Typography

It's interesting to see how after a credit crisis, economists start to take money and banking a bit more seriously. Adam Smith, who experienced his very own credit crisis -- the collapse of the Douglas Heron and Co , or the Ayr Bank, on June 22, 1772 -- is no exception. His views on money and banking became much more nuanced after that event. Ayr Bank had been founded in 1769 in the Scottish town of Ayr. It expanded to Edinburgh and Dumfries, and in only a few short years it had succeeded in wrestling a significant chunk of Scottish banking business from incumbents the Bank of Scotland and the Royal Bank of Scotland. By 1772, according to Checkland, the Ayr Bank supplied 25% of Scotland's bank notes and deposits. In early June 1772 one of Ayr's largest customers, Alexander Fordyce , skipped London for Paris to avoid debt payments. A run on the Ayr Bank began that precipitated the bank's failure by the end of the month. Upon observing the bank run, David Hume writes from...

Ok, readers. Here's a chance for you to flex your muscles. The following chart shows various short-term interest rates: Why are these rates all so different? Can the differentials between them be arbitraged away? What sorts of institutional rigidities might be preventing arbitrage? For instance, we know certain institutions like Fannie Mae and Freddie Mac can't get interest on reserves held at the Fed. What other sorts of fine details might be important? Or are the differentials between these various rates not currently open to arbitrage? Can they be explained by term risk? How much do other sorts of risk, like liquidity risk, counterparty risk, default risk etc drive spreads?  A few specific questions: a) The DTCC Treasury General Financial Collateral (GCF) repo rate used to trade at or below the fed funds rate. The Treasury GCF repo rate is a collateralized rate. Since collateral reduces risk, it makes sense it would trade below the fed funds rate. But why is the riskier rate...

This post may get a bit rambling. It's an attempt to tie together a couple of different strands that I've been thinking and reading about. Modern monetary theory (MMT) in a nutshell, at least as far as I see it, goes something like this. Back in the 1990s a couple of clever guys came up with the idea of a government-provided jobs guarantee. They realized that this program would be seen by the public as an expensive boondoggle requiring sky-high taxes and huge debts. Could they outflank these criticisms by finding another way to fund the jobs guarantee? To find the funds the early MMTers worked backwards through the labyrinthine relationship between the Federal Reserve and the Treasury. What they claimed to have discovered at the end of their trek was certainly shocking. The US Treasury, they said, funds itself not by the conventional route of taxes and bonds, but by creating and directly spending fiat (i.e. inconvertible) money. Furthermore, it is not only the government's ...

When my mother asked me yesterday if I was still buying the bit points, I took it as a sign that it was time for another bitcoin post. One of the most popular reasons for owning bit points—sorry, bitcoin—is that the supply of coin is fixed whereas the supply of central bank money can be increased ad infinitum. Like an amoeba colony nearing population saturation, the bitcoin supply is growing at a decreasing rate as it approaches the magic 21 million number, the ceiling specified by designer Satoshi Nakamoto . Bitcoin advocates believe that this controlled supply effectively grounds the price of bitcoin while leaving the value of central bank money to flap in the wind. But this ignores the mirror image of this argument. Yes, a central bank can rapidly increase the supply of notes and reserves. But blowfish-like, a central bank can just as quickly suck this supply back in—indeed, a central bank can go to the extreme of extinguishing every last liability it has ever issued. Bitcoin, on t...

I've never understood the global shortage of safe asset meme. I'm willing to be educated. I know that Ricardo Caballero and Gary Gorton have written about the safe asset shortage problem. In the blogosphere it pops up in David Beckworth and David Andolfatto , and the folks at FT Alphaville can't talk about much else. First, there seems to me to be definitional issues. What is a safe asset? Beckworth, for instance, describes them as "those assets that are highly liquid and expected to maintain their value." But liquidity and riskiness are separate concepts. There are many financial instruments that are very liquid yet risky—take the S&P mini futures contract, the most liquid futures contract in the world. There are many low-risk instruments that are illiquid—a 5 year non-cashable Canadian GIC being a good example. How are we to reconcile these oppositions into one definition? Second, it seems to me that the concept of a safety is misspecified. How do we go...

Bob Murphy asked whether Lionel Robbins was right in saying that central bank policy in the late 1920s and early 1930s was a complete reversal of traditional central bank doctrine. A blogger named Lord Keynes, (perhaps the ghost of Keynes? ), takes exception to this idea, noting somewhat dramatically that Murphy is "dead wrong" and "utterly absurd". These sorts of us vs. them dramatics would be best left to the likes of professional sports casters (economic history is not a competition), but I'm going to look past the silly theatrics so as to delve into what is a very interesting issue. The nub of the debate, in my view at least, boils down to the definition of traditional central banking doctrine . My conclusion, which I'll get around to explaining, is that compared to the 1800s, central bank policy between 1929-1932 was probably a complete reversal. But compared to Fed policy through most of the 1920s, the Fed's policy during the Depression was sim...

Michiel Bijlsma and Jasper Lukkezen have a very good article on the Bruegel blog that deals with the question: why is there no Target2 debate in the US? On a purely technical note, they bring up an interesting point that Interdistrict Settlement imbalances can arise not just from capital outflows from one district to another, but from the daily redistribution of SOMA assets bought on behalf of the other Reserve banks by the New York Fed. I hadn’t previously considered this mechanism and consider it to be a good addition to understanding the debate. More controversially, they maintain that ISA imbalances primarily arise from SOMA redistribution and that regional capital flows contribute fewer imbalances. Perhaps, but that’s an empirical question. Continuing on a purely technical note, Bijlsma and Lukkezen note that when the FRBNY purchases from a counterpart with a depository account at one of the FRBs, this particular FRB then credits the counterpart’s depository account, which incre...

Have commented on a few blogs that bring up the meme of collateral shortages. Commodity money: It's back! (and it sucks) at Macromania Is the Fed our savior in financial regulation? at Marginal Revolution Why the Global Shortage of Safe Assets Matters at Macro and Other Market Musings The idea of a scarcity of shortage of safe assets is nonsensical to me. I just don't think this can be a real issue. If the quantity of "safe assets" somehow collapses, then the prices of remaining "safe assets" will rise to meet the market's demand for safe collateral and stores of value. You can't have shortages in financial markets. Do you think you can? and The idea that there can be a shortage of good collateralizable financial assets sounds fishy to me. Prices for those assets will simply rise until their price is sufficient to meet the demand for good collateral. The same with an excess demand for money - prices will simply fall to meet that demand.

Tyler Cowen has another post on the ECB financing sovereign governments via loans... It is finally being recognized that the eurozone made a major policy breakthrough : My thoughts: I don’t think the key here is arbitrage and government monetary financing. It’s about a slow bank run that has been enveloping Southern Europe for a few years now. The mechanism which governs intra-Euro payments requires Greek/Italian etc banks to “solve” for the bank run by submitting collateral to their national central bank in return for settlement balances. Much of this is done overnight or on a weekly basis. By establishing 3 year operations, the ECB is telling the banks and the rest of the world that they will continue to meet the demands of anyone running on the Southern European banks for the next 3 years. That sort of commitment to the system might be large enough to stop the bank run. It’s similiar to how, in the old days, banks suffering bank runs would often bring out all their cash and gold fro...

Two comments on The Money View. One on Perry Mehrling's The IMF and the Collateral Crunch and the other on Daniel H. Neilson's Is there an ECB? Neilson links to the erroneous Tornell/Westerman piece. My comments on this are in a previous post . In short, Karl Whelan's Worse than Sinn clarifies the issue. Sterilization by the Bundesbank is not happening.  Merhling and me discuss the nature of the transactions conducted between borrowing NCBs and the lending ECB. Perry, I can't find any explicit reference to whether intra-Eurosystem credits are collateralized or not. But I still think not. Collateral is posted by a borrower to a lender to protect the lender should the borrower default. Then the lender can collect the collateral instead. But ECB losses are dealt with in a specific way. See bottom of http://www.ecb.int/ecb/orga/capital/html/index.en.html In short, if the ECB suffers a loss on a loan to an NCB then that loss is allocated to all NCBs according to the ECB...