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The notgeld issue

There are two ways the banking universe can pan out as far as I can see.

One is the Gorton way, where everything is eventually collateralised and anyone with credibility or collateral can issue collateral-type obligations that turn into collateral money.

In this world banks are as good as the collateral they hold, and they can flourish if they can persuade the markets to accept new types of collateral when old forms run out.

The other is the Admati view which is about going towards a Fisher style full reserve banking plan. Banks can take all the risk they want provided they can persuade “depositors” to fully fund them in these ventures and to bear all the risk.

I like Admati’s view but also see some benefits to Gorton’s — which basically represents a truly liberalised money market.

The problem with Admati’s view is that we are basically reducing banks to venture capitalists. That’s fine. But if depositors are going to bear all the risk, it makes sense their upside exposure should not be capped to a specific return.

A much better system would be something of a sukuk system where the investors returns are linked to his effective ownership of the asset and thus its cash flow.

In Admati’s world the government regains control over money supply however, but in a way that can still stimulate new investments.

With Gorton’s world the problem is the ongoing fragmentation and explosion of shadow banking.

Everyone effectively becomes some type of lender, funding some form of collateral at the end of a chain.

The problem here is a) how good is the collateral really and b) what stops the collateral being relent into unwise investments creating too much money velocity?

If the collateral transpires to be unsound what stops the whole thing from suddenly becoming massively deflationary as well?

This is free markets banking with no checks or balances.

In fact the whole thing reminds me of the film Inception. A bank within a bank within a bank and so on.

The layering is everywhere. After all even PayPal is a shadow bank to some degree — though really it’s more akin to a zero yielding money market fund.

If anyone can issue units which guarantee some sort of return linked to some underlying collateral which may or may not be in their possession due to rehypothecation, u realise how quickly the money supply can be obscured from central source. We have layers upon layers of parallel money and currencies which are somehow loosely linked in value to the underlying currency of the realm.

But eventually the dream ends and we have to revisit economic reality.

And that’s fine providing the parallel units have encouraged the government to dish out enough additional currency (via interest to lenders) to cover all the interest liabilities of the private money market.

In short sovereign money — the ultimate liability of the system, and the dream upon all other dreams are based on — has to keep expanding to account for all the private promises of return.

Given that money is endogenous that shouldn’t really be a problem — providing output doesn’t fail.

But if there is a concentrated funding gap somewhere along the chain and the government refuses to materialise the money that the private banking world had materialised on its behalf… We have a problem.

(The government is likely to decline this sort of bailout on the basis it believes a funding gap has manifested because there isn’t the output in the economy to support the legacy money creation of the private institution.)

Indeed, in some ways Lehman happened because the government refused to materialise the money that the private banking world had over lent and lost.

It chose instead to punish the foolish investors who had made bad decisions — on the basis that it couldn’t be guaranteed to support bad lending choices and the investments of the already wealthy. And also on the basis that it believed these investors had not funded real growth.

Of course it’s not clear at all that the growth/output was not there. After all, the failure to support those bad investments initiated a major deflationary reaction — it did not keep the system balanced.

The systemic shock that followed was in some ways associated with the capitalist system’s realisation that returns were only possible by means of continued central government/bank money creation.

This was shocking because of a) misjudged inflation fears and b) a great misunderstanding about our real level of available resources and output.

The greatest shock to the capital system actually being the idea that the govt could print money to compensate for poor decisions without it leading to inflationary shocks — precisely because capitalist scarcities had by and large been overcome.

That’s not to say completely uncontrolled money creation should be encouraged. Even in a technologically abundant world there is always a risk money begins to outstrip output.

It’s worth remembering that what caused all the problems in Weimar Germany wasn’t as much the over issuance of money by the state but the over issuance of private parallel currencies by corporates to employees (often as payment proxies). These expanded the money supply in an economy plagued by external debt and scarcity to such an extent that rampant inflation was the only inevitable outcome.

These are not conditions that are easily replicated.

However, initiatives like bitcoin are our surest way to try and replicate them.

The ultimate irony with bitcoin, after all, is that even though it purposefully strives to be deflationary it’s much more notgeld than money.

If and when Bitcoin becomes so valuable and currency-like that deflation really is a problem, the low barrier to entry into the market becomes an issue. There is after all nothing stopping competing currencies from coming into the market when bitcoin supply becomes lacking.

As more currencies compete you just get the Notgeld problem all over again.

In some ways it’s even worse than notgeld because at least the german notes were redeemable for the goods and services of the corporates issuing the units.

There is no such guarantee with virtual currencies based on nothing.

A state-issued digital currency on the other hand (or one redeemable against real resources) is another matter…