Some Monetary Lessons from Cyprus

The Cyprus debacle continues to expose serious flaws in our understanding of money.  Specifically, Cyprus highlights three key important lessons about money:

  1. Money is built around trust.  Without it, money is useless.
  2. A nation that cannot create its own money or lacks monetary unity is at a substantial (and unnecessary) economic disadvantage.
  3. Modern money, being mostly electronic records (at banks), is inherently fragile.

1)   Money is a social construct that we create in order to more conveniently transact business.  I like to think of money as having “moneyness”.  That is, anything can serve as money, but the trouble with money is getting others to accept your money as a final means of payment.  Some things are more widely accepted than other things as a final means of payment and therefore serve as having a higher level of “moneyness” than other things.  Gold for instance, has a moderately low level of moneyness because it is not widely accepted.  Electronic bank deposits, however, are accepted at most businesses for final payment and therefore have a high level of moneyness.

Modern money is mostly electronic money that is regulated by the government and organized through a complex payments system that is dominated by private banks who compete to issue money as debt.  We use this system because it is organized, regulated and technologically advanced (ie, it’s better than lugging around gold bars as a medium of exchange).   That means the system is built in large part on trust.  We trust that our electronic records will be maintained accurately and that the integrity of the system will be upheld both by the entities who compete to run this system as well as the regulators who oversee that system.  When the system begins to appear fragile or chaotic (as is the case in Cyprus) the very cornerstone of money begins to buckle.

2)  The Euro crisis has exposed the great flaw in the Euro’s design.  That is, the nations are very similar to states in the USA in that they are users of a currency without a floating exchange rate.  Therefore, there is no rebalancing mechanism should a systemic disequilibrium occur (like trade imbalances for instance).  In the USA, there is political unity that allows a federal entity to collect funds from all of its participants in a rather unequal fashion.  That is, the rich states pay more into the system than the poor states and the poor states get an unequal amount of the funds via this federal entity every year.  That eliminates the risk of a solvency constraint for the poor states who would otherwise become increasingly like Greece over time.  In other words, redistribution powers the USA from becoming like Greece.  I know “redistribution” is a dirty word in some circles, but it’s as American as apple pie in the case of our monetary system’s design.

Europe’s nations not only can’t produce the currency that would eliminate the risk of a solvency crisis, but also do not have the advantage of this system of redistribution.  The result is solvency crisis and severe austerity that doesn’t come with the help of federal funding.

3)  Money is fragile.  We like to think that money is something we can touch or feel, but I think paper bugs AND gold bugs are wrong.  Yes, money CAN BE a physical thing, but today’s money is mostly just records in electronic ledgers.  That’s disconcerting to many, but the natural evolution of money from unspoken bonds (apes for instance, have been proven to use modern forms of intangible money as promises) to physical things (like the gold standard) to the current electronic system.

Our money is created almost entirely by banks who compete to issue this money as debt.  So the value of our money is distributed by entities who are inherently profit driven which can create an inherent instability if it is abused by these entities or its users.  We must better understand this reality so that we can understand the essential elements that make our money system function.  Contrary to most economic thinking these days, money is not something that is “multiplied” or originates with the government.  It originates with private entities INSIDE the banking system.

Once we understand that money is fragile we might be more cognizant of the reality that it not only requires some oversight. but must be protected not only for the sake of individuals, but for the sake of the society that relies on its existence.

For more on this subject please see the following:

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. Now if only the rest of the world can get on the same page as Cullen with this stuff. How long will that take? 10, 20, 50 years? Eternity?

  2. At least for small depositors covered by Cypriot deposit insurance, I see the problem as more under-reserving. Your’re saying that the ability to print money is a substitute for reserving, but there are other means. Insurance companies, who are currency users, can be credible via sound reserving practices. Cypriot’s cannot have been blind to the risk after IceSave.

  3. Imagine if one morning the government hit all the residents of California’s bank accounts with a levy similar to the recent Cyprus maneuver — and kept the in-state banks closed for a few days while residents digested the reality of the situation. And imagine governor Moonbeam telling everybody how sorry he was about what happened, but with California’s budget in such bad shape, he just had to let it happen for good of everybody. :)

  4. ‘When the system begins to appear fragile …’
    BEGINS to appear?
    This has been happenening since 2007.
    And no amount of new debt is going to solve the problem.

  5. Cullen, do you have opinions about

    1. What the decision makers (all of them) SHOULD have done in this case?

    2. What they can do now to limit the damage already done?

    3. What they most likely will actually do?… and the consequences which will result?

  6. To be totally honest, I haven’t looked at the micro situation in Cyprus long enough to understand what the optimal policy response is for that country. To me, this all stems from the same macro disease that starts with the inherent flaw in the Euro as a monetary system. As I said similarly with the crisis in the USA in 2008 – Cyprus (like the banking crisis in the USA) is a symptom of a larger problem within the currency (just as the banking crisis in the USA was a symptom of the household debt crisis).

  7. Wait. I am sure he is thinking about that now. As is Obama. The Bank Runs will happen.

  8. Or imagine that instead the Federal Reserve stepped in and just created trillions of new dollars out of thin air to make it all better.

    Pick your poison, it’s eat reality, or see your currency debased to nothingness.

    Dollar v Euro, and I’ll take the Euro every time.

  9. Wouldn’t work like it works on a small island nation like Cyprus. My “bank” is in the internet so if the govt can shut down access to the internet then I think it’s time to get the hell out of dodge because something is then seriously wrong with the USA. But seriously, if you reside in a moderately advanced monetary system you don’t need access to a bank to access your money. All you need is a credit card and an internet connection (maybe). :-)

  10. Johnny, do you mean new federal debt or private sector debt? Assuming reasonable private sector credit expansion, wouldn’t that be good? After all, isn’t that how the private economy grows best?

    If both the public and private sector delever at the same time, won’t we be faced with a terrible, stagnant economy?

    I’m just wondering what you think will “solve the problem”.

  11. This post made me think about taking my money out of the bank and keeping it somewhere else. I understand your point about money being created by these private entities and giving out in debt. Do you mean giving people credit lines?

  12. “loans create deposits” is a cornerstone of Cullen’s work. All those deposits you have in your bank account came from someone else who took on debt.

  13. Cullen,

    Your views on who/what creates money seems to have shifted more and more to the banking system and away from the government or central bank as time goes on. In your SSRN paper, it felt like a 50/50 mix. Now it feels more like a 90/10 ratio in favor of banks. So you seem to have drifted further and further away from MMT.

  14. I understand that loans create deposits, but let’s not forget that some deposits don’t come directly from a loan. I saved money and started a business with cash — no loans. I earn a living from fees and commissions. No loans are tied directly to the checks deposited in my account each month from business earnings. My clients have stocks, bonds, ETFs, mutual funds, etc., which are just forms of savings, as Cullen has explained. (None of my clients are on margin.) I realize that some businesses took on debt, which helped them employ my clients who saved their money and are now retired. I’m just saying that in many cases our deposits come from other deposits, with no loan in between. The loans happen much further back in the chain. Am I making sense?

  15. I don’t know.
    But the link between credit expansion and economic growth appears to be broken.
    I would say that productive federal debt (like we all say, for infrastructure, eductation, yada, yada) would be helpful. And private debt for primary investment would probably be beneficial.
    But it seems — again, it seems — that most debt these days is created for banks and wealthy people to speculate in asset appreciation. We constantly hear about all the ‘liquidity’ in the system, but for most people, they don’t have any money.

  16. In most developed monetary systems the banks create 90%+ of the money. So why would anyone focus on a 50/50 model? The key to understanding our monetary system is understanding the banks rule the monetary roost. Not the govt as MMT claims.

  17. I agree that there’s both good and bad spending from both the federal government and the private sector, which has to mean there’s “good” debt and “bad” debt too. You make good points about productive things like infrastructure. (Except we don’t need “bridges to nowhere”.) Large corporations have been taking advantage of low rates in the bond markets, which means they’re using debt. I’m sure some of this is just refinancing older, more expensive debt. Some capital spending is happening, but it does seem like much of that cash raised by cheap debt is still just sitting in cash. Consumers are still cautious, so demand isn’t strong enough yet for companies to start spending that cheap money yet. Perhaps that’s why M&A activity has picked up in recent years. Grow oranically (and hire more people) or just go buy another company (and lay off some people because of synergies/efficiencies in the new larger combination).

    Hard not get a little cynical now and then these days.

  18. a really developed model, when it defaults like in 2008 the gov must pay. So we find money to save the banks but not to invest in education or (horror !!!) in green energy because they are evil, they are costs. A real development indeed. Clearly you’re trying to just look at the world as it is, but if we don’t change it, there will not be a next time

  19. I can envision a situation in which we do not have economic growth, yet we still have advances in living standards. Difficult, but do-able. We should be trying to do that, imo. Can easily be done on the micro-level, not sure of the macro-level.
    (In fact, you could say that the advances in livings standards the past half-century have more to do with medical and technological and cultural advances rather than economic growth.)
    Anway … can we improve our living standards if debt continues to pile up and growth stagnates. Only growth can clear away debt. Well, a jubilee, might, but the prospect of that would be too awful for the financial community. The other alternative would be an economic collapse and a war which would destroy the obligations of the future to the past.

  20. Yes, that digitized $1 in your account may not have been credited to your account by a bank extending you a loan, BUT somewhere in the past, that digitized $1 was created by a bank loan to someone and it has jumped from account to account as a medium of exchange for countless transactions.

  21. I actually disagree with the main point of your post. Money cannot be anything. First, gold is considered money which is universal, and it stores value (purchasing power), regardless which country you live, regardless who agree or disagree with this. If you have gold coin or gold bar, you can travel anywhere on this planet, and exchange for whatever you need at personal level. That’s essentially the function of money. Second, money is what the government says is, and it cannot be anything. If you have an independent government, then you should have your own money being whatever the government designates. EU is so fucked up is because they voluntarily give up their control of their own destinies to a group of Europeans who only care about themselves. If you don’t have an independent government, your money is no good. The old Iraqi money or Libyan money is no longer good. In a major way, fiat money represents a solvent government. When a government is insolvent, then the money is no good. There is no such thing that US will ever be insolvent, US dollar will always be good, but that doesn’t say the dollar will always buy the same amount of anything over time. Bank can only exist under a defined government framework. Without a government, bank doesn’t exist, and cannot create anything. just my 2c.

  22. You might see the link at the bottom of the article on Understanding Moneyness. In there, I describe this concept of moneyness. In short, the gvot determines the unit of account (like the $USD) and the pvt sector can denominate anything it wants in dollars. The govt therefore determines the unit by which we measure things just like a metric system determines how we measure things. But a dollar is not always a dollar unlike an inch or a yard. A dollar fluctuates in value and the govt cannot determine what the value of a dollar is.

    In the USA, the most crucial thing to understand about the money we use is that money is a means of payment. That means of payment that is most widely accepted will be the money that is most widely used or the money that has the highest moneyness. In the USA, the money that is most widely accepted is bank deposits because bank deposits are the primary way to transact within the US payments system. The payments system is regulated by the US govt (which gives it credibility) and run primarily by private banks who issue the money into that system and manage its everyday use.

    Ultimately, anything can serve as money in the monetary system, but not everything will be accepted through the payments system. Gold can be money, but you’ll almost always have to convert gold into something else to be able to transact. For instance, if you have gold you can go to Japan and still transact business, but you’ll have to convert it to Yen in most cases. If you take that same gold bar to the USA you’ll have to convert it to dollars. You could say the same thing about many different commodities or goods, but that doesn’t mean they’re the ultimate forms of money. It just means they have a certain level of moneyness because they’re valuable in the eyes of the person you’re exchanging them with. But ultimately, the thing with the highest moneyness is the thing that is most widely accepted for final payment within a specific payments system. And in most cases, that’s bank deposits.

  23. #Cyprus and ECB officials working on capital control plans for when banks open, include limits on daily transactions

    Moneyness can morph according to changing context …swap you one deposit with restricted access and the threat of a haircut for one gold rolex preferably not from Turkey ;)

  24. I like your explanation because it explains WHY we use a particular form of money. Why does anyone use a dollar? Because the dollar is the way we access the US payments system. If you want to use a credit card in the USA or use dollar bills you have to get a bank account. Getting approved for a bank account is like getting approved into the payments system. And that payment system is controlled by private banks and regulated by the government. It’s the system where almost all transactions flow through. And since the “flow” is so central to the economic system the payments system is like the circulatory system to the economy.

    How does that sound to you Cullen?

  25. Our money is determined by what the government says is money. And the laws and regulations of the USA have determined that bank money is our primary form of money.

  26. Yes, deposits can go from one entity to another with no loans in between, however most of those deposits were created out of loans in the first place. I think you are agreeing with that, but I can’t tell for sure. This is true of physical cash as well, since it’s mostly been converted from deposits and will return to deposit status in the future.

    I confess I get a little confused about weather or not you could claim that ALL deposits originate from “loans.” I’m using a broad definition of “loan” here to include Treasury bonds. Also, I’m not attempting to distinguish between inside and outside money here.

    Say you sold a Treasury to the Fed. The Fed created reserves out of thin air to credit the bank with, which in turn credited you, the bond seller, with a deposit:

    http://brown-blog-5.blogspot.com/2013/03/banking-example-4-quantitative-easing.html

    Now I can see arguing that your deposit, in this case, did not originate from a loan. On the other hand, I’m not sure since you (or someone who paid you, or someone who paid someone who paid you, etc) did take a loan which resulted in the funds for you to purchase the Treasury bond with in the first place. This is consistent with the view that the government really just redistributes inside money when deficit spending, while issuing a net financial asset in exchange for the funds it spends. (as an aside, the reserves the Fed creates out of thin air are certainly “outside money” but is your deposit still considered “inside money?” I would think “yes.” Cullen, how should this deposit be defined?)

    In this next example, I attempt to follow a “cycle” of gov deficit spending back to a state close to the starting point, assuming the Fed buys ALL Treasuries and that other loans are paid off in between, and that no taxes are levied, and interest is negligible (yes, a LOT of assumptions there!):

    http://brown-blog-5.blogspot.com/2013/03/banking-example-6-cb-holds-gov-debt-to.html

    Starting from the final set of balance sheets, it could be the case that the Fed purchases the Treasury bond on x’s balance sheet, resulting in a deposit for x, but here again the deposit appears to be based on a loan (the Treasury bond). If the gov were to claw back from x 100% of the proceeds of the bond sale to the Fed in taxes, it could repay its loan, and we’d be back to the initial set of balance sheets (all clear).

    So perhaps it might be true that ALL deposits can trace their lineage back to some kind of loan, especially if we include Treasury bonds issued by the gov as “loans.” Cullen would you say that’s true, or is that too sweeping of a statement?

    If the gov were out of the picture (neither taxing, spending, nor issuing bonds), and the Fed were not buying any assets, I think it’s clear that all deposits must have originated from loans… somewhere in their past. True?

  27. I understand that loans create deposits, but for every 100 times we read that in here, I’d like to hear the flip side, that loans create obligations.
    If you have a dollar, that means that somewhere, somebody owes somebody else a dollar.
    As long as we can make good on that loan — or in today’s world PRETEND that we can make good, the system is fine. If not …. we’re Cyprus.
    So how do we rescue Cyprus? — by giving their banks the money they need, and creating a future obligation for somebody else.

  28. Joe, I mostly agree, but I think it’s perhaps necessary to broaden what we mean by a “loan” to a Treasury bond sale by the gov (i.e. a loan to the gov) if the Fed is purchasing some of those Treasury bonds. Take a look at this admittedly silly example (probably just the 1st and last set of BSs are all you need to look at):

    http://brown-blog-5.blogspot.com/2013/03/banking-example-6-cb-holds-gov-debt-to.html

    Of course my assumptions here are bordering on the ridiculous, but at the final set of BSs, all bank loans have been repaid, yet x has $100 of equity (as a Treas bond) that could conceivably be purchased by the Fed. In that case it seems that x’s deposit really traces its linage back to the $100 Treas bond issued by the gov, since no further bank loans are required to accomplish the bond sale to the Fed (and thus the deposit creation for x). If you agree, and lets say the Fed is purchasing x% (what is it? 10%?) of Treasury bonds out there, then couldn’t you argue that bank deposits in an amount equivalent to x% of outstanding Treasury bonds out there arise from loans granted to the gov (through Treas bond issuance) rather than through bank loans to non-bank private entities?

  29. Well first of all, “loans” are the obligations. We’re already mentioning them!

    Now consider a super simple “macro” economy consisting of a single commercial bank and a single contractor working for that bank. Say the contractor borrows $100 w/ $100 interest to be paid yearly, and the bank pays the contractor $100 a year for work. Admittedly a silly example, but this “economy” continues to hum along like this indefinitely as long as the contractor never repays the principal and as long as the contractor’s rates stay the same (exactly equivalent to the interest payments). What’s my point? That there is a basis for a debt based economy to function. Is there a possibility for instability? Absolutely! You could add to this by supposing the deposit (with a mean amount of $100 in it) is also used to pay a grocer, who pays a blah blah, who pays blah blah… who eventually ALSO pays the contractor. So you could have a multi entity economy all using money borrowed from a bank in a single loan event which is never paid back.

    Personally I imagine that in most circumstances, you need a growing amount of private debt for a debt based money economy to function in a reasonably stable manner… which invariably leads to a balance sheet recession at some point, which invariably leads to lenders taking a few hair cuts because of loan defaults, and recession spending behavior where borrowers pay down debts rather than purchase real goods and services… but at some point the credit growth starts up again, and the economy improves. I don’t know this to be a fact! Can we insert government in this picture to deficit spend when “needed,” and insure depositors to soften the blow of recessions and bank failures? … and to try and influence the rate of growth of debt (via taxes and interest rate setting) to prolong and stabilize the periods of credit expansion (the “boom” times)? Sure, I think that probably makes sense. But these are just my intuitions! I can’t prove any of that! Can we devise a better more stable system? Probably. But this is rapidly getting beyond my ability to reason this out with words… I think mathematical models could be useful here… to at least get a feel for what’s required for stability (policy wise and behavior wise). Perhaps overall this isn’t such a terrible basis for a monetary system. Using gold certainly had its limitations. Whatever the Europeans are doing clearly has its limitations… and the Chinese, etc.

  30. Yes I see what you’re saying. However, couldn’t you argue that if:

    1. The Fed holds $X of Treasury bonds purchased from non-banks.

    2. The gov spends every dollar it raises (i.e. it’s TGA account is $0)

    That $X of bank deposits held by private non-banks trace their lineage to $X of loans to the gov (bonds auctioned by the gov) currently held by the Fed.

    For example, say that there are $1T in outstanding T-bonds amongst the non-bank public (this amount doesn’t really matter), the TGA account is at $0, and that the Fed owns $10B in T-bonds purchased from non-banks. It seems to me that $10B in privately held bank deposits then arose from loans to the gov (T-bonds) rather than bank loans. Now if the Fed sells $3B of bonds, then this amount immediately drops to $7B, etc.

  31. Hey Tom, the examples on your blog are excellent and very useful. Thanks for doing them. What do you think about perhaps colour coding them to more easily see which asset belongs to which liability?

  32. Agreed; there is a macro disease of the EMU; the euro as a monetary system is flawed. Additionally, Cypress has shown clearly that self proclaimed government guarantees to protect deposits is no guarantee at all and that all EU citizens are open to potential banking account seizure by their respective governments.

    As you said in your piece in point #1, “Money is built around trust. Without it, money is useless.”

    In this context and in light of the latest developments, the EMU is a dead man walking. So here is the next relevant question. In a world where politics can´t overcome the obstacles to reach the monetary nirvana of an autonomous currency issuer,,, where do we, as depositors in our respective national banks stand today in Europe?

    I think if you are honest, you would say the “unspeakable”; get hard cold cash while the gettins good!!

  33. The “moneyness” you refer to is really value, values of goods, services, and financial assets including stock, bond, real estate, etc. Money is something you use to settle a transaction with, either cash or credit. Many things can be money, ie, to be used to settle a transaction, but money cannot be anything. The way you define money confuses a lot people. You never use the word “cash” or currency”. Cash is really the ultimate money. In a monetary system, government can only accept one type of money to settle transactions. That’s why there is no competing currency in US. That’s why Ron Paul wants silver coins to be circulated as money, and FBI arrested the guy who uses silver coin.

  34. Thanks!

    I’m up for making any changes that make it easier to see. Can you give a concrete example of how you’d do that? I guess in general I tried to make offsetting assets and liabilities on the same row (on a single BS). However, in some instances, a cell represents a summation of items…. and I didn’t always stick to that row convention perhaps.

    Are you talking about color coding across separate balance sheets, or on the same sheet?

    On the two “capital requirements” examples I color coded the text to show how deposits induce reserve requirements and loans induce capital requirements. Was that useful? I could always use the background color for another purpose.

    http://brown-blog-5.blogspot.com/2013/03/banking-example-3-capital-requirements.html

    http://brown-blog-5.blogspot.com/2013/03/banking-example-31-capital-requirements.html

    Email me.

  35. By the way, cash is only good in their own country, and USD is an exception because of its reserve status.

  36. A deposit guarantee by a government that can’t print its own currency is no more of a guarantee than a private guarantee is. Just one of the fundamental flaws in the EuroZone.

  37. You say the ultimate form of money is physical cash (bills and coins)? I disagree. Plenty of places (including local governments accepting tax payments) don’t want cash! Sometimes small businesses also don’t want it: “We don’t accept bills over $20″ … you ever see that sign in a coffee shop? Even if there’s no sign, try buying a donut with a $1000 bill. Or using it in a vending machine.

    I realize that not all places accept bank cards either, or accept them w/o charging you a premium anyway.

    Plus there’s all kinds of problems with cash: try traveling with huge sums! Try taking large sums out of your bank. Plus the worry of losing it. Plus you get NOTHING for cash (at least my bank pays me a token amount for my checking deposit).

    Convenience, record keeping, and security/risk are three big reasons why I think bank deposits are superior to cash in most cases. Cash does still have some advantages in certain circumstances, but those continue to dwindle for the most part.

  38. Wow… how come there’s no EU wide insurance system? Just didn’t have the political unity/will to pull that off?

    What do you think happens now that the Cypriots have rejected the deal? Is a bank failure even worse for the under 100k Euro depositors? If there’s no EU wide guarantee on the insurance it sounds like it likely would be worse. Do you think it will come to that?

    Copola’s article (here on pragcap) seemed to imply that given an out and out bank failure the under 100k crowd might actually be better off (but perhaps I misread that).

  39. Well, traditionally, cash is money, and cash is backed by the government. Take a look at the dollar bills from the federal reserve, in god we trust. It’s really worth a cent, but the value could be $1-100, that’s defined by the government. I cannot print a $100 bill myself. Now the digital money only exists in the last 20 years after the Internet. I agree practically cash has a lot problems, but that’s a practical matter. I am not obsessed with cash being money, whether paper money or digital money, but any money will have to be defined by the government first. In US, USD is money, nothing else. I agree bank deposit is the ultimate money. Bank deposit, to any individual, is equal to cash. This ” moneyness” of anything valuable, or any finanial assets, is not helpful, and confusing.

  40. Tom, illustrate this …
    You and I each have 10 bucks in cash. We incorporate as banks.
    I lend you $100. Then you lend me $100. We charge each other interest.
    We each have $110 in deposits.
    We use the money to buy stocks, which we use to back the loans. The stocks go up up by $10 every year, which we use to pay the interest and pay our bills.
    Now we get greedy. We decide to leverage up 35 to 1. We each loan each other $3,500 and buy investments. Boy, we’re rolling it in now. Our stocks go up, we’re paying each other interest, we hire some guys from MMT to show us that the market would have to fall by 25 percent for us to lose money and we hire a guy from Stanford who tells us that’s impossible..
    Sometimes we take in some deposits from off the street to make ourselves look like a real bank.
    Then the market crashes, we panic and each of us demands our money back.

  41. Govt decides the denomination. That’s why we call it a “US Dollar”. Govt also decided to make the banks the dominant players in the payments system by giving them the keys to the system of money. Cash facilitates inside money. That is, in order to obtain cash you must first have an account in inside money. It’s just for convenience purposes. That’s it. It’s a secondary form of money to the most important money – bank money. In theory, govt money could be the dominant money because the govt has the power to tax which makes its money highly credible and virtually risk-free. But the govt has handed the keys to the monetary castle to the banks and has therefore put deposit money above that of govt money. It might seem backwards to some, but that’s just the way it is….

  42. If you have hard assets, you don’t even need to sell them to get money.
    You can very easily get loans.
    Of course, if you don’t have hard assets, you can’t get a loan.
    Jewels were great for this. They were accepted everywhere, you could hide them from the authorities, you could cross borders with them, they could easily be hocked for money, which you could put to work. You could pass them down to your children without being taxed. They were portable.
    So, I agree that defining money as a method of exchange is very narrow and not very useful. Your money might be dollars here, pounds there, oil futures somewhere else. What matters is how you can store your money.

  43. Ha, you bring up an interesting point. Of course loans create deposits, but banks can’t loan themselves money presumably. I wonder if there are restrictions on banks loaning each other money in the way you describe. They can certainly loan excess reserves to other banks. Does anybody know what the restrictions are?

  44. La monnaie est une créance générale sur les biens et les services .Elles est divisible et garde sa valeur avec le temps .Elle est crée en contrepartie de l’économie réelle. Ces qualités sont soumises au respect du principe de confiance.
    Aujourd’hui tout est déréglé. La finance crée de la monnaie fictive appuyée sur la corruption , la fraude fiscale, les trafics .
    Que fait la place de Londres . Elle gère cette masse de monnaie fictive . De nombreuses officines proposent des structures opaques dans les territoires britanniques pour loger des offshores avec des comptes bancaires par exemple à Chypre . Ces fonds reviennent par le canal bancaire dans la city de Londres . Voilà ce que fait la City . Du lavage d’envergure.

  45. Unless you get the dreaded “Server too busy” from the bank’s website as it “crashes” ;-)

  46. So moneyness is built on trust. And it appears that most of what the political process does ends up undermining trust, as one side seeks to outmaneuver the other to its benefit. Doesn’t this situation with Cyprus vis-a-vis the Euro consortium point out the folly inherent in any political economy built on a fiat monetary system? And doesn’t that undermine much of the policy advice I see on here that suggests countries can just paper over these minor disagreements between the profligate and the frugal by creating money out of thin air? Won’t the frugal eventually figure out that the profligate are (in effect) giving their savings a “haircut” via the printing press?

  47. Ha, thanks Joe. I know you send me a long .pdf once… is that my cue to go look it up in there?

    Does Regulation F ban the kind of scenario that Johnny sketched out above?

  48. BTW, I added in raising capital through a sale of stock to the capital requirements example. The decision to make the required capital a mix of retained earnings and capital from selling stock made it a little complicated… plus my determination to stick with my previous conventions of showing the whole balance sheets of all actors didn’t help.

    http://brown-blog-5.blogspot.com/2013/03/banking-example-31-capital-requirements.html

    Perhaps I’ll take another cut (w/ another example) where I only show the CHANGES on the CB’s BS. This will let me start off after stock has already been sold, which will make it much simpler.

  49. Section 206.4 Credit exposure
    Stipulates that a bank ordinarily should limit its credit exposure to an individual correspondent to an amount not more than 25 percent of the exposed bank’s total capital, unless the bank can demonstrate that its correspondent is at least “adequately capitalized.” Certain transactions that carry a low risk of loss, such as transactions that are fully secured by government securities or other readily marketable collateral, are excluded from the calculation of a bank’s credit exposure.

  50. Hi, Tom: Don’t you think banks and financial institutions are constantly loaning each other money, not in the one-to-one outline I presented, but certainly they are all making loans back and forth to further their investment or loan portfolios.
    Didn’t we see see that in the financial crisis, when the money sent to bail out AIG went directly to Merrill and other parties. Or when Lehman got a margin call and couldn’t handle it.

  51. Johnny, I really don’t know. Like I say, I know they can loan excess reserves, but that’s very different. Perhaps you should ask Joe. He probably has a much better feel for it. See his comment above:

    http://pragcap.com/some-monetary-lessons-from-cyprus/comment-page-1#comment-140917

    I don’t fully understand what he’s getting at, because I don’t fully understand the correspondent bank situation. I know he’s covered that before… and somewhere I have a link to those comments (back in the archived comments section). I would be very hard pressed to diagram what he’s saying on example balance sheets without more information! (Although that might make an excellent example to add sometime!).

  52. I think a bank can lend to its subsidiaries. I don’t know the specific regulations around that though.

  53. Like Apple, the FED has a reg for that. See Regulation W – Transactions with Affiliates.

    Banks borrow reserves from other banks so they can clear deposit outflows. Banks also keep their own deposits with other banks. These are examples of the correspondent relationship. But banks also invest in securities that have other banks as counterparties. AIG sold a ton of CDS on CDOs to other banks, and when they triggered they couldn’t pay, so Fed bailed them out with Maiden Lane III. Like Lehman, AIG also bought MBS which lost a ton of market value and so they got a loan from the FED with Maiden Lane II so they could also pay off counterparties.

  54. I think you are being very optimistic about the internet. It will shut itself down in the event of a panic. Doesn’t the President. ATMs will be useless. Credit card transactions will not go through.

  55. Bank creates loan, and other financial assets. They are strictly speaking not money, but they are assets. Since you call them money (inside money), that’s why there is such ridiculous “moneyness”. The way you explain QE as asset swap reflects precisely that. In 2008, those so called financial “asset” were worth 10c on a dollar, but Fed bought them on face value. Those were the bank created “inside money”. Those bank created “inside money” didn’t all end up as bank deposits. Fed bought those junk with freshly minted cash equivalent “outside money”. Am I totally wrong about this?

  56. The Fed bought financial assets at market value, not deposits. If an entity cannot guarantee the return of your deposits it doesn’t mean your deposits fell from par. It means you’re not getting all your deposits back. The govt doesn’t change the value of deposits by insuring them. For instance, the people in Cyprus had their deposits stolen and replaced with lower value financial assets (bank stock). That doesn’t mean deposits in Cyprus are worth less. It means their govt decided to replace deposits with financial assets. When the FDIC has to insure your deposits that’s the govt using its power to tax to take deposits from other people and replace your lost deposits.

  57. Right. If a bank says it’s not going to return your deposits it doesn’t mean your deposits are worth less. It means they don’t have the ability to return them to you. A dollar is always worth a dollar. Financial assets are dollar derivatives in essence. Their value can fluctuate relative to being able to exchange a dollar at par (or viewed differently, the value of the dollar fluctuates around other financial assets). The govt doesn’t guarantee the value of the dollar at par via insurance. The govt guarantees that you’ll get all your deposits back via FDIC insurance. They do so by taxing other inside money and giving it to the depositors in the case of bank failures.

  58. fyi, investigative reports by several newspapers (and reposted here at pragCap earlier threads) show that diamonds could only get about 1% of their value when being sold 2nd-hand or black market, which destroys the myth that jewelry is a good store of value

  59. It’s also worth noting that many deposit insurance schemes in the EU are private sector insurance.

    Two things of note:
    1) Deposit insurance is insurance for the case that one bank fails, not all of them at once.
    2) When the government decides to confiscate your money, no insurance applies. It means get the hell out.

  60. Well they could just take money from home owners for example, force some bond on them or something like that. Germany did that once.

  61. Call me paranoid, but I’ve been keeping quite some cash at home ever since the crisis started.

  62. What do you mean, ‘My bank is the internet’?
    Isn’t that like saying, ‘My bank is a building.’

  63. But that’s still a bank. Your online bank can fail, too.
    What am I missing?

  64. A (not so) quick question for mister Roche.

    Great blog! Last year I tried to spend some time reading your manual on MMT. I trade futures using anything but economics still, i was curious to see what all the rage was about. I have a phD in maths/stats, my brain has probably fried after 15 years of trading because i could never really grasp MMT. I just suck at economics, and it started way early in college. Now, you ditched MMT and moved onto a new theory. Can you say that you are totally satisfied with the new one?

    I have this dizzy sensation that noone really knows what is going on on the monetary size, that we are very much in unchartered territories as it is frequently said, and that the sharpest minds trying to comment and even build a de facto theory (note the antinomy) on that very empirical round of various improvisations from central banks left right and center, are going in circles. Do economics work? I wish there was a perfected economics/monetary theory out there, that properly monitores AND that can explain the mess we’re in, and yield solutions to move forward.

    I no longer want to waste my time reading about sophisticated econometrics/ monetary models totally decoupled from reality. There is so much confusion out there, but if you tell me the new monetary theory now put forth by Pragcap is worth studying, i will take your word for it, sincerely hoping that you will not ditch it next year for something new.

    Best,

    Nico

  65. Of course. I was being playful implying that my bank won’t shut its doors (since there are none). My bank could still refuse withdrawals electronically though.

  66. Hi Nico,

    My conversion from MMT to MR was an evolution in my thinking. 2 years ago I would have said that MMT was the best way of understanding the modern monetary system. But as several of us pried into it more we began to see an increasing number of contradictions and problematic perspectives within MMT. Bear in mind, I still think MMT is a far superior way of viewing the world than most other economic theories or models, but I think there are some things missing from the MMT perspective.

    MR, in my opinion, is a more balanced view of the world that focuses almost entirely on the operational side of things. It’s a mesh of many different theories and operational understandings so in my view, it’s the best of all worlds since it’s not Austrian, it’s not Keynesian, it’s not monetarist, etc. It just describes what is. No policy, no politics, etc. What you see is what you get.

    I am in the process of editing my paper on the money system. So keep an eye out next week for a post on that. When I post it I would recommend taking an hour and reading the paper in its entirety. It’s about 35 pages, but I break things down in rather simple terms (as far as this stuff goes). I don’t pretend to have all the answers, but from my perspective, MR is the cleanest and most accurate view of the money system that currently exists. I hope it will only become cleaner and more accurate as time goes by.