Thursday, October 08, 2009

Endogenous Money Supply In The Long Run

This post is not about how the United States Federal Reserve cannot control, on a day-to-day basis, the quantity of money in circulation. Rather, I consider financial innovation over time leads to the creation of new debt instruments that fall under a reasonable definition of "money".

One way of looking at money is that, under capitalism, money buys goods, and goods sell for money, but goods do not buy goods. A simple example: I understand one can write checks against a hedge fund. So hedge funds are money.

The emergence of new forms of money illustrates why no final systems of regulations can exist in a capitalist economy. Should something like the Federal Deposit Insurance Corporation be set up to guarantee these new forms of money? If so, some capital requirements, restrictions on leverage ratios, and so on would need to be instituted. Maybe some sort of firewalls, as in the Glass-Steagall act, should be rebuilt.


e.j. said...

Goods do buy goods; "money" is just the medium of exchange. Goods therefore are exchanged indirectly for one another using a currency to replace the need to barter.

When I write a check against my checking account, I am writing the check against the balance in the account. My checking account itself is not money.

Debt instruments fall more reasonably under a definition of an "asset" that is redeemable for money.

Assets like debt instruments should *never* be guaranteed. Guaranteeing bad debt removes the risk of holding it on your balance sheet. The fear of certain failure or insolvency must not be numbed by an FDIC guarantee when a firm considers holding riskier assets.

Perhaps the best way to "regulate" the financial industry is to simply let markets fester out poorly-run institutions. Institutions that run soundly, profitably, and responsibly would attract the most private capital and those that are wildly leveraged against bad debt or without enough capital would simply fail - making markets a safer place to invest.

Just my .02

Anonymous said...

Wow. Money is "just" the medium of exchange... That notion was blown out the water by Sraffa and others in the 1930s when von Hayek raised it...

As for "my checking account itself is not money", well, I would suggest reading up on how banks create credit and make loans...

As for guaranteeing bad debts, well, the state did not guarantee banks before the 1930s and there were plenty of bank runs, bank failures, crises and economic cycles....

Why? Well, because banks are capitalists operating in the market to make money. To suggest that "markets" work singularly fails to understand the basics of capitalism and banking as a capitalist industry...

An Anarchist FAQ

Anonymous said...

We have FDIC insurance today and still have "bank failures, crises and economic cycles."

Right - money is not "just" the medium of exchange. It also comes about spontaneously and arbitrarily by government decree.

We have a fractional reserve banking system that allows banks to create loans. The FED has the monopoly power to print unlimited dollars if a bank is in trouble. So, it is the power to inflate that stands behind the fractional reserve system. In this sense my checking account is money; the bank will lend out 10x the balance because it is backed by the FED.

Banks are capitalists operating in tandem with the federal government in the market to make money. What could go wrong?