jt26 Says it Better

Once again, a reader says it more concisely.

jt26 said:

“I see your argument. In essence, your point is if liquidity is not an issue how can the MOE function be more important than the MOA function.”

That’s a great way to put it. Creating loans is not the problem. Our banking system can always create more loans. So what is happening with the balance sheet and collateral of the world – and therefore the MoA function of monies – tends to dominate what happens in the MoE functions.

Ok, you sticklers on actual banking practices – banks cannot always create more loans, but the constraint is far less binding than “going out and finding deposits so we can make this loan to builder X”.

This improved re-statement of my own argument by a reader has happened to me before, and greatly helped to advance the idea. It’s a collaborative process, so much thanks to jt26!

Note, this helps to explain something which is simply skipped over by Scott Sumner. Here is something from his recent post:

“Suppose Zimbabwe goods are priced on gold terms, and a strange phenomenon causes 1/2 of all the gold in the world to disappear.”

Well, it sure seems to me figuring out what could make 1/2 of the money supply vanish would be highly important. In our world, we can begin to identify how this happens. We know that most loans are backed by some form of collateral, be there visible today (like real estate) or claims on future cash flows (like credit card debt).

We spent a ton of time going over S = I + (S-I) here, and I did a few posts on Money-Like Instruments. It’s clear we can take almost anything and repo it out to get cash money. When money-creating banks are part of the repo market, the demarcation between money and collateral becomes extremely blurred.

Gorton points out using private collateral in the money creation process is inherently unstable. It’s because there is default risk baked into private collateral creation. It’s part of the contract specs, using my old futures product development terminology.

Of course, there are ways to think about this more clearly. I wrote a long rant on the distinction between debasement and default. I’ve softened my stance on default in a sovereign issued currency. I think it’s “possible” under very unusual circumstances with particular institutional setups.

But, I still consider this distinction to be at the heart of our problems – we do not recognize the important difference between debasement and default.

Scott Sumner is only looking at only the “debasement” side. They are looking at how money changes in value, without regards for how this money came into being, or why it might be destroyed.

 

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Expert in business development, product development, and direct marketing. Developed strategic sales plans, product innovations, and business plans for multiple companies. Conceived the patent pending Spot Equivalent Futures (SEF) mechanism, which allows true replication of spot and swap like products in the futures space.

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beowulf
3 years 7 months ago

“I’ve softened my stance on default in a sovereign issued currency. I think it’s “possible” under very unusual circumstances with particular institutional setups.”
Like that time Russia dropped a ton of bricks on Warren’s head (the Russian government had monetary sovereignity, as Rodger Mitchell would say, but it defaulted anyway.

“I’m beginning to think that banks+repo+money markets is another unholy trinity like banks+securitization/SPV/SIV+passive investors”

Does it even add value to the economy or is it more like financial pollution, just begging for a Pigouvian tax?

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jt26
3 years 7 months ago

“When money-creating banks are part of the repo market …” you nailed it.
I’m beginning to think that banks+repo+money markets is another unholy trinity like banks+securitization/SPV/SIV+passive investors. (I ignored the ugly little brother of securitization; ratings agencies!) The banks+repo is more complicated, as it is not clear (to me) whether (in all cases) the banks are extending credit (creating money). For example, mechanically, when a hedge fund buys an asset does it first buy on margin from a bank/PD, then repo’s it and repays the PD? (This question probably applies to the PD’s own inventory … was it financed through repo or it’s own money creation?) (PS Thanks for the title!)

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