Thursday, April 25, 2013

Macon Money

Among the many fascinating people currently affiliated with the Microsoft Research New York lab is Kati London, judged by MIT's Technology Review Magazine (2010) to be among the “Top 35 Innovators Under 35.” Through her involvement with the start-up area/code, Kati has developed games that transform the individuals who play them and the communities in which they reside.

One such project is Macon Money, an initiative involving the Knight Foundation and the College Hill Alliance in Macon, Georgia. This simple experiment, amazingly enough, sheds light on some fundamental questions in monetary economics, helps explain why conventional monetary policy via asset purchases has recently been so ineffective in stimulating the economy, suggests alternative approaches that might be substantially more effective, and speaks to the feasibility of the Chicago Plan (originally advanced by Henry Simons and Irving Fisher, and recently endorsed by a couple of IMF economists) to abolish privately issued money.

So what exactly was the Macon Money project? It began with a grant of $65,000 by the Knight Foundation, which was used to back the issue of bonds. These bonds were (literally) sliced in two and the halves were given away through various channels to residents of Macon. If a pair of individuals holding halves of the same bond could find each other, they were able to exchange the (now complete) bond for Macon Money, which could then be used to make expenditures at a variety of local businesses. These business were happy to accept Macon Money because it could be redeemed at par for US currency.

The basic idea is described here:

The demographics of the participant population, the distribution of expenditures, and the strategies used by players to find their "other halves" are all described in an evaluation summary. The project had the twin goals of building social capital and stimulating economic development. Although few enduring ties were created among the players, participation did create a sense of excitement about Macon and greater optimism about its future. And participating businesses managed to find a new pool of repeat customers.

Macon money was a fiscal intervention (an injection of funds into the locality) accomplished using the device of privately issued money convertible at par. There was a temporary increase in the local money supply which was extinguished when businesses redeemed their notes. An interesting thought experiment is to imagine what would have happened if, instead of being convertible at par, businesses could only convert Macon Money into currency at a small discount.

Businesses that accept credit card payments are exactly in this situation, facing a haircut of 1-3 percent when they convert credit card payments into cash. Most businesses that participated in the original experiment would therefore likely continue to participate in the modified one. After all, businesses involved in Groupon campaigns accept a 75% haircut once Groupon takes its share of the discounted price.

But there is one critically important difference between Macon Money and a credit card payment: the former is negotiable while the latter is not. That is, instead of being redeemed at a small discount, Macon Money could be spent at par. If enough businesses were participating, it would make sense for each one to spend rather than redeem its receipts. The privately issued money would therefore remain in circulation.

What about a business that had no interest in spending its receipts on locally provided goods and services? Even in this case, there would be better alternatives to redeeming at a discount. For instance, if the discount were 3%, there would be room for the emergence of a local intermediary who offered cash at a more attractive 2% discount to the business, and then sold Macon Money at 1% below par to those who did wish to spend locally. Again, the privately issued money would remain in circulation.

As a result, the local money supply would have grown not just for a brief period, but indefinitely. The discount itself would allow for more money to be injected for any given amount of backing funds. And as long as convertibility was never in doubt, substantially more money could be issued than the funds earmarked to back it.

This simple thought experiment tells us something about policy. Macon Money provided an injection of liquidity that improved the balance sheets of those who managed to secure bonds. This allowed for an increase in aggregate expenditure, and given the slack in local productive capacity, also an increase in production.

It was expansionary monetary policy, but quite different from the kind of policy pursued by the Federal Reserve. The Fed expands the money supply by buying securities, which leads to a change in the composition of the asset side of individual balance sheets. Higher asset prices (and correspondingly lower interest rates) are supposed to stimulate demand through increased borrowing at more attractive rates. But in a balance sheet recession, distressed borrowers are unwilling to take on more debt and the stimulative effects of such a policy are accordingly muted. This is why calls for an alternative approach to monetary policy make analytical sense.

Furthermore, the fact that Macon Money was accepted only locally meant that it could not be used for imports from other locations. The monetary stimulus was therefore not subject to the kinds of demand leakages that would arise from the issue of generalized fiat money.

Finally, the project provided a very clear illustration of the difficulty of abolishing privately issued money. Unless one were to prevent all creditworthy institutions from issuing convertible liabilities, it would be virtually impossible to halt the use of such liabilities as media of exchange. Put differently, we are always going to have a shadow banking system. But what the Macon Money initiative shows is that the creative and judicious use of private money, backed by creditworthy foundations, can revitalize communities currently operating well below their productive potential. Whether this can be done in a scalable way, with some government involvement and oversight to prevent abuse, remains unclear. But surely the idea deserves a closer look?


Update. Another important feature of Macon Money is the fact that it cannot be used to pay down debt unless the creditors are themselves local. This means that even highly indebted households will either spend it, or pay down debt by selling their notes to someone who will. If increasing economic activity is the goal, this is vastly superior to disbursements of cash.

Joseph Cotterill asks (rhetorically) whether Macon Money is the anti-Bitcoin. Exactly right, and very well put.


Ashwin Parameswaran has sent in the following via email (posted with permission):
Just read your post on Macon money - fascinating experiment and your thought experiment on how it could stay in circulation was equally interesting.  
On the thought experiment, there's also a possibility that if Macon money can only be converted into currency at a discount then Macon money itself would be valued at a discount. Coming back to your example on credit cards, this often happens in countries where retailers can get away with it. Lots of small retailers in India offer cash discounts even when they give you a receipt i.e. its not just a tax dodge. Many retailers in the UK simply don't accept Amex cards because of the size of the haircut they impose.  
On the broader subject of imagining various types of money, this is probably closest to private banking money whereas Bitcoin is by design closest to gold. Another experiment is the idea of pure local credit money without even the intermediation of a private bank-like entity which seems to be the idea behind Ripple although the current implementation seems to be a little different. Over the last year I've done a lot of reading on 14th-17th century English history of credit/money and its almost universally accepted that most of the local money worked largely with such peer-to-peer credit systems with gold perennially being in short supply. The section of this post titled 'Interest-Bearing Money: Debt as Money' summarises some of my reading. The first half of Carl Wennerlind’s book ‘Casualties of Credit’ is excellent and has some great references in this area. 
You could see the entire arc of the last 400 years as an exercise in making these private webs of credit more stable. So peer-to-peer credit became private banking. Then comes the lender of last resort and fiat money so that the LOLR is not constrained. At the same time we make the collateral safer and safer - govt bonds during the English Financial revolution, now MBS, bank debt etc. The irony is that now banks finance everything except what they started out financing which is SME bills of exchange/invoices. Partly the reasons are regulatory but fundamentally the risk is too idiosyncratic and "micro" in an environment where macro risks are backstopped. 
In fact here in the UK there's a lot of non-bank and even peer to peer interest in some of these spaces. See this one for invoice financing (the interest is partly because peer-to-peer lending in the UK has almost no regulatory burden, not regulated by the FSA at all). In a way this is just a modern-day reconstruction of the same system that existed in 16th-17th century England - peer-to-peer webs of credit. But with the critical difference that the system is not as elastic and doesn't really need to be. There are enough individuals, insurers etc who are more than capable of taking on the real risk and giving up their own purchasing power in the interim period for an adequate return. 
Lots to think about here. Briefly, on the issue of Macon Money being valued at a discount, this seems unlikely to me except in a secondary market for conversion into cash. Unlike credit card receipts, Macon Money is negotiable, and as long as it can be converted into goods and services at par it will be valued at par by those who plan to spend it. Of course there may be an equilibrium in which vendors themselves only accept it at a discount, which then becomes a self-sustaining practice. This would be equivalent to a selective increase in price, possible only if there is insufficient competition.

Here's more from Ashwin:
Another tangential point on the peer-to-peer credit networks in 16th century England was that although they had the downside of being perpetually fragile (there are accounts of middle-class traders feeling permanently insecure because they were always entrenched in long webs of credit), this credit money could not be hoarded by anyone. In this sense it really was the anti-gold/bitcoin. I wonder what you would need to do to Macon Money to protect against the potential leakage of being just hoarded as a store of value. This is of course what people like Silvio Gesell were concerned with (there are some excellent comments by anonymous commenter 'K' on this Nick Rowe post on the paradox of hoarding). I think there's merit to a modern money that could be a medium of exchange but could not serve as a store of wealth. I often think about what such a money could look like but at the end of the day we really need experiments and trials to figure out what could work. 

Saturday, April 06, 2013

Haircuts on Intrade

When Intrade halted trading abruptly on March 10, my initial reaction was that the company had commingled member funds with its own, MF Global style, in violation of its Trust and Security Statement. I suspected that these funds were then dissipated (or embezzled), leaving the firm unable to honor requests for redemption.

The latest announcement from the company confirms that something along these lines did, in fact, occur:
We have now concluded the initial stages of our investigations about the financial status of the Company, and it appears that the Company is in a cash “shortfall” position of approximately US $700,000 when comparing all cash on hand in Company and Member bank accounts with Member account balances on the Exchange system.
A shortfall of this kind could not have emerged if member funds had been kept separate from company funds. As it stands, the exchange is technically insolvent and faces imminent liquidation.

But the company is looking for a way to "rectify this cash shortfall position" in hopes of resuming operations and returning to viability. It has requested members with large accounts to formally agree to allow the exchange to hold on to some portion of their funds indefinitely:
The Company has now contacted all members with account balances greater than $1000, and proposed a “forbearance” arrangement between these members and the Company, which if sufficient members agree, would allow the Company to remain solvent... 
By Tuesday, April 16, 2013, we expect to be able to inform our members if sufficient forbearance has been achieved. If so, we will then resume limited operations of the Company and we will be able to process requests for withdrawals as agreed. If sufficient forbearance has not been achieved, it seems extremely likely that the Company will be forced into liquidation.
So traders find themselves in a strategic situation similar to that faced by holders of Greek sovereign debt a couple of years ago. If enough members accept the proposed haircut, then the remaining members (who do not accept) will be able to withdraw their funds. The company might then be able to resume operations and eventually allow unrestricted withdrawals. But if enough forbearance is not forthcoming, the company will be forced into immediate liquidation.

What should one do under such circumstances? As Jeff Ely might say, consider the equilibrium.  The best case outcome from the perspective of any one member would be immediate reimbursement in full. But this can only happen if the member in question denies the company's request, while enough other members agree to it. As long as members can't coordinate their actions, and each believes that his own choice is unlikely to be decisive, it makes no sense for any of them to accept the haircut. Liquidation under these circumstances seems inevitable.

On the other hand, what choice do members really have? Although their funds are senior to all other claims on the firm's assets, the cash shortfall will prevent such claims from being honored in full. And since members are scattered across multiple jurisdictions and lack the power to coordinate their response, even partial recovery through litigation seems improbable. Facing little or no prospect of getting anything back anytime soon, some might choose to roll the dice one last time.

The obvious lesson in all this is that in the absence of vigorous oversight, "trust and security" statements can't really be trusted to provide security.