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About the talk
Speaker: Dr. Garth Baughman
Garth Baughman is an economist at the Federal Reserve Board in the Payment System Studies section. He studies topics in applied theory including money and payments, labor, and industrial organization. He earned his PhD from the University of Pennsylvania in 2015.View the profile
Hello, my name is Garth Baughman. I'm an economist at the Federal Reserve board and today I'm going to be presenting a paper called Global demand for back-to-back stablecoins that I've written with a colleague of mine. I just want to take a moment to thank the organizers. It's a really great program that you guys have put together. And I think it's going to be a lot of fun. I should also say that you can find the full paper on my website, which is www.com. And I also welcome any comments or questions at my email, which is start buddy. Bachman at frb Dhaka.
So one more housekeeping thing. I have to make a disclaimer which is that the analysis and conclusion set forth or going to be mine did not indicate concurrent by the other members of the research staff, the Board of Governors of the Federal Reserve System. So there's this big new thing in payments, which is stable coins as a new payments made the payment. So what are stable clients with other assets? So this could be diamonds. But the ones that are going to be
tied to some currency. So most are tied to a single currency. For example, of feather is tied to the US dollar at the end of 2019 and their market cap in excess of 4 billion. But there's many others. So make her die tries to keep its value. Stable by following an algorithm of of a certain kind. There's true USD which is a competitor to tether access Gemini dollar, the list continues to grow this many, many of them out there these days. We're going to think about a particular class of stablecoins that have been proposed, which instead of tracking one single currency are
going to try and follow a basket of of several currencies. So the most prominent example of this is going to be Facebook's Libra which was when it was proposed last summer, was going to follow a basket of of different currency. And had a mission to enable simple of Global Currency and financial Financial infrastructure. That would Empower billions of people. So subsequently to point out has added a single currency coins. Alongside the basket. Another prominent proposal came from a governor of the bank
of England. Mark Carney in his proposals for the artfully named synthetic, hegemonic currency. So it's such a global could, dampen the domineering influence of the US Dollar on global trade. More recently just took a month or so ago. There was a proposal for an Asian digital currency backed by a basket comprising, the N1 Yuan and Hong Kong dollar. And this was proposed that the Chinese people's political consultative conference. So when you're thinking about stablecoins there, lots and lots of questions that
can come up. And I imagine a good portion of this whole week is going to be dedicated to these various question. So four founders of their questions about technical design and implementation. Once you start thinking about coins, that you're trying to keep at a stable value, You need to worry about liquidity management, transaction pricing how you're going to custody the reserve fund. If you keep one and many other questions, Some Regulators. You tend to get a different set of questions, so they're worried about various risks. So risks, if the stablecoin where the scale
widely, they're worried about risk, the payment system to transmit the monetary policy, Regulators are often concerned about consumer protection, anti-money laundering, and terrorist financing. I'm not to talk about any of that today. Instead of going to focus on a much more basic kind of question, which is just what are the fundamental economics of a basket currency. I'm going to break this into a few different parts I'm going to ask, how does back is backing affect demand for a currency from the public. How would a basket currency
affect welfare? So does it? Make people better off? They use it. And what is the effect on both of these demand and Welfare of the baskets? Composition weights of how you design the back? So, just step back for a second. What are some of the intuitive reasons that people have proposed as to why a basket backed stablecoin would be beneficial, Well, looking at Mark Carney, the question seems to be about political economy concerns. So he thinks the having a basket back currency would reduce the pendants
on any single country specifically the United States Economic Policy, so monetary policy and trade policies. there's also a question of having brought attractiveness, so if people have a behavioral preference for a currency, that's close to their domestic one, in some sense that a basket currency might have a broader appeal across the globe There's an important knock-on effects. In payments. You can Onix when one fence about adoption, which is Network effects. So if one has a global audience the more people that use a currency, the more people are going to accept
it and so the more useful it becomes There's a whole separate consideration of portfolio. Theory concerns as to why you might want a basket currency and that's going to be at the back of currency might have less volatility through something like a lot. In this paper, we're not really going to think about political economy or behavioral reasons. We're really going to focus on the last one, which is the portfolio Theory. Explanation for why a back because he might be desirable or also a little bit about the network again.
Emily. The other questions for future research. So I'm giving you a little bit of an introduction, let me just summarize. The big takeaways of what we're going to do and what we get out of it. So we're going to do is build a micro founded model of money and trade in currency choice. In this model, we're going to have to trade shocks that are going to drive to man for a basket back currency. We're going to calibrate up the parameters that model and numerically solve it. When we do this, we get for basic findings.
So our first headline, finding is the Holdings of the basket currency in our preferred celebration are going to be relatively low comprising, less than three and a half percent of world currency Holdings. Our second major finding is that despite these low Holdings, the welfare benefits are not insignificant and they're going to be on the order of about 2 per cent of GDP. So how can those two things dry? How could it be? The people don't use a currency much but is substantially beneficial to a world whilst there was going to be
and spend it in cases where marginal utility is really hot in cases, where they really wish that they had that little bit of extra value devices. After we think about those two first order concerns, we're going to consider it a composition of the basket and we're going to find the time that the basket is not terribly. Important. For welfare doesn't have big effects on welfare. I'm not going to actually show you this exercise today, I don't really have time, but all the details are in the paper and you can look at exactly why
that happens. But briefly there's a disagreement among different parties for the consumers from different countries as to which way they want the basket to do whether they want it to be like their currency or different one. And this disagreement leads the overall welfare effect be relatively small Finally, we're going to do an exercise where we think about these Network effects and specifically, we're going to think about whether low demand for the basket. Would incentivize is sufficient to incentivize sellers to actually
invest in the technology to accept currency. Where can I find that? It may not, it's kind of a suggestive calculation and I'll walk you through it at the end. If I was to summarize in a phrase, what we find in this paper, it's the various spheres of basket backs. Currencies may be overstating. For these reasons that I'm highlighting, that their Holdings would be relatively low and that they may be beneficial Let me talk to you about this model that we've built. I'm not going to show you any math today. If you go look at the paper you can see all the Gory
details and all of the equation just going to give you the building blocks that go into the mall. So the academic predecessors are going to be these two papers one by Lagos and right and one by Shang is a Workhorse monetary model. In the model from Kathy is going to be a model of international currency competition. So this is this is where we're getting our inspiration for the competition between the various currencies. So in the model you have two countries I'm going to call these home and foreign and I'm going to suppose that home is a
larger country so we're thinking of the United States. Within each country, I'm going to have two kinds of Agents. I'm going to have buyers and sellers. The model is going to have a timeline to be discreet time and I have the street. It's going to go on forever. People have long Verizon's that they're planning for and each. Is going to be broken into two sub. First is to be a decentralized market, that's the first step. And then a centralized Market, In the decentralized market there 121 random meetings between buyers and
sellers. This is going to be the retail exchange part of the economy where people are going to need money. The Second Step. The centralized Market is the international market with General consumption, Goods where people can trade currencies on the Foreign Exchange Market and that's where they're going to do their portfolio. And all agents are going to Discount the future at a standard rate. So drilling down into this decentralized Market, I have buyers and sellers they're only going to differ in this decentralized market. Industry. Centralized Market buyers are going to receive utility
from consuming but they can't produce sellers are going to produce at some cost, but they don't want to consume. And I'm thinking of the good that's traded in this market, is being a retail good. Something that you go out and then physically start. such that you couldn't, it's not always the case that any two buyers and sellers to trade It is going to be the case that the good is divisible, so it's not lumpy then you can you can divide it up. That's going to have people buying different quantities, based upon their currency Holdings and then finally am assuming that the
good is non storable so you can't use this good as an asset to finance purchases. Trade is going to be subject to certain fractions. Buyers May travel from their home country to the opposite country. I'm going to suppose for Simplicity that sellers. Don't they're going to stay put Meetings in the decentralized market are going to be anonymous in temporary. There's not going to be the ability to commit that would allow me to give you good on a promise that you pay me back later. So I'm ruling out Credit in this economy. This is all to motivate the need for
a medium of exchange which is going to be it's going to be our three currencies. But then within a meeting, we're going to have buyers and sellers bargaining over price and quantity subject to the limitation. The buyer can only transfer the money that they already. So trade in the centralized Market is going to be in a general good. And then money people are going to rebalance their money. Buyers are going to work to produce this General good, and they're going to use that good that they produce to get money that they're going to carry
into the next decentralized Market. Sellers. Can you take the money that they had from the previous Central a decentralized market? And sell it. Consume this General good. There's an important. Technical assumption comes from this Lagos, right paper? The agents in the centralized Market quasilinear, preferences for this. The importance of this is going to, it's going to remove the history dependent. And there for a while. So I'm not going to have to carry around histories of individual agents. That's all going to get wiped out in. Stone, the
decentralized market Traders Anonymous. There's no commitment. So I need some medium of Exchange. The medium of exchange is going to be a currency issued by governments. So I have a fiat currency issued at home, a few issues in the foreign country. And I'm going to have both country of both currency is growing at some constant equal rate. Funded by lump sum taxation. Importantly, I'm going to have kind of dumb central banks here that don't respond to anything. They just keep the currency growing at a costume, cheerleading monetarist Central Bank
Then the third currency the Innovative part of this model is the basket currency. So what is the basket currency once you drill down into the details of the model? So it's going to be a technology that in the centralized Market combines some Kappa units. Nominal units of the home currency with 1 - 1/3 units of the foreign currency into one unit of the bastard. Once that unit is assembled, it can't be broken apart until the next centralized market. So this Currency really is a separate currency. It's not the
same as carrying around a Forex portfolio. I have this further is something that in each centralized Market, all previous issuance of the basket currency is, would beat me and trade it back to people, trade back. The underlined currencies, the people This is going to have an important implication in terms of pricing of the currency in Arbitrage. Condition such that every. In the centralized Market, the value of the basket is just going to be a straight weighted average of the two, underlying stopping
bubble, equilibria and speculation or anything else. This really is going to be a state. It's important to remark at this moment but besides the composition of the currency. There is no fundamental difference in between the Fiat currencies and the basket of currencies. It's not the case that the basket currency is cheaper to use or abuse electronically. Where's the Sovereign currencies? I don't have any of that in the, this is really just about the portfolio
value of having a basket rather than individual sovereignty. So I'm going to have to trade stocks that are going to create demand for this basket. Specifically, I'm going to have these tracks that affect the probability that you travel from home to foreign and vice-versa for Simplicity, and how to trade state with his positive probability of travel and a new trade state where there's no probability of travel. But because of these different possibilities portfolios of individual. Buyer of a buyers in each country are going to hit just depending upon the state. So if you think
there's a high probability that some of the other countries current This poor circulation in demand is going to create fluctuations in the value of currency, affecting those poor countries with currencies purchasing power. Because currency, purchasing power fluctuates. There's demand for a more stable unit of a Valium medium and medium Exchange. I'm going to refer to this value of the basket, is the insurance motive for holding the best. If a currency is expected to appreciate upon the arrival
of a trade shock, you would rather hold the basket because that currency would appreciate last There's another another motive for holding a currency, which is going to be suspended bility. So for for me, in this model spend ability is going to be how many at Sellers accepted given many times. Do sellers are going to differ in each country based on their type and what it, what do I mean by type type is going to dictate with currencies. You're set up to except for. Now, I'm going to assume that this is, but I'm going to consider several different
For timing just to reiterate at the beginning of a. Nature's, going to draw the trade shock. So whether you move to the traitor, the no trates de then the decentralized market is not open. This is my retail Market buyers May travel an agent that agents trade bilaterally. In the amount that they can trade is going to depend upon the buyer's money holding and the sellers type. After the retail Market is decentralized market, then I have a centralized Market which opens and outstanding basket currency agents produce they rebalance their portfolios
starring currency. They made by new basket currency, and they consumed that General, good, and move on to the next. So I get some theoretical results out of this, this model that I want to talk about before I turn to the numerical. Simulation The first point that I want to make is about the composition of not of the basket and its relation to stopping monetary policies. The result will be getting the paper is that if you have a nominal nominally fixed basket. So, if the basket is 50 Euro cents and $50
sense. Then existence of a stationary Markov equilibrium is going to require that both of those currencies grow and equal rate. That is both countries have to have the same monetary policy in order for me to construct currency the higher inflation. If it. That currently depreciate relatively, then that currency Well then, eventually the back of currency is not going to have any value coming from the high inflation, current. All of the value of the basket is going to come from the
lower inflation, which rules out the existence of a stationary equilibrium. Crucially, as a result of these constant nominal share. I have a conjecture that instead fixed real weights would provide a better sister, but we're going to leave that for for future work. Most of the proposals that we've seen for the prettiest explain how they're going to fix the basket or they'd be explicitly say that they're going to rely on its nominal shares. And so that's what we're going to model today.
the second theoretical result that I want to talk to, that is the feedback effects of the basket, currency on the value of sovereign, So to reiterate trade, shocks are going to affect the demand for currency and therefore its value in a high triplet real estate demand for the other countries. Currency, local demand for the other countries, because the probability that I'll need it to trade a secret. When countries are a different sizes. Like we're going to assume here there differential effects of this state transition. So importantly, the small country's currency is going to
be more volatile in response to these trade show. In this environment with volatile currencies, the basket is going to have to get the two kinds of effects. There's going to be Direct effects of the basket General equipment. The fact is that the baskets movement is always going to be between the movements of the two Sovereign current in this provides insurance. That has a direct effect on portfolio through substitution effect by the life, insurance value of the back. So I'm going to decrease my
There's also a general equilibrium effect. That's going to go in the other direction. So went to, man for a basket varies across state. The value of the component currencies, more volatile. This is the insurance value of the best in the interactive effective is going to have. This is an indirect effect on portfolios through prices. Melanie turn quickly. All of the other parameters of the model we calibrate to match the United States and Mexico and you can go see the paper to see the details of how we
calibrate the model. The five areas that I think about different, which sellers, except which currencies, The first scenario is going to be a national currency scenario sellers in each country are going to only accept their local currency. International currency scenario scenario sellers sellers in the country are going to accept the home currency only one-third, only accept that. Then we have three cases with the basket. First thing of a foreign adoption center area. So no, a large share of
f. Sellers are going to take it. The home adopt scenario, is the reverse and then in a scenario, we're about 2/3 of both H and S sellers, except the basket along side, their domestic currency with the remaining third of each sellers, only accepting their domestic currency and I'm going to think of these is the gun. The government's never going to take some exotic stablecoin be used. I talked about how trade shocks affect currency to me, this shows up in the relative values of the currencies across States,
is going to be the value of the, of a given currency in the trade State /. Its value in the note States, And you can see that these values differ significantly between the across the five scenarios. But importantly, the basket is always in between All right, let's make it. Let's look at currency demand in each of these scenarios. The first in the National currencies example, if you travel your only option is to use the local currency, nobody accepts other people's currencies.
The key thing to take away from this picture is just the buyers are going to hold some of each currency in both States. Why do they hold it in the no trade State? Because there's some chance that the transition to the traits and need to use this currency. Of course, demand for for the opposite currency is going to be higher in the trade station. International currencies cases of the dollar dominance case. Home buyers only demand a little bit of So I can say demand for both currencies is somewhat lower in this economy. Why would because dollars are substituting for foreign in the National
currencies case, we always both needed. Now, home only needs home and for, and to also use home for lots of this transaction. Do I compare things to the basket cases? I need to think about these partial vs General equilibrium. So, the hot colors here are going to be partial equilibrium. The cool colors are going to be in the thing that I really want to point out is that in partial equilibrium, the insurance value of the basket currency is much higher. So this is the basket equilibrium.
I should also point out that in this case, we're only one kind of buyer. Accepts the currency you only demand the currency in one kind of one state, and that's to ensure against the state. So when the both accept all that, I want to point out here is that the difference between partial and general equilibrium tide of washers out. And that's because both buyers or moving in and out of So just say I get a takeaway in both of my one country except scenarios you have much higher demand, where is in the
both except it's about the same. That said it really is significantly higher welfare under the both steps relative to the international demand is much higher is serving a stabilizing role. If you think about back, the composition people are going to end up disagreeing. And the result is that welfare is not that important. I'm running out of time. So I'll just say if you calculate sellers willing to pay to accept the currency, you get relatively low number. So, in everything
that I showed you, I fixed sellers acceptance profile, but given that maybe I could calculate their willingness to pay and it's not as much as it's really not that high. And so there might be some concern about getting sellers So in conclusion, what are we doing today? I built a model of a decentralized exchange with trade shocks to study demand for basket back money. Extracting, for many risks and costs of such an asset. We find the general equilibrium effects on component, currency's volatility limits, the baskets
value. The presence of the basket. If both sellers in both countries except can greatly improve welfare, Optimum back or going to depend upon where the country's currency is accepted, but they don't matter that much for welfare. And low Demand on the part of buyers for the basket currency is going to limit, sellers blindness to a pay to accept the best. Don't thank you guys very much. I hope you have a good day. Hey, I walk in your question.
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