In my last thread on Gorton and Zhang's new working paper, I criticized their criteria, in Table 1 of their paper (p. 5) for selecting among options for regulating stablecoins. Here I turn to the paragraph immediately following that table, which itself calls for a thread.
Here they claim that the option of requiring that stablecoins be 100% backed by reserves or Treasurys "ties two forms of money together at a fixed ratio," thereby making "a shortage of one pf the forms of money" likely.
To illustrate, they point to the currency shortages that plagues the pre-Fed national currency system (1866-1014). They say these were caused by nat'l banks reluctance "to move all the Treasuries to back national bank notes," that this caused deposits to expand instead, and
that in consequence "demand deposits basically became the shadow banking system of their time, and there were runs on demand deposits."
I hardly know where to begin pointing out just how perverse this account is. It actually turns the received--and correct--account of what went wrong with the national currency on its head! The problem wasn't that deposits weren't backed by bonds: it was that notes had to be!
That note backing requirement, originally aimed at financing the Civil War (it was neither necessary nor sufficient to keep national banknotes at par), ended up artificially constraining note issuance because the requisite bonds became scarce and costly to acquire,
That happened because the government ran routine post-bellum surpluses, and used them to retire its debt. Treasurys soon commanded a premium. As the premium rose, it became harder and less profitable for national banks to maintain their note circulation.
Between 1880 and 1890, as the bond premium rose, the quantity of national bank notes fell by 50%! Yet the economy was growing. There were major "currency panics" in 1884 and 1893 and another, bigger panic in 1907.
All authorities understood then, and most understand today, that the bond-backing requirement was to blame, not just for cyclical currency shortages, but for seasonal ones: hence the complaint that the U.S. currency stock was "inelastic."
Had national banks been able to issue notes on the basis of their general assets, as banks elsewhere could, there would have been no shortages. Instead, the quantity of notes, and the note-to-deposit ratio, would have varied with demand.
That's why other countries did not experience U.S.-style crisis. Canada was the most famous example of this: same gold dollar, same seasons, highly depended on exports to the U.S., yet--no currency crises.…
Yet there were several dozen Canadian banks of issue during the last decades of the 19th century, their notes were backed by general bank assets (mostly loans), and they weren't insured. Here's a picture showing how the currency supply behaved there and in the US:
(Bear in mind Canada was about 1/10th the size of the U.S. in wealth. Hence the difference absolute magnitudes.) Canada did experience occasional bank runs and failures. But they mostly involved small banks, and compared to the U.S. losses to bank liability holders were trivial.
GZ are, so far as I know, the only authors to try and suggest that pre-Fed U.S. banking crises were a result of too many bank deposits, rather than too few national banknotes!
I submit they offer this strange view because they need a story that squares with their claim that private money can't work unless its fully gov't backed. So: backed national bank notes = good private money; unbacked deposits = bad private money. Convenient. But wrong-Very wrong.

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More from @GeorgeSelgin

20 Jul
Thread: The right way to go about deciding how to regulate stablecoins.

Having explained why loose (and misinformed) comparisons with 19th century banknotes are the wrong way to proceed, I thought I'd offer some positive suggestions.
(1) Acknowledge the fact that there are many types of stablecoins, with different underlying technologies and principle uses. It is highly unlikely that any broad-brush regulatory treatment will be appropriate to all.
(2) Stop calling them "money." They are niche exchange media, not generally accepted exchange media. And that is itself not a bad thing so long as national monies are also available.
Read 13 tweets
20 Jul
Anti- GZ, cont'd: the rise of national currency (pp. 27ff.) GZ conclude their discussion of antebellum currency by stating that, because that currency violated the NQA (No Questions Asked) principle, the antebellum "community had no money."
As I've already pointed out, regarded as a description of conditions on the eve of the Civil War, is very misleading, in part because there was by then no shortage of official coins, which were undoubtedly national NQA means of exchange.
As for state banknotes were, although discounting cont'd to disqualify them as truly "national" currencies, by the 1860s these discounts tended to be modest. Furthermore, almost all state bank notes were par monies for their "state" communities, if not in some surrounding states.
Read 25 tweets
19 Jul
My Gorton and Zhang critique series continues with a look at their discussion of antebellum U.S. currency (pp. 23ff.) Although their discussion of that history is better than many other recent ones (see…), it is still misleading.
Although GZ recognize that most bank failures back then had nothing to do with "wildcat" banking, they still exaggerate the extent to which antebellum currency was (literally) "subpar."
Just as CZ "cherry pick" by focusing on US currency experience, ignoring what happened elsewhere, they also cherry pick from the diverse US record. I've already noted how they ignore the Suffolk System's successful achievement of a uniform New England currency--a "good" cherry.
Read 18 tweets
19 Jul
Gorton and Zhang's highly eccentric interpretation of pre-Fed banking crises isn't just inaccurate: it's topsy-turvy. And, like many of their paper's historical claims, it is contradicted by a wealth of evidence from other banking systems. 1/2
The _fons errorum_ of this and many of GZ's other mistaken arguments is their assumption that private monies must be 100% backed by reserves or Treasurys, or otherwise fully guaranteed by the state, to be stable and to trade at par.
While such arrangements can contribute to stability, they are neither necessary nor sufficient. Indeed, the Treasurys-backing requirement for national bank notes, for example, was a fundamental _cause_ of instability under the pre-Fed national currency system.
Read 8 tweets
18 Jul
I ended my first thread on Gorton and Zhang's new working paper (…) by observing (with a nod to work by the late, lamented George Kaufman) that bank runs aren't necessarily a bad thing:…
That makes for a neat segue to my next criticism, concerning GZ's table 1 (p. 5). Here they consider various "Options to Address Stablecoins," asking of each whether it (1) would eliminate runs on stablecoins and (2) would make it unnecessary for their users to scrutinize them.
Based on those assumed goals, they narrow down acceptable options to three: treatment like ordinary banks, 100% reserve (or Treasurys) backing, or replacement w/ CBDC, that is, outright prohibition.
Read 24 tweets
18 Jul
I see now that, despite my fond hope of having a last, quiet day off from work (I have been o leave recovering from minor surgery), I have to continue my (probably futile) attempt to counter Gorton and Zhang's misleading article. But before I do, some preliminaries.
First, I am not doing this because I'm especially fond of stablecoins, or because I don't think they need to be regulated or even because I don't consider them especially risky. Personally, I wouldn't touch a stablecoin with a 10-foot pole.
Nor am I pitching any sort of "free banking." I only want people to understand how past free banking systems worked, and what self-regulating capacity they harbored, because I believe this understanding will help inform sounder bank regulatory policies.
Read 6 tweets

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