Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

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Tue, 27 Dec 2016

Financial crises prior to the typewriter

The Bank of England’s Bank Underground blog has a “Christmas Special” on financial crises in the UK in 1847, 1857 and 1866. The first commercially successful typewriter was invented only in 1868 and so all the letters from the Chancellor to the Governor of the Bank of England were handwritten. I was familiar with these letters from reading Andreades’ excellent History of the Bank of England, and several other sources, but unlike the Bank Underground blog posts, none of these sources contain any facsimile of the actual letters. What struck me was that these letters were written in rather poor handwriting. The blog posts take the pain of transcribing these letters, and without this, I would not have been able to decipher some of these words. This is all the more surprising since Andreades does state (at least in once case, page 336) that the official letter was sent two days after the Bank of England was unofficially informed about the decision.

Bank Underground also links to a newspaper article written by Karl Marx about the 1857 suspension of the Bank Act. I find it hard to disagree with the following observation of Marx about the report of the Select Committee of Parliament on the operation of the Bank Act:

The Committee, it would appear, had to decide on a very simple alternative. Either the periodical violation of the law by the Government was right, and then the law must be wrong, or the law was right, and then the Government ought to be interdicted from arbitrarily tampering with it. But will it be believed that the Committee has contrived to simultaneously vindicate the perpetuity of the law and the periodical recurrence of its infraction? Laws have usually been designed to circumscribe the discretionary power of Government. Here, on the contrary, the law seems only continued in order to continue to the Executive the discretionary power of overruling it.

More than a century and a half later, nowhere in the world have we been able to solve this dilemma of the excessive discretionary power of the government in times of crisis.

Posted at 17:55 on Tue, 27 Dec 2016     View/Post Comments (0)     permanent link


Mon, 19 Dec 2016

Euro Introduction as Demonetization

Peter Guy at Regulation Asia has an interesting piece describing the introduction of the euro as a process of demonetization:

Europeans practiced excessive cash-based tax avoidance for decades before the euro arrived. When forced to exchange their paper currencies, lira, francs, and pesetas, bundles of cash emerged in suitcases to buy other cash-generating assets like real estate.

The irony of it all is that today the €500 note is the currency note of choice for money launderers because of its large denomination (the 1000 Swiss franc note is more valuable but it is nowhere near as ubiquitous as the euro note). As Guy points out:

The euro was easier to launder with banks around the world than the individual currencies it replaced.

Guy also refers to the dangers of a cashless society, but that argument has been made far more eloquently and persuasively by Scott Garrett. The more I think about these issues, the more I think that cryptocurrencies must be a critical element of a modern monetary system in a democratic society.

Posted at 17:32 on Mon, 19 Dec 2016     View/Post Comments (2)     permanent link


Fri, 09 Dec 2016

A digital device for every Indian

It is my view that if India wants to replace cash with digital payments, it must be prepared to issue a digital device to every Indian and simply absorb the fiscal cost of doing so. The alternative is a tiered payment system with high quality payments for those with smartphones, a second tier solution for those with feature phones and a broken model for those with neither. Such a tiered payment system that makes some Indians second class citizens in their own country is fundamentally irreconcilable with our democratic values and with the constitutional guarantee of legal treatment.

Cash gives the poorest of the poor access to a retail payment system that meets the gold standard for payment systems: real time gross settlement in central bank money. It is unacceptable to give them anything less than this in a digital solution. Settlement in commercial bank money or other inferior forms of money can be a choice, it can never be a compulsion. I might voluntarily choose to adopt a paytm wallet or a bank wallet and take the credit risk that the wallet provider might fail; but I should not be forced to do so as the price for participating in digital payments. This means two things:

  1. The Reserve Bank of India should introduce electronic money on its own in the form of an official e-wallet because only an e-wallet filled with central bank money can replace cash. This would also solve the problem of interoperability between different wallets. A core function of the central bank is to be the “tender of the tender” – the issuer and maintainer of legal tender of the country. A central bank that abdicates this responsibility forfeits its raison d'être.

  2. Every Indian must be issued a digital device that allows first class access to the digital payment system. There is room for bringing the cost of this device down by careful design that pares it down to just its core functionality. I would think that a starting point for this might be something like the Raspberry Pi which is enough of a general purpose computer to run at least a bitcoin SPV client. The Raspberry Pi costs about $35, but a suitably pruned down device manufactured in truly large scale might cost only $20. Giving one such device to every Aadhar holder might cost about 1.5 trillion rupees.

In my view, this cost is affordable for a country at our stage of economic size and development, and is also quite reasonable in comparison to other big ticket fiscal expenditure (for example, large defence contracts, infrastructure projects or subsidy schemes). It is perfectly fine for you to take the opposite view that this cost is unacceptable. What you cannot do is to use that view as the justification for building a great payment system for the elite at the cost of taking away from the poor what they have today – a payment system (cash) that allows them to settle in real time in central bank money.

Posted at 11:34 on Fri, 09 Dec 2016     View/Post Comments (3)     permanent link