Milton Friedman said a lot of things that were very controversial 40 years ago, but are now part of the economics mainstream. The natural rate hypothesis, and the view that monetary policy should have prime responsibility for aggregate demand and inflation, are now part of the New Keynesian orthodoxy. This shows how much Milton Friedman won his war. But there was one tactical battle he clearly lost, and lost badly.
Milton Friedman said that if the money supply kept growing at k% per year, where k was some small positive constant like 4%, nothing much could go very wrong with the macroeconomy, so that's what central banks should do. That never became part of conventional wisdom. Some people believed it in the 1970's. Almost nobody believes it now. I stopped believing it 30 years ago. So did the Bank of Canada, when it stopped targeting money growth. "We didn't abandon M1; M1 abandoned us" as Governor Bouey is reputed to have said. Money demand just isn't stable enough, and fluctuations in money demand can be just as damaging as fluctuations in money supply. And so central banks need to offset fluctuations in money demand while maintaining some sort of nominal anchor like an inflation target.
Milton Friedman was wrong on that one, and the current recession seemed to be just one more example of him being wrong. The current recession looked like an increase in money demand, either as part of a general excess demand for safe assets (as Brad DeLong argues), or a general demand for liquid assets. It didn't look like a fall in the money supply.
Now I'm not so sure. Reading Gary Gorton and Andrew Metrick (H/T Tyler Cowen) I realise I don't have a clue what's in the stock of money any more. And when I say "money" I don't just mean credit, or money substitutes; I mean full-blown media of exchange, like currency, or chequable demand deposits in fractional reserve banks. I mean stuff you can buy things with, without first having to sell them for money, or follow up by paying money later.
Suppose you were a monetary economist in the US in the 1930's. And suppose you knew that currency was a medium of exchange, but you didn't know that demand deposits at fractional reserve banks were also media of exchange. You would have noticed the runs on banks, and bank closures, but you wouldn't think that these had anything to do with the supply of money. As far as you knew, the money supply, which you thought of as currency, would have seemed OK. You would completely miss the fall in the money supply.
Maybe we are like that now. Maybe a large part of the money supply is dark matter. We didn't see it fall. We saw the runs on the shadow banking system, but didn't see how it affected the money supply.
I have no idea if this is right. It probably isn't. But I'm not as confident as I used to be that Milton Friedman was wrong on the k% rule. Of course, it makes it even harder actually to implement a k% rule, if we include dark matter in the thing we're supposed to make grow at k%. Because if they are that hard to see, they are even harder to control.
Update: here's a simpler paper by Gary Gorton (pdf). (H/T 123.)
Worthwhile Canadian Initiative 
Is the original reason he was wrong (money demand isn’t stable enough) still there, or does this insight into possible dark matter mean that original reason was illusionary? If not, then he’s unambiguously more wrong, because we’ve got the original reason + a new reason (even harder to implement).
Luis: It’s more a different reason. Maybe what we thought were shifts in money demand were really shifts in money supply — just a shift in part of the money supply we didn’t see. So the original reason we thought he’s wrong is false; but there’s a different reason.
So under the lamp post, the complexity of the stock composition of money becomes more obvious.
Should that really provide comfort that the volatility of velocity is any less erratic?
Given the specialization and complexity inherent in the stock, why wouldn’t velocity be even more erratic?
Maybe he was even more wrong than you thought.
If the natural rate hypothesis is orthodoxy, wouldn’t papers arguing for hysteresis be heterodox? They seem fairly mainstream to me. And Mark Thoma is hardly alone in doubting whether monetary policy should have prime responsibility for aggregate demand and inflation. Actually the proponents of monetary policy are frantically moving the goalposts, defining monetary policy as anything the Fed or the ECB might conceivably do.
Any policy that depends on using the ‘demand for money’ as a driving input is even more inherently flawed than one that uses the supply of money. In neither case can one produce an unambiguously useful value, even ignoring the question of definitions.
If I routinely hold an average of $10,000 of money (the medium of exchange), I can be said to have a demand for money of that amount, but it is useless since the total is composed of at least three distinct components with both disparate purposes and economic effects.
First is money held for unpredictable purchases in an uncertain future, where an actual medium of exchange is required for an immediate payment. Think of a sandwich from a vending truck. Even if a credit card payment were sometimes accepted, you couldn’t depend on it in advance.
Second is money held for predictable purchases. In this case, think of a rent payment. Even if real money is needed, there is no need to hold it for weeks in advance when some other liquid asset can be converted to money in time to make the payment. Note that a monthly rent payment interacts with the supply of money not only due to the amount, but at least as importantly, the time of possession of actual money in advance of payment. A dollar that I possess cannot be possessed by anyone else at the same time.
Third is a remnant of money for which no preferred alternative is perceived, after any potential transaction costs.
Goods and services are always ultimately exchanged for other goods and services. Money serves as a buffering and time shifting mechanism and is not consumed in exchanges. It is the time of possession of money which is used up.
Regards, Don Lloyd
European Central Bank still pays lip service to Friedman in its monetary policy announcements. This is Trichet in October 2009:
“Turning to the monetary analysis, the latest data confirm that developments in broad money and credit growth remain subdued. In August, the annual growth of M3 and loans to the private sector declined further to historically low rates of 2.5% and 0.1% respectively. This parallel deceleration in money and credit growth confirms our previous assessment of a moderate underlying pace of monetary expansion and low inflationary pressures over the medium term.”
Here is Jürgen Stark, Member of the Executive Board of the ECB:
“On the basis of these considerations, over the dozen years since the creation of the ECB, we have continued to employ and develop new tools for monetary analysis. We did this even in the face of vocal criticism from a significant camp of economists. They questioned whether money and financial frictions had a role to play in the inflation targeting frameworks that they had identified as “best practice” for central banking.
Money has been ignored. In the canonical New Keynesian macro-model on which the intellectual foundations of inflation targeting rests, money has been considered a redundant element in the monetary transmission mechanism. At best, money is seen as a useless appendix to the model, serving only to confuse and distract any policy-maker misguided enough to consider it.
Now that the financial crisis has exposed the fault lines underlying this model;
now that it has been recognised that the inflation targeting approach focused unduly on short-term cyclical developments in the real economy;
now that economists agree that insufficient attention has been paid to financial imbalances and vulnerabilities, critics of the ECB have acknowledged the benefits of monetary analysis.
Yet, they tell us that we have pursued such analysis for the wrong purpose!
The right purpose, they tell us, is to support a broader view of our mandate, paying more attention to risks to financial stability in formulating our policy decisions. It is a little bit as if they are telling us to forget about monetary policy in principle.”
Jürgen Stark again:
“Not all historical episodes of private sector money and credit balances going off track have been followed by threats to financial stability. But, every major economic crisis in the 20th century was preceded by the emergence of monetary imbalances. <..>
The Great Depression is another case in point. It is certainly true that the banking crisis brought about by the failure of central banks to understand their role as a lender of last resort under the gold standard was detrimental. But equally detrimental was the sheer unavailability of monetary data that could have signalled the need, given the collapse in money and credit, for monetary policy to be accommodative much earlier on, to a higher degree and for much longer.”
JKH: Maybe, or maybe not. It’s ultimately an empirical question. But the answer to that empirical question is now a lot less obvious than I thought it was. I thought the answer was that Ms didn’t fall but PY did. But if Ms fell too…
Kevin: there’s hysterisis and hysterisis. To say that it takes time for the short-run natural rate to return to the long-run natural rate isn’t very heterodox. But even that is not in the canonical New Keynesian models. To say it never returns, so there are multiple natural rates, or a continuum of natural rates, is more heterodox. (But still not the same as a stable exploitable long-run trade-off between inflation and unemployment.)
Pre-Friedman, the mainstream view was that fiscal policy should control AD, and target unemployment. Monetary policy should target the composition of output between consumption/investment, and domestic absorption/net exports, by targeting interest rates and/or exchange rates. And inflation was to be dealt with by…..price/wage controls, industrial policy, weakening unions, whatever. I’m old enough to remember how it used to be done in the 60’s and early 70’s (more UK). There was a total re-assignment of which policy instrument was assigned to which target. And it was Milton Friedman’s assignment that became the new orthodoxy. Inflation was assigned to monetary policy, the composition of demand to fiscal policy, and unemployment to…..the rest of the grab bag of policy instruments, whatever, or whatever was left. Yes, there’s been a bit of a switch back towards fiscal policy to control AD this last year or two, but most people think of this as a temporary measure.
“Milton Friedman said that if the money supply kept growing at k% per year, where k was some small positive constant like 4%, nothing much could go very wrong with the macroeconomy, so that’s what central banks should do. That never became part of conventional wisdom. Some people believed it in the 1970’s. Almost nobody believes it now. I stopped believing it 30 years ago. So did the Bank of Canada, when it stopped targeting money growth. “We didn’t abandon M1; M1 abandoned us” as Governor Bouey is reputed to have said. Money demand just isn’t stable enough, and fluctuations in money demand can be just as damaging as fluctuations in money supply. And so central banks need to offset fluctuations in money demand while maintaining some sort of nominal anchor like an inflation target.”
Question I don’t know the answer to: How much of the drop of support for the k% rule (1960) in the 1970s is due to the Lucas Critique (1976)? Now the Lucas Critique is more about large scale macro problems, but it does seem to throw cold water on the general idea that we can make rules based on past observed macro relationships.
Don: I don’t think there is any (useful) relationship in Macro that can be shown to be stable on purely theoretical grounds. Ultimately, it’s always an empirical question. (Damn! I’m channelling David Laidler again! It was your Laidlerian “money as buffer stock” comment that did it).
TMDB: Welcome! I’m very glad you showed up here, since you understand this better than I do. I have little to add to your comments, but I can’t resist this quote from Jurgen Stark:
“Money has been ignored. In the canonical New Keynesian macro-model on which the intellectual foundations of inflation targeting rests, money has been considered a redundant element in the monetary transmission mechanism. At best, money is seen as a useless appendix to the model, serving only to confuse and distract any policy-maker misguided enough to consider it.”
Yep. My metaphor is that money is an epiphenomenon in NK (strictly, Neo-Wicksellian) models. Caused by, but not causing. Laidler says it’s the ghost in Hamlet.
Mike: “How much of the drop of support for the k% rule (1960) in the 1970s is due to the Lucas Critique (1976)?”
The version of the Lucas Critique applied to money targeting was….damn! Mental blank. British guy. But it was more empirical than theoretical.
I’m with Luis. How does the fact that the money supply is harder to measure than we thought, imply that money demand is stable?
OK, since nobody else has, I’ll bite.
You have been led astray by Gorton’s “bank-run” analogy. It is not true that collateral-money is a “full-blown medium of exchange.” You cannot buy anything with it, without first selling it for money, or following up later with money.
1. The only thing you can “buy” with collateral is another financial asset.
2. It is true that this “purchase” can be financed indefinitely with collateral, but so long as this is done, the purchase is not final. It can be reversed at the whim of the seller. That is what makes the “bank run” possible.
3. As a practical matter, practically all collateral-money is used to buy itself. A treasury bond is used to finance a position in the self-same treasury bond. The same was true of ABS during the credit boom; an SIV is a mechanisms for financing a super-senior tranche with itself.
So it is clear that collateral money does not have the features of a general medium of exchange. How, then, can it validate Friedman’s opinions about money?
Nick, you might find this interesting.
http://philosophyandeconomicsblog.blogspot.com/
Dark matter money is easily annihilated. Seems to me that it’s mostly created as leverage and when it goes bad it turns future promised/expected/imagined returns into present demands for cash.
What is “dark matter money” ?
Re-hypothecated collateral creates a fragile chain of loans that can, potentially, break at any link, just as it did in 2007. The amount of cash remains roughly constant within the chain regardless of the number of links — there is no mysterious “dark matter”.
JW: We saw what looked like an excess demand for money, which meant that either money supply fell or demand increased. Seeing no evidence that supply fell we assumed that demand must have increased. But if supply really fell, maybe demand stayed the same.
Phil: Gary Gorton says it’s a medium of exchange. You’re saying he’s wrong, right? One of the reasons I wrote this post was to see if we could get an answer to that question. What about when there’s re-hypothecating? So the same Tbill, (or colateralised security) in effect gets used multiple times. Isn’t that like fractional reserve banking?
(BTW, Milton Friedman wasn’t such a medium of exchange nut himself, but I am; to me, money matters because it’s a medium of exchange.)
Lee: Thanks. Good luck with the blog. It can take a lot of investment, especially at first,
Patrick: Regular bank deposits were also relatively easily annihilated, before deposit insurance and lender of last resort.
“So the same Tbill, (or colateralised security) in effect gets used multiple times. Isn’t that like fractional reserve banking?”
I do not see how it is equivalent to creating credit by commercial bank.
If we have 9 people holding $1 cash each and one person holding a $1 T-bond, the bond will travel along the possibly closed chain possibly infinite number of times (not in the US where r.h. < 140%, but perhaps in the UK where r.h. is “unlimited”), but there will still be one the $1 T-bond and $9 cash in the chain.
The whole problem may have more to do with base money demand, rather than just money demand. All else being equal, an increase in currency demand is also an increase in base money demand and creates an excess demand for money. (See my post here: http://philosophyandeconomicsblog.blogspot.com/2010/10/monetary-e.html). Banks also increased their reserve demand considerably, holding reserve ratios well above normal, which can also create an excess demand for money. On top of all that, money demand probably did increase.
Isn’t rehypothecation like fractional reserve banking? In some respects, yes. But the analogy is only partial; it might be better say that it is like the listed equity market. B wants to short a stock, so he borrows it from A and sells to C. C can turn around and sell to D, and so on. This creates a chain of matched assets and liabilities in virtual short and long positions in the stock, supported by only one actual share holding. There has been a corresponding expansion of credit, but only in the market for the underlying stock.
The traditional repo market, in which practically all collateral was treasuries or agencies, worked like the equity market. The modern market, with privately created underlying collateral, seems to occupy an intermediate position. To the extent that the raw material for the collateral is supplied by extending new mortgages (or other loans), the process creates credit in the real economy. To the extent that these mortgages are home equity loans, it creates generic retail credit.
However, it is still true that the only debt that collateral money can be used to settle is a debt in the collateral security itself. I don’t think that can be considered a true medium of exchange. It is more like privately created scrip than private money. A demand deposit, by contrast, can be used to buy generic real goods. Perhaps some confusion arises because private collateral money has been created by the purchase of real goods. But that is not the same thing.
“Isn’t rehypothecation like fractional reserve banking? In some respects, yes. But the analogy is only partial”
On the second thought, I’d agree with the analogy as bank credit extension can be seen as “a chain of matched assets and liabilities” as well.
Very much similar to commercial banking credit extension but without access to the interbank market “free” cash.
Fair to say that given the chance to start over from scratch, this isn’t likely the monetary system we’d create. What a hack.
Phil, vjk: In regular banking, with fractional reserves, if BMO customers pay cheques to TD customers, and TD customers pay cheques to BMO customers, the offsetting liabilities are cancelled in the central clearing. Only the difference is paid by BMO to TD, or vice versa. That, to my mind, is a crucial part of what we mean when we say that demand deposits at TD and BMO are media of exchange. Is there anything analogous to those cancelled offsetting liabilities here?
Phil Koop is absolutely right in both comments.
Huge confusion here about how the repo market works versus how the medium of exchange works.
The repo market is all about taking advantage of credit spreads and other risk spreads in financial intermediation. It’s equivalent to a mini hedge fund transaction – establishing a short position, usually in a low risk security, using the credit of the security to secure low cost funding.
Not about buying refridgerators, for example.
i.e. “A demand deposit, by contrast, can be used to buy generic real goods.”
I want to buy a fridge for $100, and sell it back in 2 years for $70. Instead, I deliver a $100 Tbill to the fridge store, and the fridge store delivers a fridge to me. 2 years later I return the fridge, and pay $30 cash and get my Tbill back. Less cash changes hands. Does that example work?
Nick,
Sure – you’ve repo’d your t bill as a way of paying for the lease cost of your fridge.
There’re just not a whole lot of fridge buyers doing that, unless they’ve just been fired from a hedge fund and are suffering from post traumatic stress.
“I want to buy a fridge”
You want to get cash first because the store does not deal in Tbills.
So, hypothetically, you repo your $100 Tbill at minus say 2% haircut minus 1%/360 interest to be paid. You buy the fridge with the borrowed money plus some to cover the haircut. The next day, or thereabout, you will have to repay the loan with the interest and will get back you Tbill.
Assuming some dealer takes a fridge collateral, you order the fridge that gets delivered, you repo the fridge at some haircut and interest and pay the store with the loan and some of your money. The fridge, unfortunately, is the dealer property now, legally, so you cannot use it !
“What a hack. ”
That’s called “financial engineering”
See Greenspan for more.
Also, see Volcker’s comments re. ATM
Nick, from the horse’s mouth:
http://www.ny.frb.org/aboutthefed/fedpoint/fed49.html
“The Federal Reserve began reporting monthly data on the level of currency in circulation, demand deposits, and time deposits in the 1940s, and it introduced the aggregates M1, M2, and M3 in 1971. …Over time, however, new bank laws and financial innovations blurred the distinctions between commercial banks and thrift institutions, and the classification scheme for the money supply measures shifted to be based on liquidity and on a distinction between the accounts of retail and wholesale depositors.
…
The Full Employment and Balanced Growth Act of 1978, known as the Humphrey-Hawkins Act, required the Fed to set one-year target ranges for money supply growth twice a year and to report the targets to Congress. During the heyday of the monetary aggregates, in the early 1980s, analysts paid a great deal of attention to the Fed’s weekly money supply reports, and especially to the reports on M1
…
Following the introduction of NOW accounts nationally in 1981, however, the relationship between M1 growth and measures of economic activity, such as Gross Domestic Product, broke down. Depositors moved funds from savings accounts—which are included in M2 but not in M1—into NOW accounts, which are part of M1. As a result, M1 growth exceeded the Fed’s target range in 1982, even though the economy experienced its worst recession in decades. The Fed de-emphasized M1 as a guide for monetary policy in late 1982, and it stopped announcing growth ranges for M1 in 1987.
By the early 1990s, the relationship between M2 growth and the performance of the economy also had weakened. Interest rates were at the lowest levels in more than three decades, prompting some savers to move funds out of the savings and time deposits that are part of M2 into stock and bond mutual funds, which are not included in any of the money supply measures.
Thus, in July 1993, […] Fed Chairman Alan Greenspan remarked […] “The historical relationships between money and income, and between money and the price level have largely broken down, depriving the aggregates of much of their usefulness as guides to policy.”
[emphasis added]
iThe repo market is all about taking advantage of credit spreads…
I’d say about leveraging primarily since security purchase is “self-financing”:
Buy a security
Repo the security
Pay for the security with the repo’ed cash (plus the haircut).
If delta T were required to be zero (immediate settlement) instead of the usual T+3, the trick would not work.
I’ve seen it argued that barrels-of-oil can be thought of as money, or as underlying money. The return on barrels-of-oil invested in new oil projects or in various renewable energy projects is lower than it was in historical oil projects. Thus, there is a contraction in money supply in terms of barrels-of-oil.
Nick, I am asserting that your fridge example doesn’t work, for two reasons.
The first is the one JKH alluded to: you can’t actually buy a fridge this way. If it were possible for you to do this, and for your fridge retailer to pay his supplier with your t-bill, and for the supplier to pay the manufacturer with the t-bill etc, then of course the t-bill would be money. But all you can buy with a t-bill is another t-bill.
Well then; in the repo securities market, isn’t collateral functioning as money? Not entirely, because of the second point: the transaction is not settled. The fridge store can put your t-bill back to you at any time within the 2 year period without warning, whereupon you have to come up with $100 cash. (Term repo exists, but for periods of days rather than months or years.)
A final remark: there is also an important difference between repo and historical parallels such as chains of discounted commercial bills, because in the latter case, each step in the chain finances real economic activity.
“Term repo exists, but for periods of days rather than months”
Actually, three month repo are not unusual.
Technically, since repo is nothing but a lend-borrow contract with specific terms, nothing prevents the parties, except common sense, to create a hundred year term repo.
“Is there anything analogous to those cancelled offsetting liabilities here?”
Nick, I don’t want to ignore an explicit question, but a proper answer to this question would be rather long and detailed. A shorter answer is that there can be some netting in how the exposure to be collateralized is measured, and in the transfer of collateral, but this does not shrink the balance sheet. A “general collateral” repo allows a number of broadly similar securities to be posted as collateral, but once posted, you have to return the exact security. This does not promote balance sheet consolidation.
I would like to add that I am not persuaded that netting is a particularly monetary characteristic. Nothing nets better than a future, but futures are not much like money at all.
Nick:
WRT deposit insurance and lender-of-last-resort, Canada’s banking history and practice is quite dissimilar to the American experience.
The Bank of Canada wasn’t created until 1937; before then the Bank of Montreal was the fiscal agent for the Government of Canada and led the Canadian Banker’s Association in overseeing financial stability.
We didn’t have deposit insurance at all until 1967. We went the entire Great Depression without it. We didn’t have a bank run either.
Before 1967 the last bank failure was the Home Bank in 1923. The Government bailed out the depositors on a special basis. We did the same thing when the Northland Bank and the Commercial Credit Bank failed in 1985, the next failures of note, on top of what CDIC covered.
The usual practice in Canada to this day is for a merger to be arranged among the banking community to deal with weak banks. This is how the Bank of Hamilton was rolled into the Canadian Bank of Commerce (it had similar issues to the Home Bank) in 1923 and the Bank of British Columbia was turned over to HSBC in 1985.
Nick, regarding collateral netting, I should have mentioned that in the US treasury market there is a central clearer, the Fixed Income Clearing Corporation (FICC), which allows for multilateral netting. But I know of nothing analogous for privately created collateral such as AAA ABS, which is the more interesting case. And it is still the case that treasuries don’t net nearly as well as cash (because different issues are not fungible for netting purposes.)
“If delta T were required to be zero (immediate settlement) instead of the usual T+3, the trick would not work.”
I do not understand why this should be true, since the settlement lag does not affect the relative timing of the cashflows. I mean, you don’t have to deliver the security for 3 days, but you don’t get the money until then either.
Sorry. I shouldn’t have used “fridge” as an example. That was supposed to be a metaphor. Suppose it’s not a fridge, but some financial asset, like an IBM share. Instead of paying cash for the IBM share, I deliver a Tbill as security. Then when I want to, I sell my IBM share back to the dealer, and only pay cash on any negative balance, if the share has lost value in the meantime.
Let me also ask you guys this: when Gary Gorton says that Tbills are functioning as money, as a medium of exchange, is he wrong? (That is not intended rhetorically.)
The trouble is that the metaphor doesn’t work very well. It is easier to work with real cases. Your IBM/T-bill transaction does not fit the repo model, which is a matched purchase/repurchase agreement of an asset for cash rather than an exchange of assets.
In a typical repo you do not actually own the collateral a the start of affairs and the execution of the transaction does require a lot of cash temporarily. It would work like this: B wants to buy a T-bill from A, so he borrows the money from C by promising to post the bond as collateral. B needs only enough cash to cover the haircut on the loan, but the full purchase price of cash flows from C to A.
What is money-like about this? Well, C has temporarily lost the use of his cash, but the bond he is holding is almost as good. He can post the bond as collateral and use the borrowed money in any way he likes – to buy some IBM, for instance, or even just a lot of good champagne (bearing in mind that he will have to pay the money back!)
Now, can he repo out his IBM shares? Yes. But shares are not nearly as good collateral as T-bills, and they command much higher haircuts. So if he uses his borrowed money to buy anything except another T-bill, the chain of money “creation” is going to peter out pretty quickly. But a chain of T-bill transactions is not very interesting. So when Gorton says that T-bills are functioning as money, I would say “yes and no.”
Phil (and all): thanks. I’m still trying to get my head around all this.
Determinant: Gorton kind of covers that in his book showing how NY banks used to band together during crises, similar to your canada example.
“I do not understand why this should be true, since the settlement lag does not affect the relative timing of the cashflows”
If there were no settlement leeway, no matter how short, leverage would be impossible. What make it possible is re-arranging transactions:
buy a security -> borrow cash using the just “bought” security as a collateral-> pay cash for the security
becomes
buy a security -> pay cash for the security -> borrow cash using the security
at the end of the settlement day thanks to netting.
Theoretically, you can transact with zero capital, practically there is Regulation T limiting the leverage (except hedge funds I believe).
Nick:
Don’t forget credit cards. Since 1950, economists have claimed they aren’t money, since they are ultimately paid off with a check, note, or coin. In 1840 they said that checking accounts weren’t money, since they were ultimately paid off with notes or coins. In 1710, they said that paper notes weren’t money, since they are ultimately paid off with coins.
I predict that by the year 2050, economists will recognize credit cards as part of the money supply; but by then, some new kind of money will come along, and economists will deny that it is money, since it has to be paid by credit card, check, note, or coin.
Mike: That’s how my mind was sort of working. That’s what I fear. That’s why I brought up the netting out of settlement balances, to try to argue that there was a distinction between demand deposits and credit cards. But I’m not sure if the netting out really works, since it depends on what should be trivial features, like whether there is immediate clearing or they wait till the end of the trading day.
Does it really come down to this: any asset you can quickly and easily borrow a large percentage of the value of, is almost as good as cash. Like my cows, for example, if I get them valued I can go to any bank and borrow against them.
Phil was talking about fungibility above, and the lack of fungibility of real assets makes them unsuitable as money. But if you can get them valued reasonably well, you can borrow against them quickly and easily with just a small haircut, so it’s very close to monetising those assets.
I don’t agree with all of Gorton’s arguments about collateral, but
I do agree that at least some overnight repurchase agreements serve
as media of exchange.
While I think overnight loans have served as media of exchange for
decades, starting with the eurodollar market in the sixties, the
development of sweep accounts have taken away all doubt.
When a bank sweeps funds from checking accounts to money market saving accounts
at the bank at the close of business each day, and then reports to the Fed
the balance in the money market saving account and not the checking account, and
all the while the depositors have complete access to the fund in the checking account,
then the balances in the money market savings account serve as media of exchange.
A web search of sweep accounts shows that money market savings accounts at the
same bank is just one option. Repurchase agreements are another. While
balances in money market savings accounts are included in the M2 and MZM measures
of the money supply, overnight loans by “depositors” secured by securities don’t
count in any measure. Still, the depositors have complete access to the funds
at all times.
That this scheme to avoid reserve requirements and restrictions on the payment
of interest on demand deposits has become computerized and perfected just means
that the long standing practice of using overnight lending as part of cash management
didn’t involve the creation of money.
Concern that you can’t spend repurchase agreements are beside the point. Neither
are the deposits that are checkable directly spent. It is the checks that actually
change hands. So?
Of course, we can focus on the quantity of base money and demand to hold it, and consider
checkable deposits as something that impacts the demand for base money. Or, we can included
checkable deposits as money too, and see money market mutual funds as something that impacts
the demand to hold currency and checkable deposits.
If someone has a sweep account invested in overnight repurchase agreements and they have more
than they want to hold, they just write checks to spend the excess balances. Sure, as the checks
clear, the bank has to reduce its overnight lending. But that is true with conventional deposits
as well. And those receiving the checks deposit them, and their banks get excess reserves to lend.
Similarly, if someone has a sweep account invested in overnight repurchase agreements and they have less than they want to hold, the can simply continue making deposits and write fewer checks. Sure, their
bank accumulates reserves and makes more overnight loans. But that is always the case. Other banks have
less reserves and must contract credit somehow. While the amount of credit extended by the banking system
is unchanged, the person demanding more money spent less.
Think about a banking system where everyone writes checks against overnight repurchase agreement accounts.
It isn’t that hard. As long as the banks clear the checks and then roll over the remaining funds, you can
keep the illusion that it is overnight, and everything works more or less the same with a conventional banking system. Rather than making loans, of course, the system is funding whatever securities are used
for the repurchase agreements.
Of course, today we have all sorts of deposits. But it seems to me that for at least some people, overnight
repurchase agreements serve as media of exchange.
And, if people don’t trust those borrowing overnight, or rather, the securities that had been lending to them against (the collateral) and so shift of conventional (FDIC insured) deposits, then this contracts the quantity of money if the quantity of conventional deposits doesn’t expand.
It really is like a shift from checkable deposits to currency.
Overnight commercial paper? I didn’t even know it existed. But clearly, the shadow banks were creating money, even if payments had to pass throug
“Does it really come down to this: any asset you can quickly and easily borrow a large percentage of the value of, is almost as good as cash.”
That’s fine, Nick. Then the question becomes who is doing that kind of borrowing and how much of the money borrowed is going into the real economy versus the financial economy. Almost entirely the latter in the case of the repo market I would argue.
BTW, your conclusion here is the basis on which the MMT’ers say there’s no difference between the government borrowing with bonds versus monetizing its expenditures without bonds – on the basis that bonds can always be repoed for cash. Hence they argue for no bonds at all (some of them). I think that the repo liquidity availability is an overly simplistic argument, but it meshes with your theme here.
Nick, here’s a quote I picked up from nowhere in particular – it’s definitely an oversimplification , but makes a parallel point to above:
“I think one big thing going on in all this, is that we are seeing Cantillon effects to the Nth degree. This is probably an oversimplification, but think about it: The economy is in a shambles, and Bernanke gives a trillion dollars in new money to investment bankers. What’s going to happen? They’re not going to rush to the store to buy milk and eggs. No, they’re going to buy financial assets, and indeed we saw the stock market go up 40% after Obama got in, which makes absolutely no sense. We have also seen gold setting records, which makes perfect sense too. But we haven’t seen CPI go up. In retrospect, is that really surprising? The people who buy milk and eggs are still broke; they didn’t get the trillion dollars.”
This is turning into another of those posts where the commenters do all the hard work, and all I’ve done is raised the question. Which is fine. Just wanted to let you all know that I realise that’s the case.
Does it really come down to this: any asset you can quickly and easily borrow a large percentage of the value of, is almost as good as cash. Like my cows, for example, if I get them valued I can go to any bank and borrow against them.
Nick, I have long been under the impression that you repudiated this idea:
Are you deserting Clower?