Why Do Economists Obsess over Government Money?

I was reading this post by Scott Sumner in which he concluded with the following:

“This post has already run too long, so I’ll do the quantity theory of money in the next post.  We’ll see how the central bank can control the value of money (and NGDP), by changing the currency stock.”

I just don’t get the obsession with currency and other forms of government money.  It reminds me of the obsession with the gold standard in many ways.  As if we should focus on pegging the currency to some particular money.  But doesn’t this get the entire monetary system exactly backwards?  Of course, banks don’t create money by multiplying bank reserves or cash.  If we want to really understand our monetary system we need to better understand how inside money (bank money) “rules the monetary roost” and how government money facilitates the use of inside money.

This obsession with government money gets the entire money system backwards by focusing on the cane (the facilitating feature) when we should be focused on the leg (the actual banking system).  I’ll be curious to see what Sumner says because he’s explicitly stated in the past that he doesn’t much care for understanding how modern banking works.  To me, that’s like saying that you don’t much care how the monetary system works, yet you’ll continue to propose fixes for it (or describe how it works?!?).  That doesn’t make a lot of sense to me.  The world we live in is one built around private banking, but the world economists live in is one built mainly around the Federal Reserve, which is designed to facilitate its true master – the private banking system.

 

About

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering asset management, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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Guest
4 years 1 month ago

Could QE be morphing the system into a novel form where government money does start to influence what happens? If lending is in the form of shadow banking funded by selling debt securities to hedgefunds who have just sold off their stocks of treasury bonds to the Fed; then perhaps conventional banks are no longer the only entities deciding on how much credit expands?

Guest
Oilfield Trash
4 years 1 month ago
Stone “then perhaps conventional banks are no longer the only entities deciding on how much credit expands?” Yes IMO you are correct, except I would it say conventional banks have were never the only entities that can increase endogenous credit-money expansion. ” innovations in the form of new financial instruments are encouraged through high interest rates, and repos are typical examples of such innovations in chronic and high inflation countries. People are thus able to hold interest-bearing assets that are almost as liquid as money, and monetization is effectively done by the private financial sector instead of the government”. …“The money creation process under high budget deficits can as well be characterized as an endogenous credit-money expansion rather than a monetary expansion to maximize seignorage revenue”. This is the reason on previous post of the TDC I made the comment that the financial sector would not be able to REPO a TDC, which means they would no longer be able to expand endogenous credit money (Beowulf thought that was hilarious). But what if the financial sector created a synthetic treasury (deem risk free equal to government obligations) which is basically what they did with MBS origination through Freddie and Fannie. The creation of such an instrument would allowed shadow banks to expand endogenous credit money much higher levels without the need for deficit spending of the government. When the market realized this risk free marked ABS was no substitute for treasuries a shadow bank run started and domino through the economy. I have a gut feeling that due to financialization of ABS and most of it marked AAA explains why 150% of private debt to GDP was enough to trigger the depression and it took 300% of private debt to GDP to trigger this one and would also explain why… Read more »
Guest
4 years 1 month ago

Oilfield Trash, people talk about the money supply but as far as I can see what actually influences the economy is who has the money. If the latest fad is for hedgefunds etc to buy securities based on conglomerations of loans to small businesses, then perhaps that will kick start the real economy even if it doesn’t increase the money supply and the shadow banks are purely connecting lenders and borrowers with no endogenous money creation. Perhaps this is a way to connect current wealth holders with “the idiosyncratic, illiquid economic risks that are the essence of an innovative, entrepreneurial economy” as you so neatly put it. Under such a system, the extent of QE determines the money supply. The shadow banks decide what proportion of the money supply is in use in the real economy rather than just sitting idle. If all of the small businesses default and wipe out the money supply, then the government can QE something or other to produce a new batch.
What I don’t understand is why these loans make sense for the shadow banks but not the actual banks. If there is a good chance of them being repaid then why don’t actual banks create such loans “with the stroke of a pen”? Is it because conventional banks need to be so highly regulated because the payment system depends on them?

Guest
Oilfield Trash
4 years 1 month ago

Stone

“Under such a system, the extent of QE determines the money supply”….”The shadow banks decide what proportion of the money supply is in use in the real economy rather than just sitting idle.”

The money supply is not important, the interest bearing money supply is what is important. Real rates of interest are what drives money through the economy. Positive real rates of interest will drive money into investment of real assets , negative real rates of interest will drive money into financial assets, which to a large extent are loans.

‘What I don’t understand is why these loans make sense for the shadow banks but not the actual banks.’

I do not understand this question.

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