The free banking alternative to the centralized provision of lender of last resort services

Inspired by Perry Mehrling and Fischer Black:

I think I'd take your future ideal financial model even further (slide 9). The C5 in your model provides what you call liquidity puts. I see no reason why these liquidity puts need be provided by a central bank. In the future, financial products called liquidity options - the option to buy or sell some asset (say Apple stock) at a guaranteed point in the bid-ask spread - would be popular financial products traded on organized exchanges. Just as Apple CDS allow investors to split off Apple credit risk and distribute it across the economy, so would Apple liquidity options split away the liquidity risk of transacting in Apple stock in the secondary market and evenly distribute this risk to those willing and capable of holding it.

A private liquidity options market has some advantages over a monopoly last resort system. Liquidity would be competitively priced and no longer supplied in an opaque manner. Central banks would either vacate the market for liquidity services or price their liquidity products off the private liquidity options market. Subsidies to or penalties on institutions anxious for liquidity insurance would be a thing of the past.

If central banks were to cease providing liquidity options, their sole role in the future would be as managers of the clearing and settlement system. The provision of paper money can be easily fulfilled by private banks. I guess central banks would also have to manage the price level.

The above is a free-banking view of the world. The lender-of-last resort role is transferred from central banks to private markets. It is distilled into just another financial product.

Comments

Stock as a medium of exchange

American Depository Receipt (ADR) for Sony Corp You've heard the story before. It goes something like this. There's one unique good in this world that serves as a universal vehicle by which we conduct every one of our economic transactions. We call this good "money". Quarrels often start over what items get lumped together as money, but paper currency and deposits usually make the grade. If we want to convert the things that we've produced into desirable consumption goods (or long-term savings vehicles like stocks), we need to pass through this intervening "money" medium to get there. This of course is fiction—there never has been an item that served as a universal medium of exchange. Rather, all valuable things serve to some degree or other as a medium of exchange; or, put differently, everything is money. What follows are several examples illustrating this idea. Rather than using currency/deposits as the intervening medium to get to their desired final...

Yap stones and the myth of fiat money

At first glance, the large circular discs that circulated on the island of Yap in the South Pacific certainly seem quite odd. Too big to be easily transported, the stones are often seen in photos resting against their owner's houses. So much for velocity. Yap stones have been considered significant enough that they have become a recurring motif in monetary economics. Macroeconomics textbooks, including Baumol & Blinder , Miles & Scott ( pdf ), Stonecash/Gans/King/Mankiw , Williamson , and Taylor all have stories about Yap stone money. Why this fascination? Part of it is probably due to the profession's obsession with the categorical divide between "money" and "non-money". In dividing the universe of goods into these two bins, only a few select goods end up in the money bin. That an object so odd and unwieldy as a three meter wide stone could join slim US dollar bills and easily portable silver coins in the category of money is pleasantly counterintu...

Chain splits under a Bitcoin monetary standard

The recent bitcoin chain split got me thinking again about bitcoin-as-money, specifically as a unit of account . If bitcoin were to serve as a major pricing unit for commerce on the internet, we'd have to get used to some very strange macroeconomic effects every time a chain split occurred. In this post I investigate what this would look like. While true believers claim that bitcoin's destiny is to replace the U.S. dollar, bitcoin has a long way to go. For one, it hasn't yet become a generally-accepted medium of exchange. People who own it are too afraid to spend it lest they miss out on the next boom in its price, and would-be recipients are too shy to accept it given its incredible volatility. So usage of bitcoin has been confined to a very narrow range of transactions. But let's say that down the road bitcoin does become a generally-accepted medium of exchange. The next stage to becoming a full fledged currency like the U.S. dollar involves becoming a unit of account...

Typography

Search This Blog