Resolving Moral Hazard of Currency Manipulation

Dr. Sankarshan Acharya
University of Illinois (U.S.A.)
and Research Center for Finance and Governance (India)

November 8, 2010

The constitution in most democracies guarantees (i) equal protection of everybody's earned wealth and (ii) economic stability.

Economic stability can be ensured only through policies which maintain economic equilibrium. My economic paradigm for constitutional governance obtains such policies within a model of general equilibrium. Unless one finds errors in this model or in the proof of the general equilibrium results, the policies that obtain in equilibrium should be serious basis of economic stability enshrined in the constitution.

The only way to disprove efficiency and constitutionality of policy proposals based on my economic paradigm is to construct a more general model of the economy (than my general equilibrium model) and obtain different equilibrium policies from those I have derived.  Since my model was first published on the Federal Reserve research paper series 1991, no one has come up with a more general model for constitutional economic governance than I have, to the best of my knowledge.    

The general equilibrium obtained within my model shows that some firms and households may choose to hold a part of their earnings in the form of the safest asset in the economy, while deploying the rest of their savings in risky enterprises. Only the government can offer the safest asset in the form of a fiat currency without compromising its integrity by surreptitiously creating or printing it.

My paper on economic paradigm for constitutional governance does not delve into the mechanics of creating a fiat currency and maintaining its integrity. This paper tacitly presumes (via axioms) that the government is mandated by citizens to maintain a fiat currency with integrity for exchange of labor and all kinds of produce (goods, service, ideas, etc.) and for storage of net savings. I thus obtain in equilibrium a Safe Central Bank.

This equilibrium result within a very general model of the economy is obviously at adds with the proponents of elimination of the central bank. But my Safe Central Bank, not the Federal Reserve, grants equal protection of everybody's savings, as enshrined in the constitution of the U.S. This means that to be the Safe Central Bank of the economic equilibrium in my model, the Federal Reserve Act of 1913 must be repealed and a new Safe Central Bank Act should be enacted to grant equal protection of everybody's safe assets.

Equal protection of everybody's safe assets will include disabling the central bank's power to print fiat money to be usurped by the government or privileged financial firms. This is the only way to maintain integrity of the fiat currency that is supposed to secure everybody's wealth.

Maintaining the integrity of paper currencies like the dollar, euro and yen has been impossible, of late, as the current global turmoil indicates. The paper currencies are being printed (manipulated) whimsically by the central banks to meet inefficient government expenses around the world.

China has beed accused of being the primary currency manipulator. But China accuses the Federal Reserve for manipulating the value of dollar by printing money, which is euphemistically called quantitative easing. See the postscript for Federal Reserve's justification for quantitative easing. I have made a proposal to the U.S. President and Congress for strategic quantitative easing to redress the current economic malaise.

Countries may also like to maintain optimal values of their currencies determined by balancing employment growth and stability, which is beyond the standard theory of purchase power parity of currencies.

Manipulation of paper currency has caused the most serious moral hazard problem around the world. The principals of the fiat currency are the producers of globally competitive goods, services, merchandize and ideas. The agents are the governments. The principals have entrusted their agents with the responsibility to maintain the integrity of fiat currency. By printing paper fiat currency, the agents have not only vitiated this trust. They have also inefficiently and unconstitutionally manipulated the value of individual labor and produce. As a result, those who produce little have amassed vast quantities of credits laden as net debt on those who labor and produce the most to prop the fiat currency.

The current system of money and finance obviously manipulates the integrity of fiat currency. Manipulation is inefficient and unconstitutional. It causes usurpation of produce and labor by the manipulators. Persistent manipulation of fiat currency will eventually lead to calls by people to abolish the central bank. Congressman Ron Paul of the United States Congress has called for elimination of the Federal Reserve. Feedback from main street calls for elimination of the Federal Reserve as well as the FDIC. In a recent interview on Bloomberg calls have been made to abolish the Federal Reserve. The Federal Reserve's recent decision to buy $600 billion of U.S. Treasury securities results in new money created to boost the economy. But most countries ranging from China to Germany as well as experts in the U.S. see the Federal Reserve's action as ineffective. Leaders of top twenty economies of the world have started wrangling over it.

My paper proves that a central bank, which obtains within the general equilibrium of an economy, is constitutionally efficient as long as it is chartered like the Safe Bank specified within this equilibrium. But it does not show how to resolve the problem of moral hazard about the paper fiat currency. Using a specific commodity like gold as fiat currency (without any fiat paper currency) can cause problems due to manipulation by the current holders and miners of gold.

Manipulation of country-specific fiat currency around the world can be avoided via a single global fiat currency, based on units of raw output of widely used produce like oil, food, electricity, basic building materials and metals, and basic clothing materials like cotton and polyester yarn. A central institution like the International Monetary Fund can maintain an authentic record of the number of units of raw produce in various countries and issue prorated units of the single global fiat currency paper, while maintaining a reserve for each nation.

Before a global currency is floated, the central bank in each country can follow transparent norms to issue currency based on the quantity of raw output of basic commodities. This may not be a perfectly agreeable solution, but it will go a long way to resolving (a) the current currency manipulation by central banks around the world, (b) the moral hazard of creation of money across countries, and (c) the bottlenecks in production of the basic produce everywhere.

Sankarshan Acharya

PS: This has been circulated among leaders governing the U.S. and India.


What the Fed did and why: supporting the recovery and sustaining price stability
By Ben S. Bernanke

Thursday, November 4, 2010

Two years have passed since the worst financial crisis since the 1930s dealt a body blow to the world economy. Working with policymakers at home and abroad, the Federal Reserve responded with strong and creative measures to help stabilize the financial system and the economy. Among the Fed's responses was a dramatic easing of monetary policy - reducing short-term interest rates nearly to zero. The Fed also purchased more than a trillion dollars' worth of Treasury securities and U.S.-backed mortgage-related securities, which helped reduce longer-term interest rates, such as those for mortgages and corporate bonds. These steps helped end the economic free fall and set the stage for a resumption of economic growth in mid-2009.

Notwithstanding the progress that has been made, when the Fed's monetary policymaking committee - the Federal Open Market Committee (FOMC) - met this week to review the economic situation, we could hardly be satisfied. The Federal Reserve's objectives - its dual mandate, set by Congress - are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills.

Today, most measures of underlying inflation are running somewhat below 2 percent, or a bit lower than the rate most Fed policymakers see as being most consistent with healthy economic growth in the long run. Although low inflation is generally good, inflation that is too low can pose risks to the economy - especially when the economy is struggling. In the most extreme case, very low inflation can morph into deflation (falling prices and wages), which can contribute to long periods of economic stagnation.
Even absent such risks, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed. With short-term interest rates already about as low as they can go, the FOMC agreed to deliver that support by purchasing additional longer-term securities, as it did in 2008 and 2009. The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

While they have been used successfully in the United States and elsewhere, purchases of longer-term securities are a less familiar monetary policy tool than cutting short-term interest rates. That is one reason the FOMC has been cautious, balancing the costs and benefits before acting. We will review the purchase program regularly to ensure it is working as intended and to assess whether adjustments are needed as economic conditions change.

Although asset purchases are relatively unfamiliar as a tool of monetary policy, some concerns about this approach are overstated. Critics have, for example, worried that it will lead to excessive increases in the money supply and ultimately to significant increases in inflation.

Our earlier use of this policy approach had little effect on the amount of currency in circulation or on other broad measures of the money supply, such as bank deposits. Nor did it result in higher inflation. We have made all necessary preparations, and we are confident that we have the tools to unwind these policies at the appropriate time. The Fed is committed to both parts of its dual mandate and will take all measures necessary to keep inflation low and stable.

The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.

The writer is chairman of the Federal Reserve Board of Governors.