This post is about something I don't understand.
Let's start out simple. There are two parallel imaginary worlds: the green world and the red world.
In the green world people use positively-valued green money as the medium of exchange. If I buy something I give the seller my green money in exchange. Green money flows in the opposite direction from all other goods and financial assets. I am not allowed to take green money from someone without their consent. Only the issuer of green money is allowed to create green money. The borrower of green money undertakes an obligation to give green money to the lender at some future date.
In the red world people use negatively-valued red money as the medium of exchange. If I buy something the seller gives me his red money in exchange. Red money flows in the same direction as goods and financial assets. I am not allowed to give red money to someone without their consent. Only the issuer of red money is allowed to destroy red money. The lender of red money undertakes an obligation to accept red money from the borrower at some future date.
There is a symmetry between the red and green worlds; one is the negative mirror-image of the other. But there is also one asymmetry: the red world has a fundamental problem. Each individual can increase his utility by buying more goods and selling less goods, thereby accumulating an infinitely large stock of red money. The bank that issues the red money needs to put some limit on each customer's holdings of red money, to ensure this does not happen. This is not a problem in the green world, because having zero stock of green money sets a natural limit that stops an individual buying, and the individual is fully aware of that limit.
The real world is a red/green world. It has both green money and red money. A positive balance in a chequing account is green money. A negative balance in a chequing account is red money. If I sell my car to Andy, who gives me a cheque for $1,000, the bank reduces my overdraft by $1,000 and increases Andy's overdraft by $1,000. The bank has transferred $1,000 of red money from me to Andy. IIRC my father nearly always used red money. He nearly always ran an overdraft, paying it off once a year when he sold the harvest, to keep the bank manager happy.
In a red/green world, we can define the stock of "gross money" as the absolute sum of red money plus green money, and we can define the stock of "net money" as green money minus red money.
The Bank of Canada.
Canadian commercial banks have chequing accounts at the Bank of Canada. It's a red/green system. If I bank at BMO, and Andy banks at TD, and I sell my car to Andy who pays by cheque, BMO now has a positive balance of $1,000 at the Bank of Canada, and TD now has a negative balance of $1,000 at the Bank of Canada.
But the Bank of Canada sets a 50 basis point spread between the interest it charges TD on red money and the interest it pays BMO on green money. So BMO and TD can both gain if BMO lends TD $1,000 to eliminate both balances, at a rate of interest that splits the spread between the Bank of Canada's two rates of interest. Which is what Canadian commercial banks normally do. So the gross money stock is small, and normally the same as the equally small net money stock, by the end of each day.
- If the Bank of Canada acted differently, and set the same rate of interest on both red and green money, so the spread is zero, then there would be no incentive for BMO and TD to trade in the overnight market. If BMO's customers always sold more to TD customers than vice versa, BMO's chequing account at the Bank of Canada would become more and more positive, and TD's chequing account at the Bank of Canada would get more and more negative. The gross money stock would rise without limit, though the net money stock would not change.
- Or if TD were a risky bank, and if that risk were bigger than a 50 basis point compensation would warrant, there would be no rate of interest at which BMO would lend to TD that TD would accept. Again it is possible for BMO's account at the Bank of Canada to become increasingly positive, and TD's account increasingly negative.
A red/green world faces the same fundamental problem as the red world. A commercial bank will put a limit on each customer's overdraft. Similarly, the Bank of Canada must, at least implicitly, place a limit on commercial banks' overdrafts.
The European Central Bank.
Eurozone national banks have chequing accounts at the European Central Bank. It's a red/green system. They call it TARGET2. But unlike the Bank of Canada's red/green system, there doesn't seem to be any functioning equivalent to the overnight market that eliminates negative balances every evening. The ECB can hold the net money stock fixed, but the gross money stock can rise without limit. Here is the recent data (pdf).
I think you can see where this is going. I don't understand how it is supposed to work.
Worthwhile Canadian Initiative 
accommodation = residual = net clearing result
in context of private versus “official”
dlr is right.
Here is an interesting paper which describes imbalances between regional Feds:
https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1686.pdf?1ad840394e67a3aedb6e1b1fa9401431
“Nick,
Isn’t the problem here that the overdraft is denominated in terms of green money (i.e. it has to be settled with green money) and then you want to call the overdraft red money.
The thing about red money is that it doesn’t have to be settled at all. Isn’t that correct? (That’s why you keep saying that it’s in everybodies interest to die with a mountain of red money.)”
Nick,
I would appreciate a comment on my earlier point.
Mr Sinn is at it again:
https://www.project-syndicate.org/commentary/risky-eurozone-debt-buybacks-by-hans-werner-sinn-2016-11
Sinn writes: “Frequently, if the sellers of Spanish government bonds are outside the eurozone, it will ask the ECB to credit the payment orders.”
This caught my eye, and I thought this blog might be the right place to ask:
Is Sinn right on this one?
I’m thinking that where the sellers are domiciled isn’t decisive here. What matters is through which banks they transact, and at least one of these is often in Germany — or so I have understood. I’m not a fan of stories like the one Sinn comes up with (after the above quote), where the sellers, having sold the bonds, “transfer money” to Germany or the Netherlands to buy companies or company shares.
David Hume’s “price-specie flow mechanism” was a theory that explained why there was an equilibrating mechanism that prevented all the money (gold & silver, “specie”) ending up in one part of the world. But David Hume’s theory applied to a green world.
I’m trying to figure out of there’s anything equivalent to Hume’s Price-specie flow equilibrating mechanism in a red/green world, like Target2.
“I’m trying to figure out of there’s anything equivalent to Hume’s Price-specie flow equilibrating mechanism in a red/green world, like Target2.”
Nick, really interesting question.
Local Exchange Tradings Systems (LETS) are exactly like Target2 red/green money.
My understanding is that when LETS initially appeared in the 1980s, they allowed unlimited negative balances. To get around the problem of “all the money ending up in one part of the community,” they eventually began to implement credit and debit caps. Also, when a certain period of time had passed, LETS members (both debtors and creditors) were often required to balance their accounts back to 0.
i.e. https://wiki.p2pfoundation.net/LETS#LETS_systems.27_major_weakness:_Debt_policing
Interestingly, Keynes’ bancor plan was a red/green system. Here is Keynes:
“Measures would be necessary to prevent the piling up of credit and debit balances without limit, and the system would have failed in the long run if it did not possess sufficient capacity for self-equilibrium to prevent this. (Proposals for an International Currency (or clearing) Union, February 11, 1942)”
He devised a number of mechanism to prevent this, which I went into here:
http://jpkoning.blogspot.ca/2012/09/ecb-imf-and-icu-and-other-exciting.html
So I don’t think there is an automatic equilibrating mechanism in a red/green world like Target2. It needs to have that design feature implemented at the outset, like a LETS with credit limits or Keynes’ bancor.
To some extent, T2 balances reflect national balance of payments. So a country with a T2 liability is experiencing, probably, a net outflow of funds owing to a current account deficit. In a fixed exchange rate system, diminishing foreign reserves pressure would eventually force the deficit country to deflate and staunch the net flow of funds outward. This was the equilibrating system under fixed exchange rates. Within the EZ (and it is effectively a fixed exchange rate system, one Irish euro equals one Spanish euro, for instance), this dos not appear to happen. Funds draining from a nation’s system can be replaced by the NCB of that country. So that country’s money supply does not fall even though its T2 balances are becoming less positive or more negative. That is, there are no deflationary forces in the deficit country to reduce the current account deficit. And as the ECB does not compel settlement of T2 balances, they go on increasing ad infinitum.
JP: “Local Exchange Tradings Systems (LETS) are exactly like Target2 red/green money.”
I wondered if they might be.
Really good comment.
And your excellent post anticipates a lot of what I’m talking about here.
Nick,
Willem Buiter did an analysis of the issue once which in my view was too alarmist as the situation is actually under control of the governing council of the ECB:
Click to access roublezone.pdf
JP: Great post on ICU/EMU, thanks! Your last paragraph summed up my thoughts as well, although in a much clearer way than I could have ever put it. Reading your post, it crossed my mind that no wonder many gave up on thinking how to govern the (international) financial system, and assumed instead that the “markets” will govern it on their own 😉 As you suggested (I think), the governance might work on paper but in practice the plan cannot be put to work.
From one of your quotes: “Each member-State, on joining the system, shall agree to pay to the Clearing Union any payments due from it to a country in default towards the discharge of the latter’s debit balance and to accept this arrangement in the event of falling into default itself.”
This reminds me of the bilateral clearing arrangements Germany had in place during the 1930s. The Magician himself, Hjalmar Schacht, wrote about this in his book “The Magic of Money” (freely available as PDF). He said that Germany couldn’t accept money as payment for its exports, because that money would have gone to debt repayments as per agreement with the creditor nations (who also had at least partial control over the payments system) — and this would have meant that Germany’s imports would have been restricted to bare essentials (as defined by creditors).
Instead, by exporting Germany earned credits in the bilateral clearing institution’s books (these were many, one for each nation trading with Germany), while the importer incurred debits. These balances were then cleared by German imports from the same nation.
Going to back to Keynes quote above… His ‘payments’ probably meant “payments in money”, and the “Schacht way” of getting paid in kind — Schacht called this barter — would have still been open for debtor nations? One cannot force sovereign states to stick to contracts if they themselves see that doing that would cause undue harm for the nation and its populace.
(From bilateral clearing we, of course, get to multilateral clearing, and that kind of system should probably still be called a barter — not monetary — system. Which makes one wonder if our current banking system is, in fact, more like a barter system than a monetary system.)
“….we, of course, get to multilateral clearing, and that kind of system should probably still be called a barter — not monetary — system.”
Antti,
If you read Schumacher’s (who developed the Bancor concept along with Keynes) paper “Multilateral Clearing”, you will be left in no doubt that the clearing system is monetary.
Henry: I think I will continue to see the system as a barter system, but that’s because I think that the “monetary systems” we have are all essentially barter systems. Jevons described the English banking system in the 1800s as being on its way towards a “complicated and perfected system of barter”, and it’s that kind of definition of ‘barter’ I have in mind.
But thanks for the tip, I’ll read the paper! (I recall I’ve read something similar, but perhaps not that one…)
Excellent post by JP Koning.
Although it touches on issues beyond Nick’s original question about the difference between the economics of ECB clearing of national central bank positions and that of conventional central bank clearing of commercial bank positions.
While gross TARGET2 balances are large, net balances are close to zero. (I think a few quirks about EZ non-members transacting with the system account for this.)
So in comparing the ECB system to a regular CB system, one might analogize it to the case of the pre-2008 Fed, in which net reserve settlement balances were kept fairly minimal. So an NCB holding surplus or deficit TARGET2 balances at the ECB analogizes to a US commercial bank hold surplus or deficit reserve settlement balances at the Fed. However, there is a big difference in the capacity of an NCB to respond to its situation compared to a bank like JP Morgan operating in that pre-2008 environment.
An NCB surplus or deficit TARGET2 balance reflects a net balance of payments that has not been cleared in the other direction by the domestic private sector. Although, if permissible, an NCB could in theory change the TARGET2 position that is otherwise delivered to it by engaging in international transactions in Euros on its own account, there is no way it can directly change the official balance of payments position that creates that initial TARGET2 position. For example, if permitted, the Bundesbank could buy foreign assets denominated in Euros in an attempt to clear its TARGET2 surplus position. But that does not change the fact that the same net capital inflow to Germany is still being recycled by an official entity.
Furthermore, as I noted, the collective bottom line of the NCBs in total is for the accounts of the participating members according to a capital key formula. So any proactive initiative in NCB balance sheet management is for the account of all – not just the initiating NCB. There is something circular in this. If capital is fleeing from Spain to Germany, then what is actually achieved by the Bundesbank buying Spanish bonds that isn’t already achieved by TARGET2 clearing? Perhaps more return along with more risk? But the result is for the account of all NCBs and their national governments. Why bother? Moreover, that sort of NCB specific capital flow intervention can add significantly to the financial risks for the EZ group that may be associated with the contingency of Eurozone membership exit by the weak member that is the source of such capital flows. (This corresponds I think to the convertibility risk that JP references). Again, why bother to clear the initial TARGET2 balance position, if this is doing nothing directly to restore the healthy functioning of private sector finance?
By contrast, the position of JP Morgan with respect to a surplus or deficit at the pre-2008 Fed is much different. JP Morgan has no such profit sharing arrangement with other commercial banks that clear through the Fed. It does what it does for its own account only. To the degree that has that profit motivation, then net balances either way at the Fed reflect an inefficient use of its balance sheet. So it will immediately try to correct that position. Importantly, like all big commercial banks, there is a myriad of asset-liability adjustments that a commercial bank can undertake in order to correct its reserve imbalance and improve its return on assets and equity. (There is a tendency by economists not to understand this aspect of commercial bank reserve management. The typical analysis always seems to be that individual banks undertake corrective action through the interbank market. That is only one way in which this is done. In fact there are a range of responses that include asset and liability pricing adjustments across many categories, with corresponding elasticities of flows and balances and corresponding effects on reserve positions.)
So there is an economic incentive for individual commercial banks to minimize their surplus and deficit reserve positions, such that the “balance of payments” imbalance between banks is minimized. In the pre-2008 era, individual banks simply got rid of their excess reserves through a variety of means. And while the bid-offer spread in the interbank market helped, there are many other avenues of balance sheet adjustment, including liability management of deposit pricing with non-bank wholesale counterparties or managing liquid asset positions with such short term assets as treasury bills and commercial paper or liquid bonds. Even in the case of a failing bank whose deposits start to flee to other banks, the US financial system is sufficiently deep in order for the receiving banks to expand their assets and/or reduce other liabilities such that the Fed can still have tight control over the excess reserve setting while providing LLR to a near failing bank and restoring balance to the reserve positions of the healthy functioning banks.
Again, the ECB / Euro System arrangement is one of shared fiscal impact from multiple national central bank operations. So even if national central banks took steps to correct imbalances generated otherwise by the private sector, the balance sheet effect and therefore the fiscal effect of the resulting NCB portfolio earnings would be shared among the member countries according to their capital share in the ECB. I think that means there is little incentive for individual NCBs to undertake corrective action when it comes to international imbalances.
And I think this is all somewhat separate from Keynes’ idea of motivating current account and net capital flow adjustment with a penalty on imbalances. In the case of the Eurozone, that sort of problem is all deeply behind the scenes as the source of the impact on NCB TARGET2 positions. It really can’t be resolved in a direct way by the NCBs or in a way that is comparable to, say, commercial banks operating in the pre-2008 Fed system.
@ JP, I’ll join in the congratulatory party, too. Now I understand Nick’s post better.
I particularly liked your conclusion that a better system could not have been realised for political reasons. I think the EU should have built on the ECU instead of replacing it with the Euro. Then again, doing economics in subjunctive is cheating.
JP Koning: “So I don’t think there is an automatic equilibrating mechanism in a red/green world like Target2. ”
What eventually forces a foreign exchange current account deficit country in a fixed exchange rate system to redress the balance is the fact that it is losing foreign exchange reserves. This cannot go on forever as foreign reserve holdings are finite. The deficit country cannot create foreign exchange reserves/money – it can only create domestic money.
The problem with the EZ is that NCBs within the eurosystem can create “foreign” money as well as domestic money – because they happen to be of the same denomination. So if the country is in deficit with other euro countries it does not suffer the reserve constraint in a normal foreign exchange/currency system. It can happily continue to create money to cover the losses to its internal system – there is therefore no deflationary pressure serving to rebalance the deficit country’s eurosystem payments.
Its not just then about setting credit/debit limits within the T2 system. It’s about the ability of the eurosystem NCBs being able to create euro denominated reserves. If this was not possible, then NCBs would be disciplined by a reserve constraint.
JKH: “While gross TARGET2 balances are large, net balances are close to zero. (I think a few quirks about EZ non-members transacting with the system account for this.)”
Small point. And I’m not 100% sure about this, but I think that’s not it. It might be because because the ECB itself has a Target2 account, and has used it to buy bonds (OMO/QE). (I haven’t checked this out or thought it through, because it raises a host of other issues.)
Antti: “I’m thinking that where the sellers are domiciled isn’t decisive here. What matters is through which banks they transact,…”
That sounds right to me.
I have forgotten who this comment is for:
My house, and the positive balance in my chequing account, are both assets. But only the latter is (green) money, because I can use it to buy things directly. (I can only buy things with my house indirectly, by selling it, or borrowing against it.)
My mortgage, and the negative balance in my chequing account, are both liabilities. But only the latter is (red) money, because I can use it to sell things directly. (I can only sell things with my mortgage indirectly, by buying it back.)
Nick,
We may both be right.
This from an earlier Whelan paper:
“TARGET2 balances among participating central banks sum to zero. The TARGET2 balances of the NCBs and ECB summed to zero in 2006 but were non-zero in later years because countries outside EMU joined TARGET2, using it to process euro-denominated payments.”
And this from somebody else, more recent, concerning QE:
“The QE program has been decided on by the ECB, but is run by the Eurosystem. While most of the asset purchases are executed by the NCBs, not all of them are. The ECB itself also buys various assets (everything from sovereign bonds to covered bonds, ABS, corporate bonds and agency bonds). The ECB’s purchases are distributed across the Eurozone. So what happens when the ECB e.g. purchases €100 m. in agency bonds in Spain? … So the ECB’s balance sheet will now show the Agency bond as an additional asset and the negative TARGET balance as an offsetting liability.”
From JKH’s last quote: “So what happens when the ECB e.g. purchases €100 m. in agency bonds in Spain? … So the ECB’s balance sheet will now show the Agency bond as an additional asset and the negative TARGET balance as an offsetting liability.”
Just to make sure I’ve understood this (thinking out loud):
We can think of the ECB’s own TARGET2 liability as (NCB) reserves. When ECB buys a bond, some private bank’s reserve account is credited in the NCB ledger. At the same time, the NCB debits its TARGET2 account (a debit entry increases assets), which corresponds with ECB crediting its TARGET2 account (a credit entry always increases liabilities).
Have I understood correctly that some entities have reserve accounts directly in the ECB ledger? So that if the ECB bought the bond from/through this kind of entity, it wouldn’t affect TARGET2?
I said: “We can think of the ECB’s own TARGET2 liability as (NCB) reserves.”
I should have added “kind of reserves”. ECB’s TARGET2 liability is obviously not an asset to any specific NCB (which makes it “red money”, Nick?). I had in mind the connection to reserves in the NCB ledger. (Perhaps I should have kept my thoughts to myself…)
” But only the latter is (red) money, because I can use it to sell things directly.”
Nick,
This is cannot be correct. Your mortgage and your negative cheque account are exactly the same. You would have has much chance/facility using your cheque account to sell a motor car as you would using your mortgage.
Henry said: “Your mortgage and your negative cheque account are exactly the same.”
I agree. I would say they are both a case of loans create (demand) deposits.
What happens if the reserve requirement is 100% everywhere in the EU?
Antii,
“We can think of the ECB’s own TARGET2 liability as (NCB) reserves”
This is a general comment I wrote 4 years ago in my post:
……
TARGET2 Balances as “Supra-Reserves”
An alternative view interprets TARGET2 balances held by Eurozone central banks with the ECB as analogous to reserve balances held by commercial banks with their central bank. In this framing, TARGET2 asset balances held by NCBs are net positive settlement balances of a “higher order” form of reserve. TARGET2 liability positions become deficit (borrowed) positions in these higher order reserves. This “higher order” form of reserve might be identified as a special type of reserve held by national central banks with the ECB, or a “supra-reserve”. This concept abstracts from the regular “lower order” case in which commercial banks hold reserves with a single central bank.
Within a single central bank system, a commercial bank payment includes the transfer of a reserve balance from payer to payee commercial bank. If the payer bank starts from a zero reserve position, it incurs a liability to the central bank for reserves owed (overdraft or borrowed reserves). The payee commercial bank will increase its reserve balance. Because the debiting and crediting central bank is the same bank, there is no net change in the central bank’s own reserve liability balance.
Within a multiple central bank system, a cross-border commercial bank payment will include a similar redistribution of reserve balances. The payer commercial bank’s reserve account will be debited by its central bank and the payee’s account credited by its central bank. But debiting and crediting central banks are different in this case. One will lose reserve liability balances; the other will gain them. As described above in the case of the Eurosystem, the payer central bank will incur a TARGET2 liability to offset its reserve liability reduction and the payee central bank will gain a TARGET2 asset to offset its reserve liability increase.
The relationship between the ECB and multiple NCBs in the clearing process for TARGET2 balances is similar to that between a single central bank and its commercial banks in the clearing process for regular reserve balances. A payment between two commercial banks in a single system results in a reserve decrease and a reserve increase. A payment between two central banks in a multiple CB system results in a TARGET2 liability and a TARGET2 asset. Thus, TARGET2 balances in a multiple CB system are functionally analogous to regular reserves in a single CB system. They both provide a clearing and settlement function for their own mode of inter-institutional payment.
The ECB acts as the clearinghouse for initial bilateral entries of TARGET2 balances, which sum to zero for the 17 central banks of the Eurozone. This zero sum characteristic is analogous to a regular commercial bank reserve system with a zero reserve requirement (e.g. Canada). Some banks hold positive balances while others borrow balances. The net reserves of those who have borrowed are zero, individually and collectively, while those with positive balances collectively hold the system excess reserve position that results from the uneven system reserve distribution.
……
As noted in my previous comment here, there are exceptions that result in a non-zero net balance for TARGET2 on the books of the ECB – including certain non EZ members holding balances and some monetary policy transactions carried out by the ECB for its own balance sheet rather than by the NCBs for theirs. In any interpretation, I would tend to think of the first type as “foreign” CB Euro operating accounts rather than EZ NCB quasi-reserve accounts. And while I was aware of the second type (I think mostly associated with special late crisis ECB intervention actions such as QE, as mentioned by Nick), I just haven’t followed those closely enough recently to know the full detail. The published detail of the ECB balance sheet (when you can find an unconsolidated balance sheet presentation) is pretty messy in its full classification.
sorry, spelling – Antti
Henry & TMF: I mostly agree with you, but at the same time I see more sense in what Nick is saying than you guys do. Please allow me to promote my blog post on overdrafts also in this thread. It explains how I see overdrafts and “traditional bank loans”, and how I think Nick sees them. Let me know if you disagree on something I say?
JKH: Thanks again, JKH! I’ll look into your answer when I have more time later today.
Suppose I have a term deposit and a positive balance in my chequing account. Both are an asset to me and a liability of the bank. But only the second is (green) money.
Suppose I have a bank loan and an overdraft in my chequing account. Both are a liability to me and an asset of the bank. But only the second is (red) money.
If I buy/sell a car by cheque, the second disappears directly. It takes an additional step for the first to disappear.
There’s a symmetry here.
Nick,
I think you’ve described a dual green/red money world where there is symmetry in the relative liquidity of green money positive balances and overdrafts (i.e. “red money” balances), compared to term deposits and loans.
I agree.
But there’s a different asymmetry in your example in the sense that the same payment instrument is being used in both cases (at least I infer that in this example).
It is positive green money balances that are being transferred by that payment.
In that dual green/red world, green money payment instruments can be used to adjust either green or red balances, whether they be source or destination of the payment, whether up or down in balance, whether positive or negative to start or finish.
The dual green/red world is essentially continuous at balance 0 with respect to the facility to make payments using what is essentially a green money instrument.
The asymmetry in your example is that if I sell something, it is still an incoming green money cheque that reduces my red money balance, not an outgoing red money cheque.
Maybe I misunderstood or have forgotten, but I think your original idea was that red money existed as a form of payment as well, where the direction of the payment flow in a purely red money world was in the direction of seller to buyer rather than the normal green buyer to seller direction.
In this case, having chosen an example in the dual world, you’ve made a choice about the payment instrument, which is biased to green. That’s the asymmetry.
JKH: think of the cheque that the buyer of my car gives me as an instruction to the bank to transfer red money from my account to his account.
you can think of it that way Nick – as an equivalent outcome
but in fact the cheque instructs a green money transfer in the other direction
(pay to the order of … etc.)
again, I’m referring to the aspect of the choice of payment type in a dual world
as opposed to what that would look like in a red only world
in a red only world, the buyer could still write the cheque
but the instruction would be to pay a red balance from (rather than a green balance to) the account of the cheque recipient
JKH: In a red/green world, I think we can think about it either way.
Nick & JKH:
Nick said: “If I buy/sell a car by cheque, the second disappears directly. It takes an additional step for the first to disappear.”
Did you have a look at my post? There I say:
“For instance, [in a world with only overdraft-type of “bank loans”] we would repay debt when we sell goods (item #3 in my document), not when the overdraft/credit limit is reduced (item #4). The latter is how we see repayment when we think of a traditional loan. If the accounting treatments are identical in their outcome, then why this discrepancy?”
To me, the “additional step” you talk about has no substance behind it, in the sense that we are talking about a choice regarding accounting treatment which should have no real-life (that is, outside the “accounting realm”) relevance. That additional step should not be regarded as something having to do with the repayment of debt; it is actually equivalent to closing an overdraft line of credit. This might come as a surprise to many; at least it came to me when I realized it (don’t remember exactly when — perhaps 1-2 years ago).
With all due respect — and that’s a lot of respect in case of you two — I think your discussion about whether it is green or red money that is transferred is, in the end, quite meaningless. All we have is a debit entry on one account and a credit entry on another account. Which comes first, debit or credit, doesn’t matter (in your language: the “money” can arrive at the other account before it leaves the first). You’re free to view it as a transfer of green or red money if that helps you in making sense of the system, but because that “transfer” is just a way to interpret those two entries, we can as well conclude that there is no transfer at all.
Instead,
(1) the seller’s liability (recorded in the bank ledger) is decreased, and
(2) the buyer’s
(2a) liability is increased, or
(2b) credits/assets are decreased.
Of course, we need to explain the meaning of those liabilities/debts and assets/credits. That’s what I’m doing with my blog posts on “impure gift economics”. These are records of gifts given (credits) and gifts received (debts/liabilities); “impure” means that these are gifts with all kinds of strings attached. Andy can accept a “gift” of bananas from Betty, but he has to give something of similar value (when the system works, the value is usually similar) to someone — not necessarily Betty — later (no bilateral trade balance; only multilateral, over time).
In my third post I put it like this:
“The central bank accountant follows two simple rules which he applies on a person-by-person basis: (1) if a person sells something, then credit her account, and (2) if a person buys something, then debit her account.
What is being recorded is how much each person has given or taken, without paying attention to who happened to be the counterparty in any particular trade. We know that Andy has taken goods worth SK100; from whom, it doesn’t matter. We also know that Betty has given goods worth SK100; to whom, it doesn’t matter. If we could trust that all transactions are legitimate, we could severe the link between a particular credit (entry) and a particular debit (entry), as long as the total credits equaled total debits on a given day (assuming records were updated only once, in the end of the day).”
JKH said: “but in fact the cheque instructs a green money transfer in the other direction (pay to the order of … etc.)”
I don’t think you can invoke conventional, or even legal, language to prove your point in this case. People and (thus) the law once said that the Sun revolves around the Earth, right? We can take Nick as saying that the Earth actually revolves around the Sun 😉
JKH: Regarding your explanation, and alternative view, on TARGET2… I need to think hard if I have something intelligent to add to it 🙂 Very good. Perhaps I could try to give a new angle on it, but it might be time wasted. Perhaps we come back to the subject later on!
“JKH: In a red/green world, I think we can think about it either way.”
Nick,
You call a green money overdraft, red money.
So presumably, you would call a red money overdraft, green money?
Antti,
I think I can invoke facts and obvious legality to prove my point.
The check says on the front “pay to the order of”
That’s quite clear and quite legal.
If we then make the assumption that Nick’s green/red framing of the real word is reasonable, the only conclusion to draw is that a real world cheque is a payment instrument that transfers green money balances in the specified direction of “pay to”.
Think about it – buyer, seller, pay to the order of
It can’t be otherwise logically or legally.
e.g.
the transfer by cheque of a green money balance from a starting point of 0 results in an overdraft or a red money balance equal to the size of the transfer
but its still a green money balance rather than a red money balance that’s being transferred
thinking about something in two different ways may include the way that it actually happens, and the way that it actually doesn’t happen but hypothetically could happen with some appropriate modification
How about this situation.
I have a green money overdraft. I can clearly settle the overdraft by giving the bank a green money cheque from another green money account.
However, could it be extinguished by the bank paying me a red money cheque?
Is my green money overdraft reduced or does the bank raise another red money account in its name which is increased?
In which case there are now two accounts, each of different colour to the other, where previously there was one.
It’s all getting impractical (costly presumably) and bordering on the absurd.
Living in a green/red money world could get complicated and confusing.
And presumably we can now call red money overdrafts green money.
Henry,
“Nick, you call a green money overdraft, red money.
So presumably, you would call a red money overdraft, green money?”
The plot thickens.
I think that’s right.
A green money overdraft is created by spending a positive green balance down through the zero lower bound of green money – so creating red money as a result.
I think a red money overdraft would be created by spending a negative red balance up through the zero upper bound of red money – so creating green money as a result.
(“Spending a negative red balance” means, similar to green, getting rid of that balance. In the case of red money, that’s done by selling stuff, rather than by buying stuff as is the case with green money.)
“It’s all getting impractical (costly presumably) and bordering on the absurd.”
Either we crossed that bridge a long time ago, or we never will cross it.
“Either we crossed that bridge a long time ago, or we never will cross it.”
LOL!!! You know what I am going to say to that one, don’t you?
“In which case there are now two accounts, each of different colour to the other, where previously there was one.”
And if this is correct, the cost of a dual green/red money system would be higher (account balances might be negated by complementary green/red transactions, but would grow ad infinitum).
And the higher cost might explain why a dual system has not naturally arisen.
Henry & JKH:
I wrote this on “red money overdrafts” to JKH in the other thread 1-2 days ago:
“We, of course, need to introduce overdraft into red-only world. This is no ordinary overdraft, but it’s symmetrical opposite. It doesn’t involve any credit. If you have an overdraft in the real or mixed world, you can buy without ever having a positive balance on your checking account. If you have an overdraft in the red-only world, you can sell without ever having a negative balance on your checking account — that is, without possessing “red money” prior to the sale.
Nick might protest by saying that a positive balance on a checking account is not allowed in red-only world. But here you, JKH, and I should agree: a positive balance should be allowed, because that balance is not “green money” in red-only world. It’s a non-monetary asset, just like a negative balance is a non-monetary liability in the real world.”
JKH said: “e.g.
the transfer by cheque of a green money balance from a starting point of 0 results in an overdraft or a red money balance equal to the size of the transfer
but its still a green money balance rather than a red money balance that’s being transferred”
Are we now talking about the real world? If yes, good. My point is that one cannot transfer balances. It’s all arithmetics. One makes entries and those entries change balances. Already Schumpeter thought of it like that.
It sounds silly to think of transferring a credit (“green”) balance when account balance is zero. Make a debit entry and you get a debit balance. Nothing transferred. Change one balance here by making a debit entry, and another balance there by making a credit entry. You don’t need to transfer any balances; you don’t need to decide whether its a credit or a debit balance you want to move, because you just cannot move an account balance. It’s impossible.
You talked about two ways to view this. You’re aware that I’m offering a third way?
Antti,
I am a lazy old sod and not given to thinking too deeply about things unless I think there is something serious at stake.
Reading your second paragraph above leaves my head in a whirl – and I can’t quite bring myself to trudge through the argument. I am over it!. 🙂 I’ll leave it to JKH who is much more perspicacious than I am.
As I suggested a few days ago, Nick has created a monster and I am more than happy to leave the beast slumbering in the corner as I fear continual prodding might might stir him unnecessarily.
Henry:”unless I think there is something serious at stake”
How about the first real revolution in macroeconomics since Keynes? 😉