“Money is a project; its an institution, an ongoing governance effort. It’s not a simple or spontaneous convention. It is not a commodity. It is none of those things. It is not a simple social custom. It is an orchestrated affair.”
--Christine Desan
Earlier this month, in one of the many manifestations of the evolving occupy movement, several lecturers presented at the Occupy Harvard gathering. The audio is available on the Internet or through iTunes it is well worth the 36 minutes and 48 seconds. (The revolution may never be broadcast, but it is certainly going to be a good listen while jogging on your favorite MP3 device.)
One of those lecturers, Christine Desan, presents a dense, thought provoking explanation of the financial crisis of 2008. She starts with a critique that is dear to me that collectively we are woefully uninformed about what led up to 2008 and what exactly happened. She wasn’t long with figures but she sees the financial crisis as a massive bank run. From there, with her unique historical perspective—an expertise on the nature of money, she declared that money in its present form allows easy formation of credit, debt, and leverage. Markets, financial markets in particular are new markets, are allowed for by this latest form of money and are susceptible to volatility. How this can occur is explained in the bulk of presentation that followed.
After the introduction, Desan moves to a description of money in the medieval era—she described how money functioned in medieval Great Britain; specifically before Charles the second and the introduction of bonds and other innovations. At that time money was gold and silver coinage, which was kept strong by act and intent of the ruler. The English kings maintained the content of coins pure and kept purchasing power of each piece high. One more significantly different practice involving medieval money was that rulers asked for a fee to use these coins. All this had the effect of keeping the amount of coins scarce and liquidity inadequate for an economy to grow let alone boom.
Consequently, for many transactions, such as a day’s bread or wages, the era had its unofficial (informal) markets in credit. This set up credit networks and the medieval history is full of court cases trying to rectify these many fragile and complicated credit accounts. Desan points out in a separate lecture-- the draft is available in pdf format bellow, “The 13th century laborer who made one or two pennies per day could not use them for everyday exchanges; they were too valuable to buy bread by the loaf or ale by the cup, each of which might be worth a fraction of a penny. Rather, he would use credit, run an account, or make his own food and drink from grain he bought in bulk.”
Charles the second strapped for cash to fund, well . . . everything, changed the nature of money in England by extending the minting of coins to those who could pay him for the privilege; he reversed the tradition. This brought in silver from all over the realm but also decreased the scarcity of coins and increased liquidity. The second innovation, the initiation of bonds, a form of paper money, did even more to increase liquidity. [Niall Ferguson in "The Ascent of Money" credits the Italian city-states of innovating government bonds.] The speaker then mentions money in its present form allows easy formation of credit, debt, and leverage. How new markets, financial markets in particular, spring forth from this new money is the weakest part of the talk. And, it is no small point that Desan moves over too quickly is that with increased liquidity comes the option of borrowing in the short term for long-term loans.
Despite these limitations, she makes clear a key insight to explain how volatility arises spontaneously: With every market, participants drive the valuation of assets and drive the creation of money by first creating 'near money' in the form of credit relationships. My take away is that it is better to say booms and busts always existed in the inaccurate and complicated borrowing and lending schemes of the informal credit market. The new money captured and amplified these volatile market events.
Desan then makes the transition to the financial crisis of 2008 with the modern credit being the many forms of lending and borrowing by banks and bank-like entities—she calls these ‘IOUs’ and ‘near-money;’ we know them as derivatives and mortgage backed securities. So, in the early 2000s the shadow banking system created near-money in the extreme, lending for the asset-backed security market. I have to mention the speaker missed an opportunity to include in that category the 50 to 60 trillion dollars in credit default swaps that were created as insurance for the mortgage and other asset backed securities.
This brings up a question I have heard from time to time since 2008-2009: Where did all that money go? A question that motivated my first interest in the financial crisis was that question flipped on its head: Where did all that money, 60 to 70 Trillion dollars in assets, come from in the early 2000s? The answer is that participants themselves created the scale of these IOUs. Events of this latest boom and bust therefore lend credence to a provocative concept which Australian economist Steve Keen first introduced to me, which he called "endogenous money creation." This is a mechanism at odds with the conventional idea that government creates the money supply. Yes, this is the same notion advocated by the Austrian school of economics; money is created every time a bank leds and another borrows.
It is the same group that brings us advocacy of gold and silver exchanges as a response to unrestrained money creation. I acknowledge there is a lot of passion and hope that gold can serve as a key mechanism to restrain errant money creation, but after this lecture I am even more skeptical of the power precious metals to discipline market transactions. I see that even at an earlier time when it powerfully limited credit and excluded formal market participation, gold never restrained informal credit transactions.
A piece on the Planet Money podcast on NPR this summer summarizes my points better than I can. The showcase was about individuals who established here in the White Mountains of New Hampshire a camp and community devoted to promoting gold in exchanges rather than other money. It is an interesting experiment and another piece of audio well worth listening to. I was struck though how inefficient gold is as a currency and how easily credit is extended despite gold as the preferred exchange. Although there were individuals available to weigh and 'mint' gold and others who attempted to cut shavings for use in small exchanges, elsewhere in the market credit and informal valuation arose quickly and naturally as illustrated by a nine-year old offering a beer with each purchase.
http://www.yale.edu/...
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http://en.wikipedia.org/...
http://mises.org/...
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http://krugman.blogs.nytimes.com/...
*As I have read and written before, only a tortured exaggeration of the facts would blame government housing policy, the mortgage giants, or even interest rate fluctuations as the only or the most powerful force in this boom. The promise of extraordinary profits, inscrutable complexity, over optimism about debt burdens, and just plain greed drove market participants.
One more tidbit that helps explain the overoptimistic hopes for profit in the subprime market is mentioned in the following audio from NPR. Hard lending, lending to nontraditional borrowers, inspired the nobel prize winning microfinance as well as subprime lending. Hard lending always had high returns. Even the celebrated microfinance has its problems. Take this quote from a recent NPR report
"Last year, Bangladesh's government capped microlending interest rates at 27 percent. Prime Minister Sheikh Hasina has accused the Grameen Bank of sucking blood from poor borrowers."
http://www.npr.org/...
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