Speed counts on coronavirus economic rescue, says Prof. James Wilcox

Closed due to coronavirus
Photo: Gwengoat for Getty Images

*Updated March 16

Former Fed Economist and Prof. James Wilcox is a longtime observer of federal fiscal policy, monetary policy, and the economy. A professor of finance and economic analysis and policy, Wilcox served as a senior economist on the President’s Council of Economic Advisors from 1990 to 1991, as an economist with the Federal Reserve from 1991 to 1992, and as chief economist for the Office of the Comptroller of the Currency from 1999 to 2001. His research focuses on small business lending, banking, and consumer spending.

Wilcox shared his perspective on the week’s stock market whiplash as well as what the Fed and the government can do to cushion the widening economic crisis caused by the coronavirus pandemic.  

Prof. James Wilcox
Prof. James Wilcox

President Trump on Friday declared a national emergency that will free up $50 billion in aid, and stocks mostly bounced back from Thursday’s crash. Will the national emergency status help economically?

The emergency declaration allows for some helpful actions right away. Much more will need to be done. The declaration was also valuable if it signals that the Administration will be doing much more than it has so far. We have a serious problem. It calls for large, rapid responses. 

The Administration can help by using fiscal policies now. Speed counts. The old saying that ‘a stitch in time saves nine’ holds for financial markets, businesses, and households if they have their operations or cash flows disrupted. Getting more help sooner to those who are more impacted can avoid more pain for them and can avoid taxpayers’ paying more to help more later. 

The sooner the government acts, the better—and the cheaper—it will be for all of us.

The House passed a coronavirus emergency relief bill Friday night that includes two weeks of paid sick leave for some workers and up to three months of paid family and medical leave, $1 billion in grants to states to help pay unemployment insurance, and some food assistance. The Senate will take it up this week. What kind of policies do you think are most needed right now?

We want to get the most immediate help to those facing the most pressing pains. If supplies and demands contract as much as now seems likely, there will be real cash crunches for some big and small businesses, for higher-income households and lower-income households. Some businesses will have serious shortages of customers, and perhaps of materials and parts as well. Some households will have their hours or jobs cut. They may face serious cash, or liquidity, shortfalls—they may become “ill-liquid.” Policies should be adopted now that will be ready and able to provide financial triage. When illiquidity turns into insolvency, it causes many more problems. The sooner they can get help, the less they will need—’a stitch in time.’ 

One policy that could greatly help is government loan guarantees. The law passed about two weeks ago authorizes about $50 billion more SBA-guaranteed loans to small businesses harmed by the virus crisis. And some much larger companies may warrant help too. Most visibly being hammered by the corona crisis are airlines, hotels, and, of course, cruise companies. They won’t be the only ones. This emergency may well call for a program akin to a Large Business Administration that can quickly provide funds for large businesses. 

These policies can be really valuable to businesses and households. They can also benefit the nation. Nonetheless, they do impose costs and risks on taxpayers. Hard-headed, helpful policies need not be give-aways like tax breaks. For example, a payroll tax cut—which has been discussed—is aimed at entirely the wrong group of people. To be paying payroll taxes you need to be working. It is the businesses that are hurt by this crisis and cannot afford to keep employees that we should aim at. We want to help the workers who have lost hours or jobs, and the businesses that are in danger of going under. 

 Policies funded by taxpayers can be more like investments. In the 2008 financial crisis, taxpayers got too little in return for the enormous costs and risks their government took on their behalf. 

It’s not inevitable, but a recession now appears pretty likely for the U.S. economy.

Last week you commented that “darkening clouds have now come over the economy.” Is a recession inevitable at this point?

It’s not inevitable, but a recession now appears pretty likely for the U.S. economy. The more nations that impose widespread restrictions like lockdowns, the more likely that we have a global recession.

With appropriate policies, a recession in the U.S. could be shorter and shallower than usual. A lot depends on how the virus situation is handled and proceeds. At this point, forecasting the economy requires a guess about how effectively medical tests get distributed and used, how well our medical system can handle the volume of patients requiring some or a lot of care, and so on. I really don’t know much about the severity or probabilities of the various virus scenarios. Even forecasting what policies will get enacted is problematic.

But, anyone’s forecast for the economy will have to change if we keep getting surprises, good or bad, about the policies and management of the corona crisis. The larger and the sooner our fiscal response, the less likely that we have a recession this year or next. The early performance on health and economic policies has not been good, but they both show signs of improving.

Why do you say a recession could be shallower and shorter this time (with that big if)?

It is our good luck that the virus arrived here when our economy is on very solid footing. There have been few serious excesses, imbalances, or problems. Growth has been steady and unemployment low. We haven’t had a recession in over a decade. If the economy were ever going to withstand a shock, this is one of the better times. The job market has been very strong. Households’ finances have improved greatly. Housing has been strong. The same applies to businesses. After-tax profits have been very strong for a very long time. Even state and local government budgets have been in good shape lately. And, the financial system is really solid. Unlike the 2008 financial crisis, when problems erupted in—and were made worse by—financial institutions, this time around, the financial sector is in very solid shape. It’s strong enough to cushion some of the jolt to households and businesses. In the previous crisis, instead of being shock absorbers, financial institutions did the shocking. 

Unlike the 2008 financial crisis, when problems erupted in—and were made worse by—financial institutions, this time around, the financial sector is in very solid shape.

Yet last week, stocks were crashing, and bond yields weren’t rising as they usually do. That led some to say the system is more fragile than it appears. What was going on?

The size and suddenness of the recent stock market declines built up some frictions in financial markets, especially in credit markets. That’s why the Federal Reserve was right to pledge an essentially unlimited availability of cash for financial markets to borrow. The Fed has also jumped in to buy lots of longer-term Treasurys when it appeared that even those bonds were suffering from illiquidity. These two operations have both lubricated the frictions in credit markets and signaled that it’s ready to act quickly and decisively if need be. The result is that borrowing rates will be lower than if the Fed had not acted.

The Fed is expected to drop interest rates to zero. How much will interest rate cuts help stem the crisis?

*Update: The Fed cut interest rates to near zero in an emergency move Sunday.

The Fed cut interest rates by half a percent just a short time ago. And, now there is a very good chance that it will just cut short-term rates to zero. Every little bit helps. And longer-term rates are now much lower than they were over the past year. Mortgage rates are down by a full percentage point. And that has already touched off a refinancing boom that will leave homeowners with more to spend elsewhere. The lower rates may also draw in more home buyers, too. 

The Fed has done what it should do, which is lubricate and reassure financial markets, and the rest of us. But there are real limits to what it can do. In this situation, lower interest rates will not be the solution for workers who lose hours or jobs, or for businesses that lose customers. Making funds available to those who are cash-strapped will be. Whether assistance comes via paid sick leave, unemployment checks, government-guaranteed loans, or some other form is the province of fiscal policy. The sooner the government acts, the better—and the cheaper—it will be for all of us.

 

Do multinational corporations exploit foreign workers? Q&A with David Levine

A garment factory in Southeast Asia. Photo credit: Liuser for Getty Images

In trade debates, multinational corporations are often cast as villains exploiting low-wage workers in countries with weaker labor laws at the expense of Americans. But do multinationals actually exploit foreign workers?

Dean Ann Harrison, Prof. David Levine and three co-authors recently reviewed the evidence in a paper for the Brookings Institute. It’s part of a larger effort that enlisted prominent academics to better understand the many questions that have been raised about the role of multinationals in the global economy—from tax avoidance to job loss to their contributions to economic growth.

Harrison is one of the most highly cited researchers on multinational firms, offshoring, and the effects of direct foreign investment on developing countries. Levine is a labor economist and chair of the Haas Economic Analysis and Policy Group who has studied effects of industrialization on health and education in developing countries.

David I. Levine
Prof. David Levine

To answer the question of whether multinationals exploit foreign workers, Levine, Harrison, and their co-authors reviewed the current academic research. In areas where it was sparse, they also looked to research by groups such as the International Labor Organisation, World Bank, Oxfam, and Human Rights Watch.

We spoke with Levine to get the big picture on their findings.

 

You started this project by defining what exploitation means. How did you do that?

There are many different approaches to thinking about a complicated concept like exploitation, and we looked at it in three ways. The most straightforward is asking whether workers are worse off than they would be had they not worked for the multinational company. But a simple measure such as whether they’re paid better than the alternative may still fall short of what many observers would consider fair. There are lots of other definitions of exploitation, such as taking advantage of someone’s weak bargaining power to offer them a worse deal. So, a second approach is asking whether workers are being paid a “fair share,” given that they’re often producing products that are quite valuable.  Different stakeholders and philosophers have different definitions of what a “fair share” means.  And then a very different approach is, rather than looking at how workers treated relative to someone else, but aksing whether their employers are respecting their fundamental human rights. Almost every country with multinationals has signed on to the core labor standards of the International Labor Organisation (ILO), which include prohibitions on slavery, child labor, and discrimination against women, and gives workers the right to join a union. By this definition, exploitation simply means not respecting human rights.

If these firms were paying twice what workers got elsewhere, we wouldn’t expect to see so many quit. So it doesn’t appear that workers feel these jobs are particularly cherished.

To clarify, when we’re thinking about the question of exploitation, we’re usually thinking about the companies operating in lower-income or developing countries. How do these companies do on wages?

There’s pretty strong evidence that on average these workers are not being exploited in the sense that they could earn more elsewhere, on average. Multinationals do not typically pay less than domestic firms. In fact, they typically pay more, and sometimes meaningfully above market wages. But larger firms often pay higher wages, and multinationals tend to be large firms. It’s usually pretty easy for these companies to hire, and it’s not surprising that we see migration from the countryside towards these factories. But we also see quite high turnover in most of the factories where we do have data, which means the workers aren’t feeling super overpaid. If these firms were paying twice what workers got elsewhere, we wouldn’t expect to see so many quit. So it doesn’t appear that workers feel these jobs are particularly cherished.

We’re in a time of growing inequality. How did you look at exploitation from the perspective of whether workers get a “fair share”?

Many philosophers and citizens would agree the world would be a better place on average if poor people were a little less poor, even if that means rich people have to pay a little bit more for luxury goods. To the extent that these branded companies like Nike, Nordstrom, or Apple are making a lot of profits, it seems fair to many people for them to pay above-market wages in poor countries. And although it does look like multinationals pay a little bit higher on average, there is not evidence that they are systematically sharing a lot of the surplus. The wages in most studies are not a whole lot higher than people would earn elsewhere. And there’s a lot of turnover, which is not what you expect if you’re sharing a meaningful amount of your surplus. If you see a branded product from Apple, Nike or whatever, the assembly workers received a very small share of that value.

Does that, in your view, constitute exploitation?

I am one of many people who thinks that if poor people producing goods for rich people got paid a bit more, and rich people paid a little bit higher prices for luxury goods, the world would be a bit more fair and just.

There’s strong evidence that there are tragically high levels of exploitation in terms of violations of basic human rights, and women are especially vulnerable.

Where does the evidence lie on the question of human rights violations?

There’s strong evidence that there are tragically high levels of exploitation in terms of violations of basic human rights, and women are especially vulnerable. For a young woman to go work in an apparel factory in many parts of the world puts her at high risk of sexual harassment or much worse. There isn’t evidence that multinationals are worse at stopping sexual harassment or abuse than domestically owned firms, but having lower rates of sexual harassment doesn’t let them off the hook. They’re still violating these fundamental human rights that everyone agrees to.

There is not much evidence of severe violations such as slavery—meaning people being forced work for no pay—athough there’s evidence of workers having to work overtime without pay, and evidence of suppression of labor organizing. Health and safety violations are common. There are also well-documented cases of some multinationals providing worse conditions to migrant workers than to local citizens.

Over the past decade, Western-based multinationals have almost universally adopted zero-tolerance policies against child labor in their affiliates and supply chains. There have been improvements, but enforcement is variable and violations are still uncovered. Audits at factories don’t uncover things like employees bringing work home for their children, which some reports have found.

The term multinational covers a wide range of companies. Did you look at variations?

There are several dimensions of variation. The scattered evidence shows companies headquartered in countries with higher labor standards such as Northern Europe treat their workers better on average than companies headquartered in low-wage countries like China or India that have less consistent labor standards themselves. It also depends where you on the supply chain. Suppliers tend to have lower standards than the multinationals themselves. A supplier to a supplier to a supplier tends to have lower benefits, if any.

For consumers, knowing that a multinational company produced a product tells little about the living standards or human rights of the workers who made it. Sometimes the nation of origin is a more valid indication. For example, few workplaces in Saudi Arabia or Kazakhstan respect the core International Labor Organisation agreements that those nations agreed to.

In the paper, you state that while activism targeting individual companies can improve working conditions, it may not be the most effective approach to combat exploitation overall. Why?

Multinationals are more visible internationally. So to protect their brands, they may find it profitable to treat workers a bit better. Thus, activism against these companies can have an impact. But fundamentally, multinationals employ only a modest share of the workforce of poor countries, and only a subset of those multinationals are producing high-visibility luxury goods for prosperous people. The problem is that if one brand starts paying a lot more than the market wage and raises their prices, they could lose their market share. Even if one could solve the coordination problem and get them all to treat their workers better, that would still leave the bulk of workers at multinationals that aren’t delivering luxury goods, and also at the domestic firms where the bulk of workers are always going to be.

To the extent that multinationals can help countries improve their regulations and their anti-discrimination policies or environmental enforcement, we could imagine some useful improvements. And if multinationals are promoting corruption and non-transparent governance and favoritism, they are worsening the system and should be held accountable.

Even if companies producing expensive branded projects shared more of their surplus with workers, it would not end global poverty. Improving the welfare of vulnerable workers requires broader policies such as improving schools, reducing corruption, and enforcing human rights standards for all employers.

You also looked at the flip side of the problem—whether multinationals hurt workers at home by moving jobs overseas. That’s a whole other large topic, but in brief, is offshoring exploitation?

Here we are moving from the question of exploiting to the question of harming workers. There obviously is a basis for concern. If you were producing clothing or furniture or autos, and your company shut down your factory and opened one in Vietnam, you lose your job. The evidence here is not great, but it does seem like on average the growth of outsourcing and multinationals relocating jobs has been bad for Americans at the middle and bottom of the wage distribution, especially in manufacturing. But every time we see an outsourced job, it doesn’t mean that if you banned outsourcing there would have been one more American job. If I told General Motors they weren’t allowed to close their factory in Michigan and open an engine factory in Mexico, they could have simply gotten more robots in Michigan. Or they could have stopped producing their own engines and just imported them, or they could have not been able to compete and just closed to more of their remaining U.S. factory.

The research doesn’t nail down what share of outsourced jobs would have been lost anyway, but it’s a reasonable estimate that most of them would have disappeared due to technology and automation. Increased import competition is also a factor. So while we should be concerned about job loss and declining demand for medium-skill American workers, the evidence shows that outsourcing is not the main challenge they face.

If I were to meet you at a party and ask “Do multinationals exploit workers,” what would be your short answer?

I would say that they do not do enough for their employees and for the employees of their suppliers to protect basic human rights.

 

How the slave trade’s financial legacy harms Africans today

The global trade in enslaved people is directly linked to distrust in Africa’s financial system.

Elmina Castle and Fortress in Ghana
Elmina Castle and Fortress in Ghana was a center of the West African slave trade. (Photo: M.Torres for Getty Images)

Nearly two-thirds of Africa is “unbanked” and has no relationship with a financial institution—one of the highest rates in the world, according to the World Bank. The rapid rise of mobile money sent through smartphones is steadily boosting financial inclusion across the continent, but the lack of access to traditional banking accounts and loans is depriving millions of Africans of the ability to save and borrow money they could use to start a business or move to a neighborhood with better schools.

This poor access to financial services has a multiplier effect far beyond savings and lending, affecting everyday life including employment options, says Berkeley Haas Prof. Ross Levine. “How well the financial system operates can shape an individual’s overall socioeconomic horizon, even if that person never takes out a loan,” he says.

Many scholars have looked at the myriad reasons for the lack of financial inclusion in Africa, ranging from poverty to the effects of colonialism. In the first study of its kind, forthcoming in The Economic Journal, Levine and two coauthors have pinpointed another important factor: The devastating impact of the global slave trade that gripped Africa most intensely from 1400 to 1900.

Broken trust

When Africans were captured from their villages and sold into lives of toil in faraway countries—often by other Africans who sold enslaved people to Europeans, Arabs, and Indians—the trust of those who remained in their neighbors and in institutions fundamentally broke down. The fact that this distrust could linger so long after slavery faded was a surprise to Levine. “I would have thought that institutions, social coherence, and trust would have had plenty of time to emerge once the slave trade ended,” he says.

To measure the connection between the African slave trade and trust in financial institutions, Levine and his colleagues analyzed data about the intensity of slave trading within 51 countries as well as within 186 ethnic groups. To isolate the effect of the slave trade, the researchers controlled for a number of factors that could have influenced the results, such as a country’s legal system and how long it has been independent, as well as individual-level factors such as education, income, and age of the population.

The study showed a strong, negative correlation between the intensity of a country’s historical exposure to the slave trade and the rate that households currently own or use an account or debit card at a bank or other formal financial institutions; save money at formal financial institutions; obtain short-term loans, credit cards, or mortgages from banks; and use the internet or mobile phones to make financial transactions. They also cross-checked the country-level results with results by ethnic group, finding that ethnicities with higher rates of enslavement also had higher rates of mistrust in the financial system.

To quantify the magnitude of the effect, the researchers examined a hypothetical scenario in which one group of countries that had a relatively higher intensity of slave trading (such as Sierra Leone, Malawi, Ethiopia, and Guinea) suddenly became much more like countries that had a relatively lower intensity of slave trading (countries such as Burundi, Zimbabwe, Niger, and South Africa). In that scenario, the probability that the average person would have saved at a bank, received a bank loan, or made a transaction with a mobile money account would have increased by 50%. In a continent with a low starting point for participation in the financial system, that represents an increase in financial inclusion of millions of Africans.

Wide variation in financial participation

Along with the high-level macroeconomic impacts, the study showed considerable variation across countries in the real world:

  • Credit card use in Mauritius and South Africa—where the slave trade was less intense—was greater than 16%, while it was below 0.5% in Madagascar, Sudan, and Ethiopia, where people were sold into slavery at relatively higher rates.
  • In Mauritius, where the slave trade was negligible, only 0.3% of the respondents indicated a lack of trust in banks.
  • More than 16% of those surveyed had received a loan in the last year in Botswana and Mauritius, which largely escaped the slave trade, while less than 2.5% of survey respondents received a loan in the last year in Guinea, which had a much more intense slave trade. However, loan rates did not match the intensity of slave trading in several other countries (Niger had far lower loan rates than Uganda, though slave trading rates were similar).

All this data shows something else beyond the numbers. “Factors that influence culture have a very long-run, enduring effect on communities,” says Levine. “Culture exerts a first-order impact on many of the economic outcomes that people care about.”

That insight offers some hard lessons for financial services businesses and policymakers, since trust is vital for finance to work, says Levine. Putting your money in a bank involves a certain trust that the legal system and the government are going to properly safeguard your money. Similarly, financial institutions must be able to trust that a loan recipient will pay them back. Without trust, the cost of enforcing every single contract would become overwhelming and reduce the overall availability of credit, and therefore limit economic growth and opportunity.

“Establishing trust is important for financial services companies everywhere, but it is much more difficult to create that trust in countries that had a more brutal experience with slavery.”

Criminal punishment is harshest in racially diverse counties, study finds

Two people walking down a prison corridorWith 5% of the world’s population and 25% of its prisoners, the United States is the most punitive country in the world. Among developed countries, the disparities are even more striking: The U.S. relies on incarceration for 70% of criminal sanctions, while in Germany, it’s 6%.

Why is the U.S. system so harsh?

A new paper by Asst. Prof. Conrad Miller and Benjamin Feigenberg of the University of Illinois at Chicago reveals how diversity, often celebrated as one of America’s foundational assets, might also help explain the punitive nature of its criminal justice system. The paper also offers new insight on the system’s disparate impact on African Americans, who are incarcerated at six times the rate of whites and face longer sentences for similar crimes.

Punishment varies widely between counties

The researchers split their investigation into two steps, looking first at whether punishments differ between counties. They collected county-level data over several years on every criminal arrest in four states—Alabama, Texas, Virginia, and North Carolina. Did the arrest lead to charges? Did the charges lead to formal sentencing? Did the sentence involve jail or prison time? Even when controlling for factors like age, race, and criminal record, they found dramatic variation in how different counties punish the same crime.

“People arrested in the top 25% of counties that are most punitive are two- to four-times as likely to be sentenced to jail or prison than someone who has committed the same offense in one of the most lenient counties,” says Miller, a labor economist and research fellow at the National Bureau of Economic Research whose research focuses on hiring and discrimination. “There is this huge difference in outcomes, even in the same state, with the same laws on the books.”

Diverse counties more punitive

Next, the researchers investigated a potential explanation for this variation. Prior research shows more diverse locales tend to be relatively miserly with social benefits. The underlying theory suggests that people in racially homogenous places are more willing to pay taxes into social welfare because the beneficiaries are likely to look like them, to be a part of their “in-group.” Perhaps individual preferences around punishment reflect the same bias, they theorized, and punishment is lighter in counties where prospective defendants are likely to be of the same race.

This is precisely what they found. Arrests in jurisdictions that were predominantly white or predominantly black were least likely to result in a jail or prison sentence. The severity of punishments climbed as counties grew more diverse and peaked in jurisdictions roughly that were about 30% black. (Though Miller and Feigenberg looked primarily at black-white racial divides, they noted that some Texas counties with large Latino majorities were among the most lenient.)

Reflection of voter preferences

In theory, at least, this presents a simple fix. “Our results suggest that if all jurisdictions within these four states adopted the policies of the most homogenous jurisdictions, then overall confinement rates would decline by about 15%,” Miller says — a significant figure considering the four states they study comprise roughly 20% of all prisoners confined by states. But how, practically, to make this happen is complicated.

In Miller’s view, the fact that racially diverse counties tend to be most punitive is likely a reflection of voter preferences, for which there is no policy fix. County residents vote prosecutors and judges into office, and these office-holders, in turn, strive to represent the will of their constituents. In racially diverse counties, that means prosecutors push for harsher charges—felony rather than misdemeanor, for example—and judges impose stiffer sentences—prison rather than probation or community service.

No simple fix

These findings also complicate efforts to reduce racial disparities in the U.S. criminal justice system. It would seem that, at least within the states Miller studied, these disparities are in part a result of how populations are distributed. It is more common for large populations of whites to live in overwhelmingly white counties, thereby exposing criminal defendants to relatively lenient systems. Large populations of blacks, on the other hand, tend to live in more racially diverse areas, like Houston, which ends up exposing them to more severe sanctions. In this way, racially unequal punishment is embedded in the geographic spread of populations.

One potential solution, Miller says, is to loosen the bond between voters and prosecutors and judges. That local courts are so tied to local preferences is a peculiar feature of the U.S. criminal justice system, and one that could be changed. Other countries provide models. Still, Miller couldn’t avoid a bit of pessimism when dwelling on the practical takeaway of the work.

“Perhaps there is some kind of broad kumbaya story: If we all had the right interactions at the right point in our lives we wouldn’t think about ‘in groups’ and ‘out groups’ in this particular way,” he says. “But, given the overall results, it’s not clear what the narrow solution to this problem is.”

The paper, “Racial Divisions and Criminal Justice: Evidence from Southern State Courts,” has been conditionally accepted to American Economic Journal: Economic Policy.

 

Prof. Laura Tyson to lead governor’s new economic council

Prof. Laura Tyson, Photo: Karl Nielsen
Prof. Laura Tyson (Photo: Karl Nielsen)

Influential economist Laura D’Andrea Tyson, who served as dean of Berkeley Haas and as a presidential advisor, has been named by Gov. Gavin Newsom to co-chair his new Council of Economic Advisors.

The 13-member panel, announced on Friday, will advise the governor and state finance director on wide-ranging economic issues “and deepen relationships between the administration and academic researchers to keep California moving toward an economy that is inclusive, resilient, and sustainable.”

Tyson will co-chair the council with Fernando Lozano, an economics professor at Pomona College. 

 “I look forward to working with this expert group of advisors to support Gov. Newsom’s goal of fostering inclusive, sustainable, long-term economic growth for all of California,” Tyson said. “As the world’s 5th largest economy and the nation’s leader in innovation and new business formation, California is in a strong position to tackle major economic challenges—including adapting to climate change, creating good job opportunities throughout the state, and reducing homelessness.”

Two other UC Berkeley professors were also appointed: Maurice Obstfeld, the Class of 1958 Professor of Economics who served on President Barack Obama’s Council of Economic Advisers from 2014 to 2015 and as chief economist at the International Monetary Fund from 2015 to 2018, and economics and public policy Prof. Hilary Hoynes, the Haas Distinguished Chair in Economic Disparities and co-director of the Berkeley Opportunity Lab. Lieutenant Governor Eleni Kounalakis, MBA 92, will also serve on the panel.

Gov. Gavin Newsom
Gov. Gavin Newsom (Wikimedia Commons)

“For California to continue thriving, we need our economy to work for everyone in every corner of the state,” Newsom said in a statement. “Our state is experiencing its longest economic expansion, with record-low unemployment—3.9 percent—increases in personal income, and billions in investments, but this expansion has unevenly benefited people across the state. We need to invest for the future, adapt to a changing climate and keep our budget balanced. This Council will keep its pulse on what’s happening in our economy while making policy recommendations to prepare us for what’s to come.”

 An expert on trade, competitiveness, and the future of work, Tyson is a distinguished professor of the graduate school and faculty director of the Institute for Business & Social Impact, which she launched in 2013. She also chairs the board of trustees at UC Berkeley’s Blum Center for Developing Economies, which aims to develop solutions to global poverty. She served as Berkeley Haas interim dean from July to December 2018, and as dean from 1998 to 2001. She led London Business School as dean from 2002 to 2006.

Under the Clinton administration, Tyson served as Chair of the President’s Council of Economic Advisers from 1993 to 1995 and as Director of the White House National Economic Council from 1995 to 1996. She was the first woman to hold those positions.

Much of Tyson’s recent research focuses on the effects of automation on the future of work. She has also devoted considerable policy attention to the links between women’s rights and national economic performance.

The new council will meet with and advise Gov. Newsom upon request. The group will be guided by the Department of Finance’s Chief Economist Irena Asmundson.

 

 

 

 

What are stable coins? Cryptocurrency Q&A with Rich Lyons

Cryptocurrency - stable coin illustration

 

Cryptocurrencies are not investments for the faint of heart. As anyone who has followed the Bitcoin saga knows, the rollercoaster price movements of these digital assets are only for those with strong stomachs (or who want to conceal their transactions). In recent years, however, a new form of cryptocurrency has emerged with the promise of much less volatility. So-called stable coins, such as Tether, the stable coin market leader, are pegged one-to-one to the U.S. dollar or other asset, in theory making them safer.

Berkeley Haas News spoke to Rich Lyons, professor of finance and economics who served as Haas dean from 2008 to 2018 and is now UC Berkeley’s first chief innovation and entrepreneurship officer, about this new wrinkle in cryptocurrencies. Lyons, an expert in currency exchange rates who holds the William & Janet Cronk Chair in Innovative Leadership, recently co-authored a paper with Ganesh Viswanath-Natraj of England’s Warwick Business School examining what keeps stable coins stable.

Among their conclusions: Stable coins could open the door to the wider crypto world without the wild price swings of free-floating cryptocurrencies like Bitcoin. Even so, as Lyons stresses, stable coins are not necessarily the safe havens they are advertised to be.

If you look at a price chart of Bitcoin over the past few years, it looks like a trek through the Himalayas, with enormous peaks and valleys. Why are cryptocurrencies so much more volatile than traditional currencies?

We can answer that question by thinking about the dollar-euro exchange rate, which is more volatile than people originally thought it would be. The issue is that the euro’s fundamental value is a difficult thing to pin down, leaving a lot of room for speculation. Instability like that gets magnified in the world of cryptocurrency. At the end of the day, the Bitcoin-dollar exchange rate is just another exchange rate, and a lot of those same speculative dynamics are there.

But why are Bitcoin’s price movements so much greater than those of traditional currencies?

The big issue is that the fundamental value of Bitcoin is even more nebulous than that of the euro. We can at least start to think about the fundamentals of the dollar-euro exchange rate, like the growth rate in Europe versus the U.S. With a cryptocurrency like Bitcoin, the fundamental picture is much harder to pin down. You have the same speculative dynamics as in a regular currency market, but with much fuzzier fundamentals.

Cryptocurrency illustration

What exactly are cryptocurrencies?

Over the past five-to-ten years, what some people are calling the digital asset economy has emerged. The digital asset economy lies outside the traditional banking system and is generally housed on a blockchain, which is a secure, decentralized electronic ledger used to record transactions. The digital asset economy includes cryptocurrencies like Bitcoin and so-called initial coin offerings. These assets serve multiple purposes. For example, I could issue 100 tokens, and by buying one, you could own one one-hundredth of a work of art. We can break up lumpy assets and give people ownership of small slices. In addition, this digital asset economy gives people in countries that might not be able to hold assets because of capital controls or other restrictions access to more of the world’s assets.

What’s the purpose of stable coins?

Because this digital asset economy is largely outside the traditional banking system, the issuers and traders of these assets aren’t like regulated financial institutions. They don’t have “know-your-customer” rules or anti-money-laundering regulations. At first, this digital asset economy lacked a store of value, that is, assets with relatively low volatility that people could hold knowing the value wouldn’t change drastically. Because Tether and other stable coins are pegged to traditional currencies, they have become stores of value in that alternative financial world that otherwise lacks a store of value.

Prof. Rich Lyons
Prof. Rich Lyons (Photo Copyright Noah Berger)

Haven’t stable coins been controversial?

Yes. For example, there was a question of whether the issuers of Tether were manipulating the price of Bitcoin. Part of the reason that scenario is possible is that Tether is used as the medium of exchange in over 50% of Bitcoin transactions. When people are buying and selling bitcoins, more often than not they are trading tether for bitcoins. One reason is that when you go from dollars to bitcoins, you are also going from inside to outside the banking system. That has high transaction costs. Tether is already outside the banking system, which makes it a much cheaper and more frictionless way to go in and out of Bitcoin.

Most people see the cryptocurrency world as pretty wild and woolly. Are stable coins as safe as claimed?

Tether is pegged to the dollar at one-to-one, and its price has generally traded within 1% of one-to-one. But about a year-and-a-half ago, there was some concern in the market that Tether was not backed one-to-one with assets; i.e., if there was a mass redemption of Tether, the collateral would not be sufficient to cover the full amount. This concern led the price to fall as low as 95 cents to the dollar. There was an audit, which was not 100% transparent, but it did restore confidence in the marketplace.

What kinds of questions should we be asking about stable coins?

Stable coins come in a number of different flavors. Some purport to be 100% backed by redeemable collateral that’s in escrow, collateral that can’t be captured and run away with. But part of the question, even with Tether, is whether it really is 100% collateralized. And is all that collateral really liquid? If you have to sell in fire-sale conditions, even a “100% collateralized” asset may not turn out genuinely to be 100% collateralized.

What are the long-term prospects for stable coins and cryptocurrencies generally?

There will be a lot of shakeout. The stable coins that have the greatest market confidence concerning the legitimacy and liquidity of their collateral will win out. Meanwhile, if you think about the literally thousands of initial coin offerings, all the tokens, all the cryptocurrencies—90% of them will be valueless in 10 years, in my judgment.

In a shakeout scenario, do stable coins have an advantage?

Most stable coins have collateral. So, if a stable coin fails, it won’t be a complete cataclysm. Whatever collateral is left after liquidation costs will go to the holders. But, when you talk about cryptocurrencies that don’t have any collateral—the Bitcoins and ICOs that don’t have any fundamental value backing them—when those go away, their value goes to zero. I’m not predicting that Bitcoin will necessarily go to zero, but certainly there are a lot of assets in the digital economy that will go to zero over the next 10 years. At the same time, you’re seeing assets in the digital economy that are getting 10 times the valuation they had two years ago. You’ve just got to be in the right place. And it’s anybody’s guess what the right place looks like.

How are cryptocurrencies in general and stable coins in particular evolving?

This idea of inside the banking system versus outside the banking system—that’s a pretty bright line right now. But when central banks move into the digital asset world, the line won’t be as clear. A well-functioning stable coin adds a lot of value, and all of the big central banks are doing a lot of research on cryptocurrencies. Many of them are saying they will launch a digital currency in the next five years. My prediction is in 10 years we will have three or four important stable-coin digital currencies, based in blockchain, and issued by central banks. They will live more in the traditional regulated banking system. That will fill in the continuum.

You and Ganesh Viswanath-Natraj just released a paper titled “What Keeps Stable Coins Stable?” What questions were you looking at?

We wanted to look at how tightly the price of Tether was pegged to the dollar. What we found was somewhat surprising. Tether trades at both a discount and a premium to the dollar. You might think a stable coin would trade like the Argentine peso in the early 2000s, when the peso was pegged to the dollar. But people didn’t have full confidence that the Argentine central bank would support the peso, so the peso consistently traded at a discount, sometimes substantially so.

What might explain Tether trading at a premium to the dollar?

There is this vehicle currency demand that can cause Tether to trade at a premium. If I as an investor can get into Bitcoin by either using dollars or Tether, but it is expensive to get into Bitcoin using dollars because transaction costs are higher, than I’d much rather buy bitcoin using Tether because it gives me a near costless option for getting into Bitcoin whenever I want. That “vehicle-currency demand” for Tether is what pushes its price above one US dollar.