In 1994 I had the opportunity to have dinner one-on-one with the current CEO of Citigroup, Vikram Pandit. At the time I was employed as a trader in the Japanese equity derivatives department at Morgan Stanley, which Mr. Pandit oversaw. He struck me as a decent, thoughtful, ego-free person. Given that he is now a central player in crafting the changes that are occurring in the financial markets, I wanted to share my thoughts with him on the proposed reforms. It is my belief that all of the measures currently under consideration miss the most important aspect of the overall picture — i.e. the role of money. It is my hope that someone in a position like Mr. Pandit’s might promote the argument that the reforms currently under consideration are inadequate and that if we fail to address the fundamental problems with money itself we will at best accomplish a temporary fix for our problems.
Following is the text of the letter:
Oct. 29, 2008
I know that your time these days is subject to intense demands, so I don’t expect that you will necessarily have the time to read (much less respond to) this letter. That being said, I have spent a good deal of time over the past several years thinking about issues of monetary economics, and I have some thoughts which are relevant to the current crisis.
As I watch the unfolding drama of the attempt to save the financial system, I can’t help but despair that all of the proposed reforms ignore the most fundamental cause of our problems. We can (and should) update our regulatory framework, improve transparency, etc., but unless we address the heart of the matter – i.e. the nature of money itself – we will only be instituting a temporary fix for a perpetual problem. It will always be the case that in the aftermath of a crisis there is outcry for reform and regulation, but as the memory of a crisis recedes, the pursuit of profit inevitably overwhelms the abilities and resources of the regulators. New abuses arise which eventually lead to the next crisis.
Since I recall that you were an economics professor before you became a banker, I wonder if you are familiar with the work of Silvio Gesell. Gesell was a German monetary theorist from the first part of the 20th century. His ideas largely fell into obscurity due to the fact that he was on the losing side of two world wars, but Keynes was a great admirer of his work (which is how I became acquainted with it). Keynes believed Gesell’s thinking on the subject of money to be unsurpassed and famously predicted, “the future will learn more from the spirit of Gesell than from that of Marx.”
In brief, I would summarize Gesell’s thinking as follows. Traditional money is a fundamentally flawed tool for accomplishing the purposes for which it is intended. More precisely, of the two purposes for which it is intended – i.e. as a medium of exchange and a store of value – only the former is proper and appropriate. By trying to accomplish both, we are asking the impossible, since the two are not fully compatible, and when they work at cross purposes the results can be extremely harmful. He argues that by asking money to serve also as a store of value, we end up with a fatally flawed medium of exchange.
In more concrete terms, Gesell starts from the most basic proposition of economics – i.e. that commerce operates as a result of the interaction of supply and demand. He then observes that, while real goods are subject to a natural “penalty to hoarding” (i.e. storage costs, decay, etc.) and are therefore compelled to be offered for sale regardless of whether the producer incurs a profit or loss, money is subject to no such compulsion. (Incidentally, I noticed today that the top financial headline is about the White House urging banks to stop hoarding money. Well, of course they’re hoarding money; it is the only logical thing to do under these conditions.)
Money is therefore able to exact a “tribute” (i.e. interest) for its services and will withdraw if this tribute is not assured. This is why deflation is the greatest nightmare of the financial authorities. In a deflationary environment money withdraws, and monetary policy is powerless to compel its circulation. In Gesell’s words:
“The present form of money acts as intermediary for the exchange of wares only on condition that it receives a tribute… No tribute, no exchange… This profit has nothing in common with the merchant’s profit; it is a separate effect produced by money itself, a tribute which money is able to extract because, unlike all other wares, it is free from the material compulsion of being offered for sale… Without this tribute, money will not be offered in exchange, and without money to effect exchanges no wares will reach their destination. If, for any reason, money cannot exact its accustomed tribute, there is a crisis; wares lie where they are and rot… If we now consider the conditions upon which money offers its services as medium of exchange, we see that commerce is mathematically impossible with falling prices.”
It is this property of traditional money that is largely responsible for the seemingly inevitable crises that plague modern capitalism. This is what is at the root of the dilemma facing the Fed right now. We are in a classic Keynesian “liquidity trap”, and the Fed is “pushing on a string” in an effort to stimulate the economy. They can print as much money as they want and lower interest rates to zero, but as long as people anticipate further price declines and don’t perceive solid investment opportunities, they will not spend or invest. However, if money was subject to the same “penalty to hoarding” that applies to real goods, it would not systematically withdraw during times of instability. And to repeat, it is precisely because money is designed to be a store of value that this problem occurs.
Gesell proposes reconstituting money in such a way that it intentionally loses value over time according to a predetermined schedule of depreciation. This would create a disincentive to hoarding, promote freer and more reliable circulation of money, and reduce the likelihood of a liquidity trap. Even in times of economic uncertainty, holders of money would be faced with an incentive to “use it or lose it”. Furthermore, such a monetary medium would likely achieve a much higher “velocity”, which would lead to a more vibrant and robust economy and a more equitable distribution of wealth.
Of course, I realize that what Gesell suggests is nothing short of revolutionary. Such a change would alter every aspect of our economic and political landscape. As such, the points in history at which it would be politically feasible to attempt such a change are extremely rare. Only a painful crisis is capable of awakening the public to the importance of our monetary arrangements, and if we attempt to deal with the current crisis while leaving the most important part of the puzzle untouched, we will be missing out on a once-in-a-lifetime opportunity to make a change that could solve our existing problems and prevent their recurrence.
Of course, I understand that your main concern these days is ensuring the survival of Citigroup, and an issue like monetary reform may be beyond your purview. I also realize that as the CEO of a bank, such a fundamental change in the nature of money would be threatening to your business model. On the other hand, I believe that banks which embrace a new-and-improved monetary medium would prosper at the expense of those who resist the change. For someone in your position, I would think the prospect of being able to put your company on the cutting edge of a new era in finance while simultaneously contributing to the well-being of mankind would represent an exciting and compelling opportunity.
In any case, Vikram, I wish you wisdom and luck in this monumentally challenging time. I don’t know if these thoughts might be of any use to you, but I figured that, at the very least, they would represent a different perspective. In the unlikely event that you find yourself with a few minutes to spare, I would love to hear you thoughts on all of this.