock of assets, hold this C and I until you find someone who'll exchange for them with the M they have in their stock of assets. Now they are holding C and I and you are holding M. So here income isn't a flow, it's just a trade, an instantaneous swap of assets held in a portfolio.

 How much of economics is taken up by definitional debates and confusion? You'd think there would be a universal set of definitions for economic terms somewhere so these issues don't pop up. When I read William Hutt's books I'm always pleased because he uses his first chapter to explicitly define every term he'll be using.

and once more *phew*:

N: "Will those trades all take place in an instant, with some buying and some selling a stock of antiques? Or will those trades happen slowly over time, as people buy or sell a flow of antiques, and slowly get back to their long run desired stocks? That depends. If antiques are a small part of your wealth, and the market is frictionless with all antiques identical and so zero search costs (obviously not, for antiques). Each person would instantly buy or sell a stock of antiques to get back to his personal desired stock. Otherwise, there will be a flow of trades. If antiques are a large fraction of your wealth, you may only buy and sell slowly, in a flow."

 me: Ok, thinking in a world with stocks, (an infinite series of balance sheets), trades still happen in an instant, even if you introduce search costs. You hold the antique on your balance sheet until you don't. The antique is in your hand up until the moment it enters the hand of the buyer.

 Introducing frictions means that someone can have the intention of selling that antique and will need to incur costs to search out someone to trade. But it doesn't mean the process must be a conceptualized as a flow. Rather, the intention of selling an antique just moves the antique to a different part of an individual's balance sheet. It continues to lie in the asset column of their balance sheet, but is moved from long-term assets to current or liquid assets. Introducing search costs means that instead of an interval of two balance sheets before a swap occurring, the interval is some number larger than two.

My rough final thoughts are that thinking in terms of stocks, not flows, introduces a number of important categories that flow-based economics ignores because it is focused on flows. The most important of these is a stock of non-durable consumption goods. In flow-based economics, it's always been odd to me that factories produce, and we instantaneously use up, consumption goods.

A stock based world also is terribly confusing way to go about things, because the word savings in a flow-based world is attached to a different category than that which it is attached to in a stock based world, much like how in the Great Debt debate the word "our children" can be attached to either a period of time or a cohort.

Japan, Productivity Norm, and Deflation

Lars Christensen teaches me some interesting things about Japan and deflation in Did Japan have a “productivity norm”?

See also an older post here titled Japan’s deflation story is not really a horror story.

This involves George Selgin's idea of the productivity norm. See Less than Zero (pdf).

I notice that Paul Krugman has also chimed in on Japan, charting GDP per working age citizen rather than GDP so as to adjust for demographics.

*Update: Lars has responded to the Krugman post here, and includes another chart. As I pointed out in the comments, I am not entirely convinced by his chart because he computes it on a per capita basis, not a per worker basis. Krugman's chart measures the ratio of Japan's per worker GDP to that of the US, which is a more powerful way to visually tell the tale. Unfortunately the time axis's resolution is by the decade in Krugman's chart, which gives no granularity, and he only includes the US.

So I made my own chart.

I think it's worth noting that, in regards to Lars's post, Japan's relative per worker GDP bottomed in 1999 and began to rise, which was before quantitative easing began in 2001. 

As for Krugman, my chart doesn't show the same large rise in Japanese per worker GDP relative to the US in the 2000s that his chart shows. It was more of a pause. But I am using World Bank data, and Krugman is using something else. Note also how Japan has done far better than Germany, France, and Italy.

**Update: Krugman has another post, More On Japan (Wonkish).