Wednesday, May 13, 2009

Mankiw's Negative Interest Rate Solution

The following link is old but I can't seem to get it out of my thoughts.

April 18, 2009
It May Be Time for the Fed to Go Negative

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

I strongly suspect Mankiw has vastly underestimated how effective his solution would be at thwarting deflation. Mish offered a great heckle but I've decided to do a serious heckle of my own. If nothing else, I've had a month to think about it.

I think Mankiw's solution needs a name. I propose...


Currency Crisis

A currency crisis, which is also called a balance-of-payments crisis, occurs when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value.

1. 10% of the currency is destroyed instantly at the time of the Fed's announcement. That's clearly meets the "value of a currency changes quickly" criteria and therefore undermines the currency's ability to serve as a medium of exchange or a store of value.

2. Not knowing which 10% has been destroyed until a full year has passed adds long-term uncertainty. We know that uncertainty breeds fear and panic. Fear and panic clearly undermine the currency's ability to serve as a medium of exchange or a store of value.

3. The currency is destroyed randomly by pulling a number out of a hat. Randomness is the very essence of uncertainty. Once again, more fear, more panic, and it further undermines the currency's ability to serve as a medium of exchange or a store of value.

4. Would the currency truly be destroyed randomly? Imagine the money that could be made for those who knew ahead of time which dollars would turn worthless. Conspiracy theories and rumors about a currency can clearly undermine its ability to serve as a medium of exchange or a store of value.

5. If the government is willing to destroy 10% of the currency instantly, then most reasonable people would entertain the notion that the government might do it again. This adds even more uncertainty, more fear, more panic, and undermines the currency's ability to serve as a medium of exchange or a store of value. Worse, markets tend to look ahead. How much future currency destruction would be priced in immediately?

6. Our currency is backed by faith. It says right on the dollar that "This note is legal tender for all debts, public and private." If it no longer was legal tender, then the dollar would have incorrect information on it (a lie). That would transform the faith-based currency into a lie-based currency. That would clearly undermine the currency's ability to serve as a medium of exchange or a store of value.

Mankiw says, "the expected return to holding currency would become negative 10 percent." Based on what I've written here, I would argue that it could easily approach something closer to negative 100%.

Behold the power of compound unintended consequences and the ability of mainstream economists to ignore them.

8 comments:

Anonymous said...

RIO RANCHO, N.M., May 14 (Reuters) - President Barack Obama raised the prospect on Thursday that China and other nations could stop buying U.S. debt and said the United States needed to tackle its deficit to avoid long-term economic damage.
http://www.reuters.com/article/bondsNews/idUSN1450425320090514

I don't know when he's going to clue in the Peeps that SS and Medicare are going to get thrown under the bus, tax's are going to increase and inflation is going to stalk the land but I'm sure he'll get around to it eventualy.

Kevin

Stagflationary Mark said...

Kevin,

"...inflation is going to stalk the land..."

No problem! We'll sell that land!

http://latimesblogs.latimes.com/laland/2009/05/selling-off-state-real-estate-to-help-the-budget-.html

"Gov. Arnold Schwarzenegger wants to sell the Los Angeles Memorial Coliseum, San Quentin State Prison, the Orange County Fairgrounds and other state property to raise cash amid the state's growing fiscal crisis, according to a copy of a proposal reviewed by The Times."

Perhaps Obama can follow California's lead?

Come on down to Crazy Obama's "Capital for Capitol" going out of business sale! Everything must go! We won't be undersold! The first 500 bidders on the Pentagon will get a free shot of imported Vodka! And don't miss the silent "grab bag" auction on Fort Knox! That one's sure to be a hit!

EconomicDisconnect said...

Mark,
It was funny that the other night you had a story with robots in it. I had a poll up a while ago that asked what the next big bubblw would be with the usual susupects; gold, oil, the dollar, real estate and one outlier-robots. I caught a bunch of flak on the robot thing, but really they could be the next bubble! Here was the post:
http://tinyurl.com/psnl69

Great post on the Mankiw article, I hated that thing when it came out!

Stagflationary Mark said...

GYSC,

"It was funny that the other night you had a story with robots in it."

Here's what's funny to me. You posted a few links from "The Onion" recently. I was actually planning to post the "Nation Ready To Be Lied To About Economy Again" article but was surfing on the Playstation 3 at the time (not very easy to use it to post).

That link is a riot. Here's what you posted for those who might not have seen it.

href=http://economicdisconnect.blogspot.com/2009/05/two-chances-to-make-difference.html

Anonymous said...

Mark,

"Perhaps Obama can follow California's lead?"

Maybe he could do us all a favor and sell California.
LOL
Kevin

Stagflationary Mark said...

Kevin,

Green Shoots + Gang Economy = ????

California's Gangrene Shoots US Economy!

It all makes sense now!

Sell it? No. Sever it before it infects us all, lol.

Shame on me. Gallows humor.

EconomicDisconnect said...

Mark,
Not sure if you are following the Mark Patterson drama, but I was able to get a copy of the letter the Treasury sent to him to get him to recant his Qatar words:
To: Mark Patterson of MatlinPatterson
From: The Treasury, you Punk
Re: Stupid words, but we can save this thing yet!

Mr. Patterson,
We at the Treasury were deeply saddened to read your comments made in Qatar concerning the TARP program. While we bent over backwards to hand out money so you and your ilk could spend taxpayer money to enrich yourselves, we are rewarded with this kind of slap across the face. Here at the Treasury we have a saying:
"Don't' Piss Down My Back and Tell Me It's Raining!"
Which yes, we stole from the "Outlaw Josey Wales"; regardless please be advised that we do not take kindly to being portrayed as ripping off the public, we are doing that, but to say so is poor taste.

Luckily after review of your comment transcript we at the Treasury have a way this can be fixed. Please find the text of what your new comments to be made, no later than Friday Morinng May 15th, will include. Do not change or alter these words in any way:

"On my comments in Qatar I would like to clarify some items that were fabricated, misstated, misquoted, and mischaracterized. While I did use the word "sham" what was not reported was that I stated that the TARP program was in fact a huge "SHAM-WOW" that was in effect sopping up the market ills of bad assets. This service is vital to the smooth flow of credit to households and small business. It has been reported that I said the taxpayers were getting "ripped off" but if you listen to the transcript closely you will hear that what I said was that losses for the taxpayer on TARP had been "WRITTEN OFF" as impossible because the deal they were getting was so awesome.

Thanks in advance for any corrections and any removal of any archived web material that states otherwise.
Mark Patterson"

The Treasury trusts you will follow our guidelines as not to jeopardize the bank secondary offerings during this silly market bounce. Not that we are threatening you, but we do control the IRS and your MySpace page does include many "friends" of the female gender that are, how shall we say, of an age bracket that may become inconvenient should the FBI want to look into it. Not that we control the FBI.

Thanks in Advance,
The Treasury, you punk.

Im kidding!!!!!!!!!!!

Stagflationary Mark said...

GYSC,

It's sad that you have to actually point out that you are kidding. Sigh. ;)